Andrew Hall, director of corporate development, QuestAir Technologies Inc.
Almost two years ago, QuestAir Technologies Inc., a Burnaby-based alternative-energy company, ran into a financing wall. There simply wasn’t a mechanism in the province for the type of financing the company needed.
It initially launched in 1996 to explore fuel-cell technology but changed direction and, in 2004, landed a potentially lucrative contract with ExxonMobile Research and Engineering Co. to develop large purification and recovery systems for oil-refining and petrochemical markets. Exxon provided some partner financing, but QuestAir needed many millions more if it was to build the systems and fulfill the contract. When it looked around B.C. for the money, it came up dry. The traditional financing track for most businesses is to start with their own money and funding from friends and family (this includes maxing out the credit cards and taking a second mortgage). The next step is to solicit the help of angels – people with deep pockets who invest privately in a business at its early stages. You then move to venture capital, larger funds that aim to invest in early-stage – often high-risk – companies. (Typically, the venture capitalists running these funds also sit on the boards of the companies they’re investing in and provide advice and direction.) Next, companies may tap funds from the private-equity investing arms of merchant banks, which usually take a company public. At this point, the company enters what’s known as late-stage financing – it’s operating and pocketing revenues and is ready to move to the public markets with an IPO. The whole system is more suited to a traditional, mid-sized manufacturing economy such as Ontario’s, but B.C.’s economy is different. According to 2005 figures from BC Stats, 98 per cent of B.C. companies are considered small businesses because they have fewer than 50 employees; 81 per cent of all businesses are “micro” businesses with fewer than five employees. Service businesses, most of them knowledge-based or in construction, account for three-quarters of all businesses in the province. The problem with this economic makeup is that these sectors often have to finance themselves through cash flow, instead of traditional expansion-capital mechanisms, because they have little in the way of tangible assets as security. They rarely have factories that can be seized by lenders or investors to offer up as collateral. B.C. has always had an economy that featured a few large resource-based companies, dozens of start-up mining ventures and many little retail and service businesses. This economy had systems in place to finance business growth: the big resource companies listed on the Toronto Stock Exchange (TSX) and the smaller ones listed on the Vancouver Stock Exchange, now the TSX Venture Exchange. Little service businesses borrowed from a bank, usually by putting up the owner’s personal assets as collateral – Jim Pattison’s oft-told story of how he began his car-retailing empire is that he had to put up his life-insurance policy to borrow $40,000 from a bank. But over the past two decades, entirely new economic sectors have blossomed that are harder to finance using the traditional system. For the most part, they involve intangible knowledge products and services, which are less predictable, and therefore riskier, from a financing viewpoint. B.C. companies have been hitting a financing wall after tapping out family and friends, early investors and small lenders. When it comes time to raise that late-stage cash needed to graduate to the public arena, there are few local financing options available. Some knowledge-based companies in B.C. try to snag late-stage financing within the traditional system, but it involves deft manoeuvring, according to Terry McDonald, an investor-relations specialist with the public-relations firm James Hoggan & Associates Inc. Some companies, especially those in the biotech or pharmaceutical sectors where development periods are very long, will often jump right from angel financing to public listings. “When you’re an early-stage biotechnology company, it can take years to develop your product and convince the equity markets that you can do the job,” he says. “So a public listing is often the only way to raise the amount of capital you need to sustain yourself. Also, public listing puts a value on your company.” But there’s a downside to going public, McDonald adds. It can be difficult for senior managers of science-based companies with long development timelines to understand the short-term nature of the public markets, and dealing with investors can take away their focus from their business tasks. “We’re unique in having so many knowledge businesses as part of our economy, and they’re growing rapidly,” notes Jock Finlayson, executive VP of policy with the Business Council of B.C. “Financing hasn’t kept pace with this growth. There’s a trend where the mid-market [financial] supplier is disappearing. Even at a good time for capital – and there’s a lot washing around North America right now – there is still a risk profile.” This trend, he adds, applies more to the tech sector and knowledge businesses (professional or financial services) than industries such as mining, which have easier access to traditional financing. Between 1997 and 2003, QuestAir had already exhausted common financing routes, raising more than $60 million from private investors and venture-capital companies. It had already gone through a series of financing rounds: A (early stage, involving family and friends), B (larger, follow-up financing involving angels or venture capitalists) and C (even larger financing rounds involving traditional financiers such as banks). But when it came time for a round D to raise more than $10 million in expansion capital, QuestAir was stymied. After the tech-induced market crash of 2001, which sent every financier in North America running for cover, there wasn’t much appetite in B.C. for large financings, and there certainly wasn’t one for an alternative-energy company that was still in the development stage. QuestAir’s newly developed clean-air systems practically screamed, “Danger! Danger! High risk!” to stockbrokers and investors still licking their wounds from the crash and wary of anything smacking of technology. At the same time, the conventional route for larger fundraising was narrowing. The Public Company Accounting Reform and Investor Protection Act of 2002 (less formally known as Sarbanes-Oxley, or SOX) imposed stringent compliance, reporting and governance requirements on all companies listed on U.S. stock exchanges. Canadian stock markets followed suit, which substantially increased costs and effectively restricted the IPO route to fewer companies. If it wanted to go public, QuestAir had to be creative. It found AIM, the London Stock Exchange’s Alternative Investments