Presentation to Canada-United States Law Institute Conference

1. Presentation toCanada-United States Law Institute Conference Session 8 - The Importance of Venture Capital in Promoting Entrepreneurship Saturday, April 14, 2007

2. Agenda • The Players: Venture Capitalists, Entrepreneurs • State of Venture Capital • Canada vs. U.S. • Cross-Border Initiatives/Concerns • Conclusion • Q & A Canada-U.S. Law Institute - April 14, 2007

3. Venture Capitalists • Common “beefs”: • “Why are their term sheets so aggressive?” • Always looking for upper hand. • Blame the lawyers? • May be new trend toward simplicity and trust. • “Why are they such jerks?” • Nature of the business. • Lack of time; spread too thin. • Success breeds overconfidence/arrogance. • Chicken or egg? • Stop recognizing own limitations. • Fail to value the entrepreneur. Lose sight of seed value. Canada-U.S. Law Institute - April 14, 2007

4. Venture Capitalists (Cont’d) • “Do deal terms limit their relationships with investee companies and the entrepreneurs that own and run them?” • Venture capital business highly reliant on personal chemistry between entrepreneur and venture capitalist. • One-on-one relationship despite all the money and the institutional names and reputations. • Most critical aspect of venture capital—and the least scientific and most prone to luck-of-the-draw. • Two moving targets. • With over-reaching deal terms in place, entrepreneurs keep venture capitalist at greatest distance possible. • Entrepreneur feels violated, defensive and at risk. Canada-U.S. Law Institute - April 14, 2007

5. Entrepreneurs • Common “knocks”: • See venture capitalists as the enemy, not an ally. • “Take-it-or-leave-it” negotiating styles of VCs. • “Scary” term sheets. • Cautionary tales seem to be told louder than win-win stories. • Love ‘em or hate ‘em, often nothing in between. • Who do you listen to? • Real trust never established. • Relationship poisoned even before negotiations completed. • Negotiations take too long – blame on both sides. • No real strategic value delivered. • Carefully choosing a VC critical element. Canada-U.S. Law Institute - April 14, 2007

6. Entrepreneurs (Cont’d) • “Penny-wise, pound foolish” on giving up equity. • Leads to bad deals. • Sets up failure down the road. • Can end up gutting the entrepreneur. • Leaving financings until too late. • Reduces chances of successful transaction. • Hurts valuation. • Increases chances of business failure even before getting funding. • Put themselves into take-it-or-leave-it play mode. Canada-U.S. Law Institute - April 14, 2007

7. State of Venture Capital • It’s NOT SO BAD! • Plus, there are investors with a NEW ATTITUDE. Canada-U.S. Law Institute - April 14, 2007

8. State of Venture Capital (Cont’d) • When it works, the value-add is huge: • VCs fill in blind spots for entrepreneurs. • Help them pick the low-hanging fruit. • Focus, focus, focus. • Set, enforce and amend goals over life of investment. • Create the right governance/oversight structures for the business. • Go deep, but not too deep. • Recognizing entrepreneur’s value-add, industry knowledge & operating style. • Industry & customer connections critical. • Can be biggest value-add from VCs. • Industry specialization, deal track record keys. • Talk to investees. Canada-U.S. Law Institute - April 14, 2007

9. State of Venture Capital (Cont’d) • Sense of people equally critical. • Horse-sense and experience reduce big mistakes in building team. • Entrepreneurs face a series of “deals” to negotiate and decisions that VCs can help guide. • Key hires, partnerships, new strategies, new customers, acquisitions, divestitures, follow-on financings, business/plant expansion. • Entrepreneurs often out of their element in negotiating and documenting these deals in conjunction with running their businesses. • VC works at all stages, from start-up to exit. • Not a truism to say that entrepreneurs need to build their businesses with the exit in mind. VCs can be critical here. Canada-U.S. Law Institute - April 14, 2007

10. State of Venture Capital (Cont’d) • Use of syndicates reduces risk to entrepreneurs and adds more value: • More imposing for entrepreneurs to negotiate and institute. • Can be harder to manage. • Tend to force entrepreneurs to take more funding. • Some VCs oppose the idea. But: • No single VC has all the answers or ideas. • Can enhance relationships. Needs to be a “good cop” somewhere. • Good cop can lead the round and be an advocate. • VCs can keep each other in line. Canada-U.S. Law Institute - April 14, 2007

11. Canada vs. U.S. • Significant convergence in recent years, with Canada moving toward U.S. practices generally. • Term sheets, due diligence, deal processes & practices have become very similar. • General trend broader than venture capital. • Borders retain little practical effect in VC industry. • VC’s geographic and industry “pods” tend to ignore borders. • Geographic isolation still an issue outside small number of Canadian markets. • For better cross-border engagement, industry-based funds should syndicate and share opportunities/spread risks. Canada-U.S. Law Institute - April 14, 2007

