The Start-up Economy

For anyone who needs an endorsement of the potential in Canada’s start-up economy, it doesn't get better than this. George Takach, a senior partner at McCarthy Tétrault LLP – someone who presumably charges many hundreds of dollars an hour for his time – frequents the halls of computer expos and hangs out at incubators, accelerators and hubs that specialize in start-ups, especially in the technology sector.

He and his colleagues talk to engineering students and coach the most promising on the process of taking an idea to market. Giving back? Yes. Trolling for work? Yes, too — and trolling is his word.

It may sound like a business development strategy for a senior associate, Takach says, though it’s anything but.

“While many of them will fail at the early stages, many will succeed and when they do, they tend to do very well,” Takach says. “Look at Shopify up in Ottawa, Desire2Learn in Waterloo, Hootsuite in Vancouver. These are all companies that started as start-ups but they’re meeting real needs in the market and they’re making real revenue.”

So are Kobo Inc. and Constellation Software, two that Takach personally helped nurture from start-ups. And there, in a nutshell, you have it.

From apps that measure our sleep cycles to the 3D printing of food, virtual shopping malls, video tweeting, using your phone to turn on your lights from the other side of the world, some days it seems like every element of our everyday life is being transformed
by digitization.

Fuelled by success stories such as Zynga, Pinterest, Square and Spotify, Hailo, Snapchat, SmartThings and Ouya, a new generation of mostly young and entirely Web-savvy Canadian entrepreneurs is racing to develop the next hot app or must-have gadget. And the Internet has democratized their chances of succeeding.

In the old days (which truthfully were not all that long ago), a tech entrepreneur would have to raise between $500,000 and $1 million just to get a beta stereotype before potential investors. Nowadays it’s closer to $100,000 and they have access to a whole new model of bringing ideas to market.

“You can print a physical prototype of your product using your 3D printer, then go to a web site where you can market it, and people can make a future purchase for when it turns into a product, which gets you investors much earlier,” says Andre Garber, director of the Startup Program at Dentons Canada LLP.

 “There are so many different things facilitating the development of products and services that allow you to get to market faster than you traditionally could that it’s giving people this newfound energy to go out and start up their own business.

“It’s a completely different landscape. There is a real explosion of excitement around this new type of anyone-can-do-it type of technology company.”

Take Pebble, one of the earliest producers of a smartwatch. In 2012, after pitching and being turned down by traditional venture capital sources, Pebble – which was developed by a Canadian engineer who graduated from the University of Waterloo – launched a Kickstarter campaign to raise US$100,000. 

Buyers who pre-bought a Pebble at US$115 would receive a US$150 smartwatch when they became available.

The company met its goal within two hours of going live.

Within six days, with 30 days left in the campaign, Pebble had raised more than US$4.7 million, becoming the most funded project in the history of Kickstarter. By the time the campaign closed, 68,928 people had pledged to buy a Pebble, raising US$10.3 million and confirming the fledgling company had a commercially saleable idea.

“You can definitely validate your product much faster by going out and raising funds for it,” says Garber, who has clients who have used crowdsourcing.

Garber himself is emblematic of the new-economy start-up clients pushing their way through to the top. He is still in his twenties and excited about all the new possibilities. Since formally starting this program in the fall, he says, a few of Dentons’ start-up clients have already been accepted into the new cohort of Y Combinator, a world-class accelerator in Silicon Valley. “We’re really excited about them coming back to Canada. It’s a great time for some of these early stage companies.”

Thanks to securities regulators, it’s possible things are about to get even better.

Funding

For those who don’t work in the so-called collaborative economy, a quick primer: Crowdsourcing and crowdfunding are different beasts. While both involve accepting money from strangers on the Internet, crowdsourcing typically involves either a donation or a pre-purchase. You contribute early, as with Pebble, and you get a discount or special promotion when the product comes to market.

Crowdfunding, on the other hand, allows strangers to invest directly as equity holders through a similar Internet platform. With no exemption to the prospectus requirements, it has been strictly verboten under provincial securities laws.

That is changing. Saskatchewan’s securities regulator has released a proposed equity crowdfunding framework that would allow issuers to raise up to $100,000 twice a year, and limit investors to a total of $1,000 annually for crowdfunded investments. The Ontario Securities Commission is looking at a regime that would allow entrepreneurs to raise up to $1.5 million a year and cap investments at $2,500 each up to $10,000 a year. The U.S. Securities and Exchange Commission is also proposing a crowdfunding rule that would let small businesses raise up to $1 million a year by tapping unaccredited investors.

Gary Solway, managing partner of the Technology, Media & Entertainment Group at Bennett Jones LLP, says the limits reflect concerns over the potential for fraudulent pitches.

“The big worry is that any start-up investments are very high risk, technology investments in particular, so regulators are concerned about small investors losing their money — even if it’s in good faith, as well as about fraud.”

It’s not clear in the wired world whether start-ups would have to limit themselves to a single jurisdiction.

Once the regulators settle on rules, crowdfunding could help trigger a paradigm shift.

What makes crowdfunding so potent is that regular people could have the chance to invest early in the next Shopify, now valued at more than $1 billion; the next Zynga, which has a market capitalization over US$3 billion and could be going public; or the next Spotify, which is valued north of US$4 billion.

Solway says the market in the US, which is slightly ahead, is already coming up with ways of separating out the more promising projects.

“What’s happening in Silicon Valley is that some of the major well-known venture capital firms are looking at setting up funds specifically to do crowdfunding,” says Solway. “So they’ll be angel investors in a start-up – they’ll have done a due diligence – and then they promote that on a crowdfunding site. Suddenly a lot of other people are going to be very interested because they’re totally A-list venture capital firms.”

The effect promises to be the equivalent of mainlining steroids into the veins of the start-up economy.

Consultants and private-equity firms raised as much as US$6 billion in 2013 just through crowdsourcing alone.

There are 84 active Canadian crowdfunding platforms, portals and service providers standing at the ready once securities regulators open the doors, according to the National Crowdfunding Association of Canada.

And there are hundreds if not thousands more in the larger global online community.

Think about it. We are looking at the possible disintermediation of angel investors, venture capital funds and even bankers in early to mid-level rounds of financing. But they will all still need lawyers. Are the law firms ready? You better believe it.

Start-up Clients

Start-ups are an essential part of the business plan at LaBarge Weinstein LLP, says Deborah Weinstein.

“We do hundreds, or even thousands, of start-ups every year,” she says from her Ottawa base. With offices in Waterloo, Vancouver and Toronto, LaBarge Weinstein stays close to major start-up clusters and has a payment policy designed to attract skittish would-be entrepreneurs.

For “qualifying start-ups” (those that have passed the firm’s informal due diligence, Weinstein says), clients are provided with start-up kits where fees are deferred until the new business can pay — which is either when they’ve raised some money through a financing or started to generate some revenue.

The client determines what they’re comfortable paying, and the firm starts billing them at that rate. How do the partners know for sure when revenues start coming in? Weinstein says they don’t. They rely on their clients to be honest. How long will the firm wait for repayment? “Years, if necessary,” she says. “Many never come to fruition and we have to write off those accounts. We just hope the person will call us for their next start-up.”

If the venture is successful and the client either sells the business, closes a major financing or decides to move to another law firm, LaBarge Weinstein only asks them to pay the accrued fees interest free.

“We look at it very simply: Many companies come in to us, some work and some don’t. Some we get to bill and some we don’t. But it’s amazing what happens when you align yourself with a client who has no money, and you take a very small risk — relative to my business, one client is a very small risk but relative to their business it’s a very big thing I’m doing for them. So we end up having clients for life.

“I can think of two clients, for example, who came to me after the tech bubble burst, about 13 years ago. I worked with both of them for over a year before I ever saw a single dollar. One of them is still my client today and paying bills. The other one is BelAir Networks, and it sold to Ericsson for a lot of money.”

Sandra Rubin is a freelance legal affairs writer.