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Razor SulemanPeter Power/The Globe and Mail

Razor Suleman strides into his office, exuberant and mustachioed. Back from lunch, the 34-year-old entrepreneur is pumped for the big task of the day: to persuade a pair of potential investors that his Toronto company, I Love Rewards, is a safe place to park several million dollars during the worst financing market in memory.

ILR is in the so-called web-based rewards and recognition business. When companies such as Rogers Communications and Marriott reward their employees with prizes or points toward purchases, ILR manages the plans online and sources the products. Its client roster has tripled from a year ago, but incoming cheques still aren't keeping up with expenses, and ILR needs to shore up its cash reserves for what's bound to be a nightmarish 2009.

Assured that everyone has been offered refreshments, Suleman leads his guests on a tour of the firm's 15,000-square-foot loft in the new-media hub of Liberty Village. The space dwarfs ILR's seven-person staff, but Suleman hastens to note that the lease costs no more than what he had been paying for a much smaller space. He shows off the To The Point meeting spot (site of brisk, standing, all-staff updates—"a nice burst of culture every day," he says), the business development area (with the likes of Microsoft and KPMG on the new-client board), the EatIn Centre (chuckles all around), and a wall adorned with four framed pages of his handwritten original master plan. (He does a new version every year: "I'm good at the what, not so much the how," he allows.) At each stage of the tour, Suleman neatly, but unmistakably, impresses key messages on the money men: We're dot-com-funky but not dot-com-extravagant; we're up on the HR game; our clients are in the big leagues; I know my limitations.

Mark Usher and Jason Nardari from Wellington Financial, a Bay Street venture investment firm, take it all in with friendly interest. They genuinely want to be persuaded—as Mark McQueen, Wellington's founder and CEO, puts it, "We're in the business of getting to yes"—but they have seen too many pretty pitches and fetching sales projections to lose sight of two fundamental issues: Can the business fly in this crazy economy? And, if we put money in, how do we get it out?

Which is why, back in the boardroom, as Suleman runs through slides boasting a young-entrepreneur-of-the-year award and arrows surging upward across charts, Usher breaks in to inquire whether ILR is, at heart, a software developer or a service provider. "What's the special sauce?" he asks. Suleman says that ILR wears both hats, but then wavers, stumbles and looks to his CFO, who jumps in with a bit of jargon about being an "SAS [software-as-a-service]play with product margin." Usher doesn't press, but makes a note.

Before Wellington makes a decision, however, the questions will become more pointed and possibly more awkward, because these days, professional investors have no room for error—and not just on account of the downturn. After years of disappointing returns, Canadian venture firms are struggling to raise money for their funds and, in turn, are putting less of it to work than at any time since the mid-1990s. The number of businesses that got VC funding in 2008 was roughly half of what it was five years ago. Meanwhile, U.S. firms, which in recent years grew to represent 41 per cent of all VC dollars plowed into Canadian companies, are in rapid retreat, dropping from $836 million invested in 2007 to around $370-million last year.

A key problem is that most of the methods that investors previously used to exit deals are now blocked. With the public-offerings market essentially frozen—there was just one venture-backed IPO in Canada in 2008—capital is mainly flowing to mergers and acquisitions, but even M&As plunged by one-third last year. One entrepreneur who did the rounds of VC firms in the fall says the message was the same everywhere: no money, no IPOs, no exits. Those companies that are still doling out cash are naturally getting more picky, and every pitch is being evaluated on the worst-case scenario: Is the business sustainable at much smaller revenues? Can the owners control their costs and maintain their gross margins? Are ILR's incentive programs, for instance, critical to boosting employee morale during layoffs, or would they be one of the first things to go when clients cinch their belts?

The best small businesses are still getting money, but the bar is higher: In 2007, Wellington did 16 deals; last year, it did eight, making it one of the more active funders. In January, Wellington raised a fresh $24-million for its fund, bringing its total to $150-million, although many VC firms are seeing their investors pull back.

Out on the sidewalk after the ILR meeting, Usher offers a quick take on their pitch: Suleman has passion. He has capital and an enthusiastic endorsement from JLA Ventures' John Albright, a top Canadian venture capitalist. He also has some blue-chip customers "who don't buy that stuff without due diligence," says Usher. But the business is "a bit servicey—there's nothing necessarily proprietary," such as a unique technology or other intellectual property that could keep rivals at bay. And Usher is concerned about how fast ILR is burning through cash: "If we put money in, will that allow them to break even? We don't want them to use it all to fund losses." Still, he says that in a four-star universe, this pitch gets 3.5, and Wellington will take a hard look. "It'll come down to a debate between their lack of assets and the fact that they have the confidence of an investor we think very highly of," says Usher, his hands already dancing on his BlackBerry as he prepares to dash off to the next meeting. "Without that smart investor, it would be a two or a 2.5."