12. Canada vs. U.S. (Cont’d) • Still some major impediments to U.S. VCs investing in Canada: • Tax treatment of LLCs (protocol to Canada-US Tax Treaty). • Labour-Sponsored Investment Funds (LSIFs) were well-intentioned tax-advantaged “retail” fund structures which ultimately damaged VC industry in Canada, especially early-stage segment. • Gap they left not yet filled, partly in fear caused by government intervention. • Canadian markets still too small for real economies of scale and sufficient “clustering”. • The global VC industry has been characterized by “spikes” or clusters of VC activity.* • Of the 16 “spikes” identified globally, 5 are in the U.S., 6 in the Far East, 3 in Europe, 2 in the Central East—there are none in Canada. *2007 Index of Silicon Valley – Joint Venture: Silicon Valley Network. Canada-U.S. Law Institute - April 14, 2007

13. Cross-Border Initiatives/Concerns • The U.S. remains by far the dominant area Canadian VCs are looking to as they expand their attention beyond Canada’s borders.* • U.S. funds listed the following as their top reasons for not investing in Canada*: • Travel Time & Effort; and • Lack of Deals that Fit Their Profile. • Although encouraging from a legal/structural standpoint, C.D. Howe Institute, a renowned Canadian think-tank recently issued a report** indicating that there are, indeed, significant legal/regulatory roadblocks to institutional equity capital moving into Canada: *Deloitte – 2005 Global Venture Capital Survey. **Financing Canadian Innovation: Why Canada Should End Roadblocks to Foreign Private Equity, Feb. 2007. Canada-U.S. Law Institute - April 14, 2007

14. Cross-Border Initiatives/Concerns (Cont’d) • Their report suggests: • Promising Canadian ventures attract only 1/3 the capital of their U.S. competitors. • Many Canadian companies are sold early in their life cycles, before they achieve market leadership, and at low prices. with the end result being a 10-year, net horizon return of Canadian venture capital firms of only 2.5% versus 20.7% for U.S. venture capital firms. U.S. money demands bigger returns than can be reached on the Canadian market. • They argue that Canadian tax rules block the inflow of hundreds of millions of dollars of foreign (mostly U.S.) capital from institutional investors and private equity firms. Canada-U.S. Law Institute - April 14, 2007

15. Cross-Border Initiatives/Concerns (Cont’d) • Report’s key recommendations: • End the tax-clearance process that foreign private equity investors must follow when selling shares of a private Canadian company. • Extend Canada-US tax treaty relief for capital gains to U.S. limited liability companies. • Permit tax-free rollover of shares of a Canadian company into shares of a foreign company. Canada-U.S. Law Institute - April 14, 2007

16. Cross-Border Initiatives/Concerns (Cont’d) • The following table from their report is telling of a structural issue in the Canadian market: Canada-U.S. Law Institute - April 14, 2007

17. Cross-Border Initiatives/Concerns (Cont’d) • Goodman & Carr recently carried out an extensive poll on the factors influencing private equity market growth, with tax/regulatory issues near the top of the list: Canada-U.S. Law Institute - April 14, 2007

18. Cross-Border Initiatives/Concerns (Cont’d) • Ontario Teachers Pension Plan, a major Canadian pension fund at the leading edge of private equity investment, reported recently that there is “genuine momentum towards developing a standardized LP agreement in North America”. • This was their own initiative adopted by Institutional Limited Partners Association (ILPA) and now driven by Dartmouth University, supported by a committee with LP’s and GP’s and other industry practitioners, including leading law firms. • There are a number of other initiatives which look to facilitate cross-border venture capital—everyone has a role in facilitating needed changes. • Economic development initiatives in Canada should be shared with relevant U.S. VC firms that might affect development of clusters and the furthering of favorable tax laws. • Small steps might be taken to share angel opportunities that offer higher ROI for American dollars. Canada-U.S. Law Institute - April 14, 2007

19. Conclusion • Overall, the relationship between entrepreneurs and VCs is a critical one to our economic health, and despite the challenges, it is always evolving--and working pretty well so far! • According to a recent Global Insight/NVCA study, U.S. venture-backed companies account for 17% of U.S. GDP and 10 million jobs on a total capital investment of only 0.2% of GDP. • Venture-backed companies have consistently outperformed non-ventured counterparts in sales and employment growth across all industries. • And cyclical downturns are less severe in the venture-backed segment. • Success is attributed to factors prevalent under, but not exclusive to, VCs such as: • Avoiding under-financing of growing businesses; • Hands-on Boards of Directors; • Open disclosure policies; and • Access to highly qualified personnel. Canada-U.S. Law Institute - April 14, 2007

20. Q & A