Financing tech growth

Short-term divergence towards pharmaceuticals and more manufacturing mandates are two trends corporate lawyers identify as COVID-19 reshapes prospects for the tech sector

In this age of pandemic, what type of technology or tech company will thrive and which will struggle? We are living in uncertain times, and the strength of the past may not be that of the future. Lexpert asked several lawyers working in M&A and in the tech sector about the lay of the land.

Our panelists are: Robert Carelli, a partner at Stikeman Elliott LLP in Montreal; André Perey, a partner (Emerging and High Growth Companies) at Osler Hoskin & Harcourt LLP in Toronto; and Deborah Weinstein, a partner at LaBarge Weinstein LLP in Ottawa.

How are tech companies funding growth now?
Deborah Weinstein:
Ignoring the [recent COVID-19 events], what you have is a robust venture community in the U.S. and a decent venture community in Canada. A number of large players — Real Ventures, OMERS and the like — are doing quite a bit of investments. The Business Development Bank of Canada has a venture arm, and you have a fairly sophisticated tier of venture capital that is a conglomerate of angels. There are hundreds of narrow niches within the tech industry itself.

There’s a decent venture capital system in Canada, but it’s much more robust in the U.S. [where], in the past decade, strategic investors such as ABC Google or large-capital companies [are] making strategic investments into rising technology companies.

Sometimes, that strategic money may come from a potential competitor that eats the smaller company for breakfast. Sometimes, you have a strategic investor who wants to also put in place a working relationship [such as] licensing or collaboration agreements. What the company taking the money has to be very careful of is not to set themselves up in a collaboration or commercial agreement [that] puts that big investor in the driver’s seat on an M&A.

A lot of people after the recession started to move to private equity. A lot of private equity has large pools or money and seeks to take on competition and be a world player in a specified niche. We’ve seen that take hold on the M&A side.

André Perey: We’ve had an incredible amount of activity in doing equity financing: venture and debt financing. The debt piece has really emerged in the last couple of years as an additional way that companies are managing their growth. Every Canadian bank is very actively involved in the tech space, where they weren’t before. It used to be a few companies; now, many are trying to lend into this.

By far the largest amount of financing for growth of tech companies has been done by classical venture equity financing. [In the deals on which Osler worked], we went from about $900 million all the way to $3.7 billion over a two-year period [2018-2019], which says these companies are raising money at higher valuations.

Robert Carelli: Pre-COVID-19, tech companies had lots of choice between private capital and public markets. In the public markets, there was a consistently strong demand for quality issuers. We saw that with Lightspeed [a point-of-sale and e-commerce software provider based in Montreal] on its IPO that closed Q1 2019 and was significantly over-subscribed; there was a big, big demand for the stock. There are not a lot of issuers, so when the quality issuers do come, there’s lots of demand. I think both [private and public] avenues are very strong.

Post-COVID, from the private side, there may be some interesting valuations and opportunities out there, [and] some private capital might be deployable at lower valuations than pre-COVID. Once things stabilize, what we saw pre-COVID is going to continue [and] that quality technology company will continue to attract both private and public equity capital.

There were always private equity or private equity/institutional shareholders that were very technology focused. I think what’s changing [is] that you’re seeing other more conventional, other private equity firms taking an interest in technology, and so the effect is that there’s an abundance of capital that’s interested in technology. And so that’s been very, very good, especially for Canada, because Canada has a very strong basin of founders who have started out and grown fabulous technology companies that attracted capital from around the world.

Are you seeing tech IPOs waning?
Absolutely. In Canada, companies can go public in two ways: i) IPOs or ii) smaller tech companies will find shell companies that are already publicly listed and will merge their business into the shell. Then that private company becomes a public company. It’s a less expensive and less rigorous way to go public.

Carelli: I expect that, post-COVID, technology companies may become a hot sector, in big demand. We’re all working remotely now and will need more and more technology. People will be more focused on health and working remotely. It is surprising that we didn’t see more tech IPOs in the last year, but there weren’t many IPOs to begin with [and] private equity had built up a lot of capital and was ready to deploy it.

The big question that [company] founders look at in going public or staying private is what kind of valuations can they get on the public market? Post-COVID, that may be a lot stronger [as] technology will become in increasing demand.

Perey: We have had, for the last several years, a very healthy ecosystem for different kinds of funding: debt and equity in the tech space. It’s been a sustained, quiet period for tech IPOs, and the main reason for that is the availability of other private capital. And they must have a significant story to tell to the capital markets to be able to go public.

At the moment, between going public vs. continuing to raise private money, you have the obvious costs of going public in the first place and the continuing, ongoing costs of being a public company. There’s a financial and human cost requiring specific personnel and changes in approach to PR, legal disclosure and governance. Those are real costs and more onerous than for the private company.

What will the novel coronavirus mean to the tech market, and where will it go?
In this market, you look at the volatility of public markets as well, and I think a lot of technology company founders would be seriously asking themselves whether they would want to have to deal with that enhanced level of volatility in the value of their companies going through this kind of crisis. I think one would assume that, when you’re private, and you’ve got sophisticated, long-term institutional investors, they are going to have more perspective on short-term fluctuations or crises, and really look at the kind of long-term value of the company that that they’ve invested in. So, I think this whole crisis is going to further the likelihood that we’ll see fewer and fewer technology companies go public in Canada, at least in the near term.

Weinstein: It’s early days, but as of now, we’re already seeing 10 or 15 per cent of deals either dead or stalled. But 85 per cent are still going on. I think the worst is yet to come, uncertainty as to when things will change. Real blows will come in the next quarter as their customers stop buying things.

On the venture capital side, venture capitalists are telling companies they’ve invested in that their budgets have to be stress-tested based on revenue or on cash flow. Cash is king during recession, and cash flow is King Kong. There are so many tech companies that don’t make money, meaning produce a positive cash flow. When you start to see companies fail, it will be due to one thing that makes companies fail: They run out of cash.

We’re also already hearing about layoffs in the tech industry. The tech companies that will tend to survive are those that have moved to a model of revenue known as SaaS: Software as a Service. Those will fare better, especially as most technology has moved to those services. Instead of salespeople having to sell software by licence, they’re now charging a monthly fee. If it is a significant technology to the operation of one’s business . . . we’ll keep paying those monthly fees. So, the coronavirus won’t hit some software companies as much as others; the SaaS companies will be better off.

The bright side is that, coming out of this, I think M&A will really pick up because you will have companies that don’t have cash flow, so there are opportunities for large tech companies to acquire very significant technologies at significantly less than they were worth six months ago. There is an insatiable need for technology or technology advancements.

You could also see a short-term divergence toward the pharmaceutical area. I think we’re going to see more technologies sold at home because I think a lot of manufacturing will now be mandated — especially in critical areas such as pharmaceutical and health — to be done in North America.

I do think at the end of this, if we can get through this, the other side of it will be more robust for companies generally.

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