Last June, Wellington boss Mark McQueen listened to a presentation by Brian Beaulieu, an American economist whose forecasts have a 97 per cent accuracy record. Beaulieu's outlook was grim. "He said, 'None of you have probably managed a business through this kind of recession,'" McQueen recalls. "That was a great bucket of cold water. I've been looking at every transaction in that light ever since."

A tall, trim man of 43, with ramrod posture and a vaguely aristocratic air, McQueen was an assistant to Brian Mulroney during his final two years in office. But he opted for investment banking as being both more family-friendly and lucrative. In 2000, while serving as head of technology investment banking at Orion Securities (now Macquarie Research), he and Ken Rotman, managing director of merchant bank Clairvest, set up a venture debt fund. "It was a hobby," says McQueen, aimed at testing a hybrid banking/VC model for funding young technology companies. The first fund raised just $7-million. For the second, they wanted to get to $40-million. In 2004, when they reached $83-million, McQueen quit Orion and, taking three of his colleagues with him, moved down six floors and into the south tower of the Brookfield Place complex to open Wellington Financial.

Wellington's money isn't for every entrepreneur. For starters, the firm is one of only about 10 venture debt firms in North America: Instead of taking a piece of a young company, it provides loans. On the financing spectrum, venture lenders fall somewhere between the banks and the VCs. Their loans are higher-interest but have less-onerous criteria than the banks'. "We have a higher comfort with the value of intellectual property," explains McQueen, "and we're more likely to fund businesses that aren't profitable." But Wellington needs to see real revenues and customers, and assets that can serve as security. In other words, it's not a seed investor—like an angel or venture capitalist—that helps start-ups get off the ground in return for a hefty one-third or more of the company. Most of Wellington's transactions are in the $5-million range, and involve outfits with one or more professional investors already on board.

"A VC is expensive and a bank is restrictive," sums up Usher. "Our money is more artful in terms of assessing the risk: What's the business worth? Who are the customers? What could it be sold for? And would it be enough to pay us back?" A 15-year commercial-banking veteran of Royal Bank, Usher joined Wellington in 2006 as McQueen's No. 2. While he has a teddy-bear-look about him, he can growl. His brusque "I don't buy it" is something of a trademark phrase.

But Usher isn't the hardest sell at Wellington. That would be Kul Mani, a former IBM and Nortel software engineer-turned-technology investment banker who came over from Orion in 2005. In a company where no deal is made without consensus agreement among the eight-person staff, he is the Dr. No whom others most often struggle to persuade. So who, then, is the keener, the one likeliest to push for a deal? "That…would probably be…me," says McQueen reluctantly. He doesn't like the characterization, but adds, "It's easy to say no, but hard to say yes. Sometimes I need to encourage the team to say yes."

The criteria for what gets the nod haven't changed, but they've been tightened to match the unforgiving economic climate. "The question is," says McQueen, "will [the client]meet their downside case, and if not, what will happen? And if yes, is the deal still feasible? It's harder now to issue term sheets [deal proposals]than it's been in five years." In fact, he says, the biggest mistake that entrepreneurs make when they are seeking funding is to push unrealistic growth projections. "That's the primary crime." He pauses. "And the penalty is death," for both the candidate's funding prospects and the business. We are used to taking what someone says and cutting it in half," says McQueen, but these days, it's a game he's less willing to play.

So it's not surprising that the Wellington team was impressed with Raj Singh. In November, the president and CEO of Wavesat, a Montreal-based developer of 4G microchips for mobile devices, pitched McQueen, Mani and Nardari for a $15-million loan to carry his company until it raised its next round of venture capital. Right off the bat, Wavesat had some big knocks against it, starting with what it does for a living. "'Chip' is a swear word in the venture capital market," quips McQueen.

Why? "Because it takes $25-million to develop one," explains Mani. "It's like rolling the dice. It either works and it's a $100-million business or, if people don't want to buy it, it's back to zero." But Singh, a seasoned tech executive, knows that in the current climate, investors want to see solid contracts, a diverse range of clients and a plan to reach profitability quickly. So instead of first outlining the products, the market and the competitive landscape, as is customary, he went straight to the "revenue ramp": The company expected to gross $12-million in 2008, $30-million in 2009, and be in the black within the year. Then he laid out Wavesat's worst-case plan, explaining how he would slash costs and limit the burn rate to survive a two-year recession.

The Wellington crew liked Singh's pragmatism, his lack of spin. "This guy has his head on straight," says McQueen. After due diligence confirmed Singh's projections were reasonable, Wellington issued a term sheet. (By mid-February, however, the power balance had shifted: Singh had raised $11.7-million from a trio of Canadian investment firms, so for the time being, he doesn't need Wellington.)

A chipmaker like Wavesat has an asset that Wellington likes: intellectual property, something the company has developed that has inherent value. This is why Wellington's investments gravitate toward software. These days, says McQueen, the firm looks for products that are have-to-haves, not want-to-haves that could get trimmed from clients' shrinking budgets. "What the company is doing has to matter to somebody," he says. But the calculus isn't that simple. "If you have $4-million in revenues, that may be sufficient to validate that clients care," McQueen continues. "But if you've got $30-million of revenue and gross margins are 5 per cent, that tells me clients are buying lots of the software but don't want to pay much. We shy away from those businesses. Software, by nature, has high margins because, if it works, it's valuable." A similar decision tree applies to non-software companies: Each "yes" moves the prospect further up the branch, and at any point, a "no" can end the journey.

Still, Wellington has done deals that defied the methodical approach. One of its most lucrative transactions was a loan to a flight-training start-up launched by three former fighter pilots. Top Aces had no revenue and no assets—Wellington's loan fundamentals—but did have a signed contract with the federal government. Wellington lent it money to buy jets. Two years later, Discovery Air bought the company for $75-million. Wellington had warrants (options in the company that could be turned into shares) and scored a 50 per cent internal rate of return. That's the "artful" part Usher was referring to—sometimes a deal just makes sense. "You never know until you have a meeting what might come of it," says McQueen.

Which is why the firm rarely turns down a consultation request, especially if a friend or colleague has made the introduction. That's how Chris Oswald, a Toronto chiropractor to the rich, found himself in the Wellington boardroom, toting ergonomic cushions and other products from his nascent business, Ergo-Health. Without a PowerPoint deck or any notes, he proceeded to explain how he had managed to sell $2-million worth of goods, mainly through Shoppers Drug Mart, while running a busy practice. McQueen knew in the first minute that Wellington would pass on Ergo-Health. The reason: lack of critical mass. "It's not yet at a size where we could finance it," says McQueen. "What he needs is a super-angel, someone with both know-how and money."

Cultivating prospects to feed the deal pipeline is a critical part of Wellington's business, so for McQueen, the hour he spent with Oswald was neither a waste of time nor an act of charity. "Everything is incremental to our knowledge base," he says. "If we hope to be in business in 20 years, lots of deals will grow and mature for us." And if Oswald manages to ramp up his business, there may yet be a future there for Wellington.

Partly because Wellington invests in more later-stage companies—businesses whose founders may have handed over the reins to professional managers—it is less concerned than other VCs about feeling connected to the entrepreneur. "There are two realities: Management is really important to the business. Management changes," says McQueen. "If you invest in management, you're hostage to management. You have to imagine how the business would work without the founders."

For Usher, the big test is whether young companies have seasoned advisers on board. "Entrepreneurs are hard-headed people," he muses over lunch at a nearby deli. "That's their strength, but it's also their weakness. In times like these, the pitches are a sanity check. I want the entrepreneur to be passionate, to have guts, to think they can conquer the world, but if they can't answer questions about the realities of the marketplace, then there's a credibility gap. If I hear one more time, 'Yeah, but that's not going to happen to my business…'" He waves a pickle for emphasis. "When we invest money, it's like a marriage. You want people who take your input and value it, and if they don't, it says something about how they're going to behave if things don't go well."

I Love Rewards' Suleman passed that test: His CFO has 20 years of experience in large and small companies, and his board includes two seasoned Canadian VCs. After the first meeting, Usher was keen enough to proceed to the next step. "We'll look at their conversion rate of prospects to clients to figure out if they can meet their revenue projections," he says. Usher knows this wouldn't be an easy deal for Wellington, but "you don't love all of your investments equally," he says.