Market. AIM was launched in 1995 to provide flexibility to Europe’s smaller and newer companies, most of which were involved in new knowledge-based businesses such as alternative energy and other technologies. AIM is far more flexible in its regulatory and reporting requirements than most traditional stock exchanges (such as its parent), but was still considered a reputable market – unlike the Over the Counter Bulletin Board, a Wild-West-style North American exchange with a reputation for being populated with dubious companies and stock scams. In Canada, the TSX operates the former Vancouver and Alberta stock exchanges as the TSX Venture Exchange, but it tends to be aimed more at retail investors who like to play the penny stocks, rather than at institutions with big cash hordes. So in December 2004, QuestAir became the first Canadian company to achieve a dual listing on both the AIM and the TSX and raised about $15 million initially on the two exchanges. Last year, it raised another $20 million. Andrew Hall, QuestAir’s director of corporate development and external communications says the company would have avoided the TSX completely if it could have because of the costly reporting required by the exchange. But many of its 75 employees receive shares as part of their pay and preferred something closer to home than the AIM. Even though being listed on the TSX added to the paperwork burden and didn’t offer much attraction to investors at the time, QuestAir undertook the more rigorous requirements to do it, says Hall. [pagebreak] AIM was the obvious choice. “There wasn’t any money in B.C., North America was reticent about financing an IPO in our field and there was more of an appetite in Europe for this sort of thing,” says Hall. “The market there was more receptive to our story. Also, we had some European shareholders and they were closer to the London exchange. But mostly we went there because we had access to capital. AIM has really carved a niche for itself with alternative-technology companies.” QuestAir’s quest for money can be read almost as a template for how some B.C. companies are going about financing expansion today. With the provincial economy booming, most B.C. companies want to embark on the expansion trail, and many of them are using traditional methods to do so. But others, particularly many involved in new knowledge-based industries, have had to become creative to finance growth. For many of B.C.’s businesses, a financing gap has emerged – they can start up and thrive as small businesses, but, when it comes time to expand and grow to mid-size, they’re having difficulty finding money to fuel that growth. The British Columbia Technology Industries Association has tried to address this funding gap with a proposal to the B.C. government to create a large venture-capital fund that can handle larger deals in the tech industry. It suggests that the government create a $150-million fund, to be matched two-to-one by industry sources, with the provision that the government’s share could be bought out within a few years. This would create a fund large enough to take companies into final rounds of venture capital financing, says association president Rob Cruickshank. Without it, companies frustrated by the lack of access to late-stage cash may continue financing expansion as they have been – by selling out to an acquirer or moving out of the province. Lee Davis heads Vancity Capital Corp., which provides growth capital to fast-growing small-to-medium-sized businesses, often involved in non-technology-based services. He observes that while this financing problem affects tech-based businesses the most, it is being felt by knowledge companies as well. As a former investment banker, Davis has seen many types of financing emerge over time and believes that, overall, the financial markets are maturing along with B.C.’s business sector. But they’re not in balance yet, he says, and many companies have had to become creative to fill financing gaps. For example, partner financing is a growing phenomenon, especially among firms that use engineering services such as a micro-hydro project. With this kind of financing, a company that has landed a contract often asks the contractor, or its own partners and suppliers, to partially finance the deal. “These are often for multi-year contracts that really help a company grow, so there’s usually a predictable income. That often makes them willing,” Davis says. Generally, Vancity Capital supplies debt, private-equity and mezzanine financing – investment that is partially debt and partially equity – to a variety of companies. Often, this is done as part of a syndicate, a collegial aspect of financing that is particularly common in B.C. with its small pool of financiers who prefer to spread the risk around. “People here have to trust in each other because there are fewer and fewer public companies,” Davis explains. “We used to have them in the big resource companies and utilities, but many of them have been bought. We need to create a new class of empire builders here.” At the other end of the scale, small businesses not involved in technology – and there are many of them – still use the traditional financing technique of debt. But even this is changing because of the changing nature of the business scene. For example, the rise in real-estate values has driven many businesses to cash in on some of that equity by borrowing on their real estate to expand their operations. At the same time, new players have emerged in the small-business lending market that are more flexible than traditional players. The unique-to-B.C. system of credit unions, for example, has moved into commercial banking in a big way in the past decade and in 2006 put out some $8 billion in business loans. This growth is partially driven by demand and partially by the retrenchment of some big banks to only signing larger lending deals. “The demand has always been there in the small-to-medium-business market, because if they didn’t get financing, they couldn’t grow, but it’s accelerated,” observes Lorenzo Cocco, associate VP of business banking for Vancity. “We’ve doubled our business book in three years. Part of it is because the national banks abandoned some clients, but a lot of it is because we’re here and can really understand a business. It’s more of an investor style that allows us to be more flexible and to step out of the formula. If a company’s really good, we can do some creative things like put a loan together based on collateral, plus cash-flow or licenses.” Between partnerships, debt and local credit unions, there’s a growing array of financing options for young companies. But if you’ve got a great idea for a software program that you’ve been puttering with in your spare time, and you’re ready to expand beyond the family rec room, the Bank of Mom and Dad is still likely your best bet. Click here to read Tony's blog.