Are you burning too much cash? Path to Profitability from a Venture Capitalist

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ANNOUNCER: Welcome to Viewpoint-- A TD Securities Podcast. Listen in as we draw perspectives from a variety of thought leaders on key themes influencing markets, industries, and the global economy today. We hope you enjoy this episode.

JEREMY WALKER: Welcome to episode 16 of Viewpoint-- A TD Securities Podcast. I'm your host, Jeremy Walker, Deputy Chair and Global Head of Communications, Media, and Technology at TD Securities. I'm joined today by Damien Steel, Managing Partner and Global Head of Ventures at OMERS Ventures. In his role as Managing Partner and Global Head of Ventures, Damien is accountable for investments and fund operations while providing strategic oversight to the business globally. Damien joined OMERS Ventures in 2011, having been with the team since its inception that year. Under his leadership, OMERS Ventures, which is based in Toronto, has expanded to include offices in London and Silicon Valley. Damien has over 15 years of venture investing experience, including prior roles with BridgeScale Partners and EdgeStone Capital Partners. Before joining OMERS Ventures, Damien was an entrepreneur in the health care sector having founded and exited a digital dental laboratory startup. Damien also serves as a board member with current OMERS Ventures portfolio investments, including Hopper, TouchBistro, Klipfolio, and Dear Life. He's also a board observer with Hootsuite and DuckDuckGo. Damien holds a business degree from Wilfrid Laurier University. Damien is an avid golfer and poker player. I've had the pleasure of losing money to Damien in both pursuits. Thank you for being here today, Damien, and by the way, happy birthday.

DAMIEN STEEL: Yeah, thank you. Halfway to 90.

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JEREMY WALKER: Let's get to the discussion. So the first thing I want to ask you about is, looking back, 2019 to 2021 were a very good years for the tech industry. Significant growth, plentiful capital, both private and public, and significantly expanded valuations. 2022 was a completely different story. And everywhere you look, both private and public companies have seen meaningful valuation compression, capital scarcity, and a very significant downsizing. What happened?

DAMIEN STEEL: That's the question of the day these days. So listen, it's been a interesting ride, I think it's a mistake to look at 2019 to current. I think in order to look at what's happened intelligently, we need to look further back. And a lot of people think that after the pain that a lot of people have felt in 2022 and currently this year, they feel like that's a negative. When in fact, if you look back over history, all we've done is revert back to the mean. 2020 and 2021 were incredible years for a million reasons. I like to joke. I say, everyone's a genius in 2021. And so the venture industry, the industry that we plan, it went through some really radical shifts in every single metric you could look at. If you look at dollars deployed, were record highs. Dollars raised were record highs. Valuations of private and public companies were record highs. And so looking back, do I think we got ahead of ourselves? Absolutely. Do I think companies got ahead of themselves? Possibly, although I would say that as an operator for a tech company, when you have the opportunity to access equity and capital at arguably the cheapest it has ever been or will ever be, you'd be silly not to capitalize on it. And so I think what we witnessed is a whole bunch of companies beefing up their balance sheet with capital through various means, which I think is good for the businesses, but along with that came a bunch of other stuff. Overhiring as an example. Today, unfortunately, we open the paper every day and all we read about is tech layoffs. Well, the reality is, most of those tech layoffs are just reverting back to where the company would have been without the euphoria of 2020 and 2021. And so you can go through all of these things, and the net of it all at the end of the day is I think we got ahead of ourselves, as I said, but we're actually at a healthier place right now. And if founders and operators are listening to this, they're probably rolling their eyes saying, yeah, right. But we capitalized, we as the tech industry. Some are paying for getting a little ahead of themselves. But overall, the industry today, despite what you read in the paper, is in a pretty healthy position. And I think well-positioned to withstand what's coming at them over the next couple of years.

JEREMY WALKER: That's a good segue to the next question I wanted to ask, which is obviously related. So looking to 2023 and beyond and assuming we're in reset mode, which it sounds like you think we are, how do you see things improving? And what characteristics will companies need to show to be successful?

DAMIEN STEEL: Unfortunately, I'm probably one of the more bearish individuals you'll meet when thinking about the market we're in and the foreseeable future. When you look back in history, you tend to see that the tech ecosystem specifically, there's a bit of a delayed reaction. And so all I know about-- at OMERS Ventures, we managed today over 60 portfolio companies. And I can tell you through real data that most of the companies didn't see much of a drop off in business metrics in 2022. And that might surprise some people, because for anybody that was investing in the public markets in 2022, it was quite painful. But what we're seeing now is now we're into Q1 and you're just starting to see impacts on the actual business of the slowdown that the market has experienced over the last 12 months. And so why is that? Well, generally we deal with software companies. Generally software companies are dealing in annual contracts. And these things take time to work themselves through the system. So we're only just starting to see churn spike in these software businesses, and that's because annual renewals are coming up, budgets are being reset for 2023 across the board, and I'm telling you, across the board, software spend is being cut. And just like everything else is being cut-- headcounts being cut, travel budgets are being cut, everybody's preparing for what they felt over the last 12 months and what's coming in the future. An interesting but scary stat I saw the other day is we actually-- the tech world today is probably feeling pretty good about itself because we just came off of an incredible January. I think the NASDAQ was up low teens for January that just passed. But interestingly, if you go back to the last big tech burst, which was arguably 2001, let me explain the stats from 2001. So 2000, the NASDAQ dropped something like 35%. I mean, don't quote me on this, I'm not going to be exactly right, but I'm going to be close. January 2001, the NASDAQ actually rebounded 12%. And incredibly, I didn't realize this, but there were four different months in 2001 where the NASDAQ was up over 10%. Guess how the NASDAQ finished that year? It was down over 30%. That story sound familiar to you? And so you think about where we are now. And so what I've been trying to tell the founders that we work with is, listen, you can't be on the wrong side of this. In our world at OMERS Ventures, we deal with companies that are burning cash. Most of our companies save a few are cash-burning businesses because of the stage that we invest in. Now, most of them are also capitalizing on the fact that they raised a bunch of money in 2021 like I referred to before. So the good news is, they're well-positioned. But we're telling them right across the board, you cannot be wrong on this. You'd rather look back in a couple of years from now and think, you know what? We could have spent a little more, as opposed to the opposite. And so as unsexy as it sounds, we're telling our companies, you need to cut burn. You need to manage expenses appropriately despite the fact that you might have more cash on the balance sheet than you've ever had before, and that's a really weird thing for a company to go through. So when I look forward, what we're telling companies, it sounds cliche, but cash is king. You need to control your own destiny. So have to make the cash you have on the books last twice or three times as long. You need to look out past 2024. This is not-- I hope I'm wrong, by the way, but I don't think this is a 2023 phenomenon or 2022 phenomenon. I think we're going to be well into 2024, potentially 2025 until the majority of the market starts to really start growing again. And so we just need to be prepared for it. On the flip side, when you look at what's happened on the venture fund level, the same thing has happened, which is, not only did tech companies raise more money than ever before in the past couple of years, but venture funds did as well. And so that creates a really interesting dynamic when you look forward. And what's also interesting is 2021, and interestingly, 2022, although I think part of this data is a bit of a spillover from 2021, both of those years, venture funds in North America raised on average more than 2x to 3x than they did in previous years on average. And so that capital is all sitting on the sidelines. And so now, the capital is not being deployed right now, and there's a whole-- we could get into a whole discussion on why that is, but it's there. And it's not going away, it's sitting and waiting. It's sitting and waiting for a couple of things. One, GPs, venture funds, like ourselves, although I would say OMERS is in a unique position because for the most part, we manage our own capital and we have a few outside partners, but we don't have a lot of outside partners. But a lot of GPs around the world today are being put under significant pressure by their investors, their LPs to not deploy capital, because their LPs are going through their own challenges. But that capital is still there, and at some point, those restrictions are going to be lifted, and those funds-- VCs are not good at not investing. So those funds will get to work. And then the second dynamic that's happening, and it's happening as we speak, is the gap between perceived valuations from what a founder thinks their business is worth and what a VC is willing to pay, that gap is starting to narrow. Founders, God bless them, but they take a long time to accept that the market valuations have changed. It takes a very specific and special type of individual to start a tech company, and a lot of the characteristics that make them great at what they do also make them not willing to accept that the market has shifted. And so that gap is narrowing. And so again, looking forward great companies are going to get funded. That's never up for debate. Valuations will be much more similar to historical norms. The companies that can show that they're thoughtful around spend, and then they've got a good plan going forward, and that they have a path to profitability. They don't need to be profitable, they don't even need to be profitable next year, but they need to have a story that's believable on how one day they will become profitable. That is all of a sudden just as important as it was historically, ignoring 2020 and 2021.

JEREMY WALKER: Well, you've been in this business a long time. So you've been through the ups and downs at least, once, maybe twice. So when you're talking to the founders of the companies that you've invested in, I'm going to make the assumption that they're generally younger and may not have been through those ups and downs. So I guess-- what role do you play with them? I mean, obviously you can talk about history, but what role do you-- are you a coach? Are you a mentor? Are you a cheerleader? Are you sometimes that dash of cold water?

DAMIEN STEEL: Yeah, yeah, all of the above. And listen, it's not just the founder community that are young and haven't been through this before. Let's be honest. A lot of venture capitalists have not been through this before. And so yes, it's a healthy level of reality. It's not easy. It's not easy because there's times where you can feel like you're always giving bad news, and that's not what I'm trying to do here now or when we sit down with founders, but we're trying to give them the benefit of what we've gone through in the past, what we've experienced in the past. VCs, listen, you've got all types that are VCs. You have operators turn VCs, you have more financial individuals that are turned VCs. But I would argue, all those skills, they become old really quickly. So what is it that we actually provide founders? It's pattern recognition, it's networks, and it's, hey, we've seen this happen before. And not only that, but we have other companies that are going through the same challenges you are. And so when we sit down with founders, it's trying to share stories from the past of just like, hey, here's-- again, no crystal ball, but here's an example of how this can happen and how things can roll out. It's introducing them to other companies that are going through the same problem because I promise you, if you're a tech startup today and you're experiencing any of the challenges that maybe I'm alluding to, there are 1,000 other companies that are going through the exact same thing. And so we try and get them together, and what I tell companies other than what I've said already, what I also tell them is hey, get around other founders. Get in those networks. Surround yourself with people who've been there and done that before. Surround yourself with people who did live through the last one. And surround yourself with people who respect you enough to tell you when you're wrong. And if you do that, you're well-positioned to capitalize on-- here's the flip side and the good news-- is there's going to be some incredible businesses that are created over the next couple of years. I mean, the tech world is changing so fast right now, that that is going to create opportunity. And so if you can be one of those companies, no better time to start a business, and that may seem weird given the backdrop of everything that I've been saying up to now.

JEREMY WALKER: Well, you've tapped into maybe my last question, but why don't we just transition in one more question where you were talking about capital. And notwithstanding the challenging last 18 months as we discussed, it's been great to see more capital available for tech companies in Canada because that's often been a criticism, especially at the seed and growth and more mature stages. OMERS Ventures has certainly played a big role in that. How do you view the health of the Canadian tech ecosystem from a capital perspective?

DAMIEN STEEL: I'll give a quick answer, but then a caveat. I think it's healthier than ever before. And I mean that because the ecosystem has matured. I mean, when I got into venture 15 years ago, we were-- when I was at EdgeStone, we were a $150 million fund. That was considered an enormous fund in Canada. And the second thing is, there weren't many US funds coming up into this country to invest. Today, there is no more border between our countries from an investor perspective. So there is as many, if not more, US investors looking at Canadian companies than Canadian investors. And while to me, that may-- arguably that's competition, to founders of companies, that's incredible. That's great news. Because the knock on Canada used to be, oh, Canadian investors, you're not-- you don't have the appetite for risk that the US investors have. Well, guess what? Canadian investors better shake themselves up, otherwise they're not going to do any deals because the US folks are going to come in here and do all the deals. So from that perspective, the market is healthy. The one caveat I would add is that in my experience, in times of crisis or times of difficulty, investors specifically, they go back to what they know. And so my expectation-- and I've seen it in 2022, and I think the same thing will happen in 2023, is that VCs will narrow their focus in terms of sectors they invest in and geographies they invest in. And it's just human nature. When things get tough, you stay close to home. And so I think for Canada specifically, I expect less US funds in the country for a very short period of time. I think it's a blip and I think-- when I go around-- we have an office in Silicon Valley now. When I talk to US investors, there is no longer a debate that Canada is an incredible place to build a tech company. And so that's the good news, and I think we're going to get back to that really quickly. And so despite all of this-- the negative tone to all of this, I am net positive on the next five to 10 years here. I think this country is set up incredibly well on just a multitude of levels.

JEREMY WALKER: Yeah. I'm glad that you have that perspective, and for what it's worth, I share it for what I see in my role. So good. Lastly-- and by the way, Damien, this has been fantastic, thank you for taking the time to do this with me today. You see all manner of startup in early stage companies. And so for the benefit of any listeners who are already engaged in or thinking about starting up a great technology company, no matter what the focus or industry, what do you view the key elements to success to be?

DAMIEN STEEL: Listen, it sounds cliche, but team, team, team is number one. And here's the good news, by the way, is, bringing it back to our previous conversations, the one negative with 2020 and 2021, it was the hardest period that I can remember for hiring great talent. That has shifted. Great talent is available. And so to young founders, to first-timers, second-timers, to people starting companies, the focus has to be on getting the right team together. I would-- as an investor, I would rather invest in a great team than a great company because I know, based on experience, that the company is going to be forced to change over time, and unless you have the right team, it can't do that. And there's a really-- when I meet with founders, I love telling them this. In all the companies that I've ever been a part of investing in, most, if not all, of the successes-- and when I mean success, I mean the company actually transacts and sell the company or it goes public, most of them are doing something slightly or very different than what they were doing when we first invested. So what does that tell you? Is the business model of the company, it morphs over time, the team hopefully stays the same, the core team. And so focus really hard on the team in the early days. And then just, again, bringing it back to everything we've been talking about now, now is not the time to outspend your competition. Control your own destiny, raise money when needed. Managing that capital in a smart, intelligent way is more important than ever. Control your destiny. And then the last thing for early companies is get proof points. Get proof points early and fake it to get a proof point. Don't-- yeah, right. Don't put your head down and build for five years to then come out the other end and realize nobody wants to pay for what you're building. There's lots of tricks these days to get proof points. Get proof points early, and then I'll repeat what I said earlier, surround yourself with people you trust who can tell you when you're wrong. And I think if you do that, it's a great time to start a business.

JEREMY WALKER: That's a good answer. Damien, thanks very much. And just to finish up, and this is maybe going off the script a little bit, but I wanted to just get your hot take on ChatGPT. You probably wish you invested in it. I wish I had, too. A lot of hype, both positive and negative. The use model seems to be incredible depending on the use, and also potentially negative if you're, for example, in high school and writing a thesis. How big is this and what's your take on where this is going to head?

DAMIEN STEEL: So I'll answer, I'll bring it up another level and say like generative AI in terms of a sector or an influence, I think it has the potential of being as meaningful as the adoption of mobile. And what I mean by that is I can't think-- keep in mind, I'm not a technologist. I joke with my team as if I'm not the least technologically proficient on our team, we have a big problem. So apologies for any techies listening to this if I mess things up. But I can't think of a technology over the last 15 years that has the potential to disrupt and change more businesses and markets than what generative AI could do.

JEREMY WALKER: Right.

DAMIEN STEEL: I mean, not only businesses and markets, but for those of you who have kids that are in high school, news flash, they're all using it. And I'm pretty sure my mom won't listen to this podcast, so I can say this. But I wrote my mom's Christmas card using ChatGPT.

JEREMY WALKER: No kidding?

DAMIEN STEEL: She was in tears when she read it. I still haven't told her that it was an AI that wrote it. So mom, if you're listening to this, I'm very sorry. But that's an example of how it's impacting-- already, it's impacting our daily lives, and you may not even realize it.

JEREMY WALKER: Right.

DAMIEN STEEL: And that, to me, is like early indications that, hey, we need to get our head wrapped around this. We need to be thinking about, how does this impact our current portfolio as a venture investor. As OMERS, we're talking with the board. We're saying, hey, we need to think about, how does this impact all the businesses we manage? And I would argue it has a huge impact. And so I don't have a crystal ball, but there's no amount of work that we won't do right now to get ahead of this, and I think it's exciting.

JEREMY WALKER: Yeah. I do, too. That's smart. Well, that's it. Thank you very, very much. I've really enjoyed this, and I hope our listeners do as well.

DAMIEN STEEL: Yeah, thanks for having me. Anytime.

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