It's a Monday morning in late November and, as usual, the Wellington staff has gathered in the glass-walled boardroom for an update on its two dozen portfolio companies and various prospects. There are more than 60 names to run through, and the talk is thick with internal shorthand. Mani reports on the board meeting at Biorem, an Ontario clean-tech firm (Wellington typically takes a non-voting seat on a company's board). "They hadn't done any scrubbing of the budget," he says. "What the board expects now is a more conservative budget than they'd given us, with much higher EBITDA numbers, because they want to make sure they're cash-flow-positive."

Usher raises his head from his BlackBerry to run through the problems at a software company. Wellington has sunk several million dollars into this business, which is rapidly burning through cash. The company may soon be looking for a buyer. If it does, the first three months will be the best chance to make a sale, says McQueen—as with a house listing, interest dries up the longer the property sits on the market.

Wellington looks at about 500 Canadian companies a year, and whether or not it invests, the information goes into an extensive database that forms the firm's collective memory and offers a benchmark for what the prospect had planned to accomplish. First up, an outfit that's become something of an internal joke. At the initial meeting, the founders told Wellington their software was "better than Google." "They really said this," says McQueen, chuckling. "'Google has good software. We have really good software.'" Pass.

Someone brings up a Vancouver-based tech company. "You know, I'm so tired of hearing that name," snaps McQueen. "We kept talking to them for six months, then the CEO quit one day. We should have as little interest in the company as he does." Scratch. Rod Bryden's latest venture, Plasco Energy Group, is on the list. It's raised $100-million in capital. McQueen is fond of Bryden, the former owner of the Ottawa Senators. "He hasn't always made the right choices in businesses, but he's a real entrepreneur, with a good heart."

When I Love Rewards comes up, Usher laughs. "We keep e-mailing, and then he cancels and is gone for two weeks. I don't know what's going on." But Usher doesn't seem put out. As he later explains, only about a third of deals happen right away. "The best people approach you before they're desperate, so you can build a relationship," he says. Indeed, in December, ILR asks for more time to supply the material Wellington had requested, so the firm can focus on its hectic pre-Christmas period. Usher's not concerned. "They're working hard to close sales opportunities, and like most small companies, they don't have the bandwidth to support the efforts required to explore a financing. We'll keep talking."

"Fifteen seconds!"

The moderator's bellow fills I Love Rewards' cavernous office. It's time for the daily, precisely nine-minute To The Point meeting. The young, casually dressed staff slouches in a semi-circle around an overhead projector. Every bit of good news—ILR's Workopolis.com site has gone live; an early angel investor in the company is here for a visit—is greeted by applause. A young man recites a list of companies, each followed by a number: the day's orders. The $40,000 total gets a round of claps.

That's a good haul for a single day. In fact, since Suleman first met with Wellington in late November, the company's been on a roll. Before Christmas, he says, "it's like Santa's workshop around here" as clients' employees redeem their incentive points in time for the holidays. On this mid-January day, Suleman reports that ILR has beaten its fourth-quarter projections by 22 per cent and is cash-flow-positive.

After the meeting, Suleman—the mustache he had grown on behalf of a charity is now gone—reclines on a leather couch in the firm's lounge. He's still interested in a deal with Wellington, he says. ILR has the opportunity to raise more venture capital this year based on its numbers from 2008, "but we're not desperate for round B to materialize." Moreover, he adds, "with companies like Wellington, the terms aren't super attractive. It's relatively expensive money [compared to a bank] And warrants make the financial expectations less clear. We'll see what kind of deal we can get."

If ILR is getting a "no" from Wellington, the answer will come fast. Getting to "yes" takes longer. Usually, one of Wellington's junior investment managers begins by researching the prospect's financial model, sales pipeline, competitors and management's background. Sometimes, Wellington conducts an independent analysis on the company's market. If the deal passes initial scrutiny, Wellington presents a term sheet outlining the structure and conditions of the proposed loan. Out of the 500 companies Wellington looked at last year, only 25 got to the term-sheet stage. If the prospect signs off, then the real due diligence begins. Wellington's staff pores over the company's financials line by line, looking at contracts and corporate documents, and speaking with customers. If the deal is still viable, a 30-page outline with a recommendation goes to Wellington's investment committee—that is, McQueen and Ken Rotman, who is Wellington's chairman and biggest investor. "At the end," says McQueen, "we're not pregnant, but we're definitely in love." Wellington can go from term sheet to done deal within 30 days.

