How to finance a Canadian tech startup from preseed to series D

Canada has a rich history of innovation, but in the next few decades, powerful technological forces will transform the global economy. Large multinational companies have jumped out to a headstart in the race to succeed, and Canada runs the risk of falling behind. At stake is nothing less than our prosperity and economic well-being. The Financial Post set out explore what is needed for businesses to flourish and grow. You can find all of our coverage here.Financing a technology startup in Canada is like an art form, according to Mark Usher, chairman of the Canadian Venture Capital and Private Equity Association.Entrepreneurs often start out with nothing but an idea and a blank canvas to paint it on. In a company’s earliest stages, they add a base layer of funding by pitching wealthy strangers on the basis of that idea alone, hoping to secure a lifeline.The picture begins to take shape when they have to convince venture capitalists that their business will amount to more than just a mom-and-pop shop, with the future expansion of their company on the line. Canada’s cybersecurity firms keep turning to the U.S. for funding, leaving us without a homegrown leader Innovation Nation: Canadian startups need new angel investors — maybe you How foreign companies use Canada’s universities to steal away huge chunks of intellectual property Innovation Nation: Why has the government put a cap on innovation success? The details are then flushed out and completed when they’re able to obtain a $20-million cheque — something so rare in Canada that management teams generally have to acquaint themselves with U.S.-based private equity funds.They have to do this, of course, while continuing to secure sales and running their business on a day-to-day basis.Usually taking place between the first five to seven years of a company’s lifespan, although it can often stretch well-beyond 10, the funding process occurs in three crucial stages. Failing at any one of them could mean scaling back operations, including any global aspirations. Success can result in the formation of a new powerhouse in the private sector and launch a company toward an IPO. To understand each stage of the financing process for tech companies, the Financial Post spoke with Usher, eSentire Inc. president and chief operating office J. Paul Haynes, and Business Development Bank of Canada senior vice-president Karl Reckziegel.The pre-seed and seed stagesBefore beginning the search for angel investors and venture-capital funds, Reckziegel said entrepreneurs typically begin financing their company by asking friends and family for funds they can use toward developing a working prototype.The goal is to generally raise about $250,000, and some company founders have been known to also mortgage their homes to get there.With a working prototype in hand, a founder will look to begin the seed stage of financing, where Reckziegel suggests they’ll aim to raise $1.5 million in an attempt to develop a customer base.This stage is where angel investors — wealthy individuals, often retired entrepreneurs, looking to back startups — come in. These so-called angels usually only invest between $50,000 and $250,000, Usher said, so companies might end up tracking down up to 15 of them to meet their targets.Some angels are organized in groups and hold monthly pitch meetings. Haynes remembers pitching eSentire to 20 angels sitting in an auditorium.“You’re getting random questions in the end and you don’t know where they’re coming from and the wrong question and answer can turn the other 19 off your deal,” he said. “I probably have some of that scar tissue myself.”The other option at this stage involves targeting a venture-capital firm. In the past two years, venture-capital firms and other institutional investors provided an average of $1.6 million in 216 tech deals during the seed stage,  according to data obtained from CVCA InfoBase.Both angels and venture-capital firms have representatives sit on a board of directors and assist them in running the company going forward.It took six months before Haynes was finally able to raise US$1 million from Toronto-based Intrepid Equity Investments. He said he chose a firm over a group of angels because each decision his company took going forward would only require one signature — that of the lead Intrepid investor — instead of 15.The early funding stageThis stage, where companies are often vying for their first institutional cheque, can be the most crucial.“It’s the real test, because once you’ve got those guys in, you’ve got a lot of momentum and value add and connections that open up your world,” Haynes said.Here, startups are looking for between $5 million to $10 million in Series A and B investment rounds, according to Reckziegel, and they’ll use the money to prove their product will work on a wider scale, launch new products and fill out their management teams.“You’re going to move from the idea to a real business,” Reckziegel said. Individual investors are harder to find at this stage and so most startups will look to venture-capital firms.The process works in the same way that a job application would. Instead of a cover letter, Haynes attached a one-page “teaser” that hinted at what was to come in a 30-page business plan. Should the business plan intrigue a venture capital investor, they’ll begin their exhaustive research.References help because they’ll want to speak with other people who’ve worked with the CEO or founder before. In Haynes’ case, he remembers an investor calling 15 customers he listed in his business plan — and asking to speak to another 15.Most firms tend to have their own areas of expertise and their own investment cycles, so companies have to cater their investment applications with these factors in mind, Haynes said.Data show that institutional investors made 259 deals with Canadian tech companies for an average of $9.4 million over the past two years.The late funding stageThe late funding stage is the easiest, Reckziegel said, because after spending years building a customer base and showing consistent growth, there is much less risk associated with companies looking to raise funds in a Series C or D round.“By the time you’re at Series C, some of those risks have fallen away,” Reckziegel said. “The technology risk is usually proven and market risk is lower because you’ve already proven in your Series A and B that you can get market traction.”Here, companies are finally looking to take the massive step toward becoming a scale-up instead of a startup. They’re attempting to become large global players, Reckziegel said, and will do so by attempting to raise about $25 million.Because companies are now looking for larger investments, private equity funds and larger institutional investors such as pension plan investment boards can play a role.As far as venture-capital firms go, Usher said there are only two in Canada that can provide this kind of capital: OMERS Ventures and Georgian Partners Inc., which in August closed the largest independent venture-capital fund at US$550 million.Multiple U.S. firms, by comparison, annually work with multi-billion-dollar funds.“There aren’t as many growth equity later stage funds in Canada as there are in the U.S., so you find U.S. investors investing in these companies disproportionately for sure,” Usher said. “There’s only so many investors who can write that kind of cheque.”Even when Canadian tech companies expand their search outside Canada, data shows the average late-stage deal they secured over the past two years was $7.8 million, when they were hoping for roughly triple that amount.Raising significant amounts in the late-stage period in Canada is not impossible, but the companies that have managed to do so are an extreme exception to the norm. In the past two years, the top five late-stage deals in Canadian tech ranged from $90 million to $207 million. Of the five, Lightspeed POS Inc. was able to exclusively raise $207 million from Canadian investors.For those that can’t do the same, there’s no issue in taking funds from U.S. investors, Usher said.“Yes they’re investing from the U.S., but the jobs are in Canada, the CEOs are in Canada, that’s a net positive for Canada,” he said. “The alternative is not pretty.”Email: [email protected] | Twitter: