Although it has been around for a while now, some entrepreneurs still don't understand exactly what BDC Venture Capital's convertible note program. This guide is here to aid them.
There are more than 100 startup accelerators in Canada by current estimates. However, only six qualify for BDC Venture Capital's convertible note program, which offers $150,000 convertible notes to select graduates of Canada's top-rated accelerators. Those six are FounderFuel, Communitech Hyperdrive, Extreme Startups, GrowLab, Launch36, and Execution Labs.
IT ALL STARTED IN 2011…
In 2011, BDC Venture Capital created the program, which it describes as a "key element" of its Accelerator Strategy to support promising Canadian startups in their early stages. To date, well over 60 early-stage tech startups across the country have benefitted from the program. And this number stands to grow significantly over the next few years as BDC VC looks to its partners to help build its network of leading Canadian technology accelerators.
"The program provides seed funds to help fill the gap that many startups face between their first financing phase (funding by founders, family and friends) and their first full round of investor financing," explained Dominique Bélanger, BDC Venture Capital's vice president of strategic investments and initiatives, to Techvibes. "Convertible notes are short-term loans designed to be converted into shares later in the company’s life—usually when it raises its first full round of investor financing. BDC VC issues notes of $150,000 each, which—if not converted into equity—are repayable at the end of a two-year term."
ARE YOU "VENTURE-READY"?
According to Bélanger, only "venture-ready" Canadian startups that graduate from a participating accelerator can be selected. And that's where people start to get lost—just what does venture-ready mean?
"A 'venture-ready' startup has developed a solid product with significant early traction," says Bélanger. "Its leaders are capable entrepreneurs eager to build a market-leading company. Other factors considered include the firm’s business model and investor or fundraising traction."
TERMS OF THE NOTES
As for the terms of the notes, Bélanger says his team designed the program to be both entrepreneur friendly and investor acceptable. Michael Mahon, BDC Venture Capital’s director responsible for the program, filled us in on some of the program’s terms.
"The notes are entrepreneur friendly because their interest rate, discount rate (the conversion premium accorded when the loan is converted into equity) and valuation cap (used to calculate the number of shares the note will convert into) are often more favourable than the terms and conditions typically offered to companies at this development stage," notes Mahon. The 'investor acceptable' part is achieved by having terms that "fall within market norms, and do not disadvantage concurrent or future private and institutional investors," he adds.
MORE THAN JUST MONEY
There are other things for startups to consider when being offered a note—it's not just $150,000. For example, BDC VC provides non-financial assistance, such as connecting a company with other investors and helping it access new markets.
Though the convertible note does not guarantee follow-on investment from BDC VC or any of its funds, recipients become part of BDC’s extended network of convertible note alumni which BDC VC actively promotes with its partners such as the C100, the Canadian Technology Accelerator program in the United States, and other startup-enabling organizations BDC works closely with.
As for the actual money portion, startups can use the $150,000 as general working capital, to develop the company’s principal technology, to hire the core team, to develop an intellectual property strategy, for business development or for general corporate development—but they cannot use it to repay debt.
It's important for startups to remember that a convertible note is not free money, warns Mahon. "BDC VC expects to convert a note into shares within two years," he says. "If that doesn’t happen, BDC VC will work with the company to see how the loan (including the nominal interest) can best be repaid."
In the end, BDC VC's objective with its convertible notes program is to balance financial outcomes with positive ecosystem impact. "The goal is not necessarily to obtain the highest returns," Dominique Bélanger affirms, "but to help the most promising Canadian startups survive and grow."
A list of real questions by our readers, answered officially from the BDC VC team.
Q: Does the above imply that those having graduated from a Canadian accelerator that is not one of the "select accelerator" are not eligible for the convertible notes offered by BDC? If that is the case, would it be possible to obtain insight into how the BDC selects the accelerators it partners with?
A: Your interpretation is correct. Our accelerator strategy is a "non-traditional" way of doing seed VC and the partnership with an accelerator is a core element. Right now, the accelerators we work with are Launch36, FounderFuel, Extreme Startups, Communitech Hyperdrive, GrowLab and Execution Labs. They all have an IT flavour, so we are exploring ways to expand our reach to include accelerators in other sectors such as healthcare and cleantech, but for now, those are the only ones.
Our view is that accelerators are intense, structured entrepreneur development programs focusing on company building. Very specifically, from a VC perspective, an accelerator’s goal is to efficiently deploy capital and mentorship to produce successful investments. We beleive there are five key success factors for a good accelerator: the foudners, the mentors, and mentor network; program structure; selection process; and the community/cluster in which the accelerator resides.
We have a number of very specific and rigorous criteria that we look at in assessing whether or not to work with an accelerator, as we are either an investor or strategic funding partner. These criteria include:
1. structure / operations (alignment with the key success factors above);
2. strong, private-sector backing (especially VC involvement);
3. stage / sector / region (we seek a balance across the country);
4. capacity for follow-on investment.
Q: Are there any plans to make these kinds of investments available outside of accelerator streams? Has BDC done one of these convertible structures outside of these accelerators?
A: Right now, BDC’s convertible note program is only done in conjunction with accelerators. As you can tell, it’s a unique way of doing early stage venture investment. It is only by working closely with trusted accelerators that we can do what do in an efficient and scalable manner.
We believe that our accelerators help us to identify and support Canada’s emerging high-potential early-seed companies. Even so, we don’t invest in all of their graduates, only those that we (both BDC and the accelerator) feel are “venture ready." Right now, we have a very select few accelerator partners but we are very carefully looking at how we can expand the program to include new accelerator partners—particularly in sectors other than IT, such as healthcare and cleantech.
We appreciate your feedback on, and enthusiasm for, our convertible note structure. We’ve tried to craft something that we like to call “standard issue, entrepreneur friendly, and investor acceptable” so that it actually facilitates the entrepreneurs in their fundraising from angels and early-stage VCs. Of course, the structure has evolved and iterated over time, and we need to ensure we are consistent with the market, but we have always stayed true to that mantra.
Q: I'm wondering if there are any plans to offer convertible notes to non-accelerator-graduating startups in the future. An accelerator/incubator model just doesn't make sense for me.
A: Right now, our approach is to work with selected accelerator partners to do this. We recognize that good companies can be created outside of accelerators, but most likely there will always be some form of accelerator involved. Why? Because it is not just about the money. With our accelerator strategy, we want to facilitate access to capital but also mentorship and market connections. Accelerators are an efficient way of doing so: they allow companies to accelerate to success, or failure. That being said, the accelerator model is not perfect, and it is not the only solution to early-stage fundraising difficulties.
Q: For the benefit of potential co-investors, what are the specifics of the program, such as capped maximum and discount percent?
A: Given that we have these notes outstanding to quite a few startups, we're not in a position today where we can or should disclose those parameters without potentially disadvantaging the companies in their follow-on funding efforts.
What I can say is that from our experience, the terms and conditions are fair for the entrepreneurs but have also proven to amenable to early-stage investors, especially angels, as overall the companies in our portfolio have leveraged BDC's funding over 2x.