Wellington enters every discussion motivated to make a deal happen. While some venture firms have now hunkered down for a slow period, either shuttering offices or scaling back operations, McQueen has no such intention. "You have to keep taking meetings. We're giving every new opportunity to do a deal a college try." He's concerned that in this climate, good ideas are going unfunded, but stresses, "The bad ideas should never be funded." It's tempting these days to blame a failed funding pitch on the economy, but he says that's too easy. Lots of business ventures are simply unrealistic, lousy bets.

And for entrepreneurs, it's a process that never really ends—a continuing, periodic test of your business's credibility, no matter how big you get. Suleman recalls hearing a speech by Steve Wynn, the Las Vegas impresario, who talked about raising money for a new casino—and ending up a quarter-billion dollars short. "I'm thinking, 'Take a few zeros off and that's my situation,'" says Suleman. "And I'm realizing that even if I'm the most successful in my business, like he is, I'll still be worrying about raising money. If I keep doing this, I'll never have enough."

Mark McQueen and the Wellington crew are counting on it.


PITCH PERFECT: How to get to "yes"

Find the right doors to knock on

Figure out what type of investment fund you should approach: seed or mid-stage, equity or debt. Most investment firms provide detailed funding criteria on their websites. Don't bother with venture lenders until you have some scale and predictable cash flow.

Get an introduction

Cold calls rarely work, and mass e-mails never do. Get an introduction from an adviser or board member connected to the funding community. Better still, have them come with you to the first meeting. "The fact that a friend or colleague has already vetted someone from an ethical, reputational standpoint is wonderful," says McQueen. "We always take those meetings."

Understand funding cycles

If you had a hydrogen story in 2002, you could raise $100 million in a week, says McQueen. Last year, it was mobile applications. "Not every year does every horse suit the course," he says. "As part of business planning, entrepreneurs need to know that the funding window opens and closes."

Be brief, but don't be too brief

"I'm not a believer in the elevator pitch—that's for the idiots on Dragons' Den," says McQueen. Rather, he says that, in no more than 25 minutes and with a presentation deck of about 15 slides, you should clearly communicate what you've got, who's on your team, who your customers are, what your financials are, and why you can succeed.

Show you can ramp up revenue fast

In this climate, investors don't have patience for long development cycles, says Kevin Talbot, managing director of RBC Venture Partners and co-managing partner of the BlackBerry Managing Partners Fund. "Companies have got to get to their proof point faster and become self-sustaining faster."

Get your numbers right

Delivering an out-of-date presentation is a classic mistake. "[The entrepreneur]will say, 'This budget assumed I'd be funded in June,' and it's now November," says McQueen. "Giving a stale financial set is not a confidence-builder, to say the least. This isn't like speed-dating where there'll be 10 more girls in the next 10 minutes. That first meeting tells us whether we should spend more time."

Value your company realistically

Gone are the days of $100-million valuations on pre-revenue start-ups, says Talbot. "We're in a period of hyperreality, and all investors are focusing on the price." Inflating your company's worth will shatter your credibility.

Be ready with answers

How much money have you spent? What was your revenue forecast two years ago for this year? Why did you not hit it? What's your bad debt? Last year you were calling it revenue, so what's happened? And what do you mean you're on your third VP of sales? Are you bad at hiring, or are there lots of bugs in your software and the clients are mad, causing sales guys to flee? Anticipate that the investor will ask the one question you'd rather not answer.

Have committed management

Don't go looking for money with a temp filling in as CEO or CFO. "We want to know who we're doing business with, rather than finding out as the result of the search," says McQueen.

Don't underestimate your needs

Raise more money than you think you'll require to get to the next phase, says Talbot. At each funding stage, you want to achieve your stated targets before you go looking for the next round. "Some entrepreneurs underestimate their capital needs because they don't want to give away too much of the company." In today's funding climate, that's particularly dangerous, "because no one knows how long the turmoil will last."

Show you can adapt to the market

How will you grow in a tough environment? Explaining how you can reduce your cost structure will give investors comfort that you can adapt quickly. But expect that everything always takes longer to execute, and costs more. Be ready to say no. "Entrepreneurs are sometimes too quick to take the first cheque and don't perform due diligence on the investors," says Talbot. "Be willing to walk out of the room and say, 'You don't get it.'"

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