Canadian Venture Capital Activity: An Analysis of Trends and Gaps (1996–2002)

Appendix A: Glossary of Terms

Note: If a definition includes a term in italics, that term is defined elsewhere in the glossary^{Footnote 114}.

Agent: A market intermediary who helps structure a private equity transaction.

Angel investor: An individual with high net worth who is active in venture financing and who invests in shares of private companies using his or her own money, typically at an early stage of the firms' growth. Angel investor is also known as an informal investor.

Average company financing: The total dollar value of capital invested divided by the total number of investee firms in a given period.

Average deal size: The total dollar value of capital invested divided by the total number of deals (or financings or transactions) in a given period.

Buyout capital: A specialized form of private equity, characterized chiefly by risk investment in established firms that are fundamentally changing their operations or strategies. Buyout funds are often called such, even if their mandates are not exclusively buyout related.

Capital available for investment (see liquidity): The total dollar value of capital under management less those resources that have already been invested by a private equity fund. In the case of labour-sponsored venture capital corporations (LSVCCs), reserves required by statutes are not included in liquidity calculations. The investment requirements of LSVCCs vary by region from 60 percent of capital raised to 80 percent of capital raised, so 20 to 40 percent of the capital under management in these funds is excluded from the liquidity calculation.

Capital commitment: Resources flowing from individual, institutional and other external sources to private equity funds.

Capital gains: The proceeds obtained on the sale of assets.

Capital under management: The total dollar value of capital resources, both invested and uninvested, in a private equity fund or the market as a whole. In the case of corporate and government groups, capital under management is generally invested capital plus annual allocation.

Co-investment: A transaction with two or more investors. It is also known as syndication. The average rate of co-investment is the total number of investments made in the total number of deals in a given period.

Company buyback: The redemption of private stock by the management of a portfolio company. This is a common exit mechanism for private equity funds.

Corporate fund: A private equity fund that is a division or subsidiary of a financial or industrial corporation. See also investor types.

Deal: See financings and investments.

Debt financing: A form of financing, other than leasing or factoring and risk capital, that results in a debt on the part of the borrower.

Disbursement: The actual dollar amount flowing from a private equity fund or funds to a company in a given transaction.

Due diligence: The process of assessing the business and financial viability of a potential investment target, as well as the potential terms and conditions of an investment agreement.

Early-stage financing: Capital provided to a young or emerging company to facilitate its growth and development, as illustrated in seed financing and start-up financing. See also stages of development.

Equity: The residual value of a business or investment after all debts and other liabilities are settled.

Equity financing: Any form or financing that contributes to the equity of the business.

Exit mechanism: The strategic means by which a private equity fund liquidates its stake in a business and achieves optimal returns. There are multiple exit mechanisms, including the following.

• Acquisition: A third party acquires all shares of an investee company.
• Company buyback: A venture capital investor sells shares back to the company or management.
• Initial public offering (IPO): A venture investor disposes of its investments through a public offering after escrow requirements have been met or through continuous disposition after the IPO.
• Merger: A venture investor sells shares to the merged company.
• Secondary sales: A venture investor sells shares of the investee company to others.
• Write off: An investment is deemed to have lost its value and is written off.

Expansion financing: Capital provided to a company to facilitate its growth and development objectives. See also stages of development.

Financial institutions: Establishments that handle monetary affairs, including banks, trust companies, investment dealers, insurance companies, leasing companies and institutional investors.

Financings and investments: Transactions involving a private equity fund or funds, related to a given portfolio company. Each financing is made up of one or more investments, depending on the presence of co-investors. Financings are also known as deals. See also size of financings.

First-time financing: See new investment.

Follow-on financing: A supplementary round of financing in an existing portfolio company that builds on its original financing, generally in line with business growth and development. Venture-backed firms are often engaged in multiple follow-on deals.

Fund: A pool of capital established for the purposes of private equity activity. Often a management company will be responsible for several funds that may vary according to mandate or investment period.

Fund manager: See management company.

Fund-of-funds: A professionally managed intermediary vehicle in which individual and institutional investors allocate or pool assets for subsequent commitment to diversified private equity funds.

Fund-raising: The activity through which a private equity fund seeks to raise new capital commitments from external sources of supply.

Gatekeeper: A professional advisor or intermediary operating in the private equity market on behalf of clients, such as institutional investors.

General partner: The manager of a partnership's daily business affairs, who is responsible for the partnership's debt.

Government fund: A government-owned, private equity fund, usually organized through a federal or provincial agency or Crown corporation. See also investor types.

Growth: Funds provided for the major growth expansion of a company whose sales volume is increasing and which is breaking even or profitable. These funds are utilized for further expansion, marketing, and working capital or development of an improved product.

Holding period: The length of time an investor holds all or part of his or her interest in a portfolio company.

Informal investor: See angel investor.

Initial public offering (IPO): The sale or distribution of the privately held stock of a portfolio company on public markets for the first time. This is a common exit mechanism for private equity funds, especially VC funds.

Institutional investor: Pension funds, insurance companies, endowments, charitable foundations, mutual funds and other non-bank financial institutions that are often key suppliers to private equity funds. In Canada, certain large institutional investors also have in-house programs for direct market activity (see investor types).

Internal rate of return (IRR): The discount rate equating the present value of cash outflows with the present value of cash inflows.

Investee company: A firm that has secured an equity or quasi-equity investment from one or more VC investors. A company could attract more than one round of financing in a given year. It is also known as a portfolio company.

Investment: See financings and investments.

Investor types: The key players in the private equity industry, based on particular fund structures and sources of capital supply. In the United States, private equity is dominated by private independent funds, while Canadian activity is diversified across several major groups.

• Corporate funds: Subsidiaries of financial or industrial corporations.
• Foreign investors: Non-resident private equity funds or corporations active in Canada.
• Government-owned funds: Agencies or Crown corporations owned by the government, such as the Business Development Bank of Canada.
• Institutional investors: Funds managed inside certain large institutions.
• Labour-sponsored venture capital corporations (LSVCCs): Funds established with the benefit of government tax credits to individuals. See LSVCCs below.
• Other investors: Investors with an interest in specific private equity deals but without a permanent market presence.
• Private independent funds: Funds structured on limited partnerships and related vehicles.

Knowledge-based industries (KBIs): Since there is no consensus of a definition of KBIs, Industry Canada has proposed a two-tiered categorization of industries. Tier one includes a narrow band of science and technology-based firms, comprising knowledge producers. Tier two includes a broad band of "high technology" firms that, based on measures of research and development and knowledge worker inputs, could be considered businesses of innovators and high-knowledge users.

Labour-sponsored venture capital corporation (LSVCC): A professionally managed, private equity fund that raises capital on a retail basis from individual Canadians, with the assistance of federal and provincial government tax credits. LSVCCs operate according to certain legislative specifications. See also investor types.

Late-stage financing: See stages of development.

Limited partner: A structure in which the investor trades off limited liability for managerial control. The limited partner is only responsible for the amount of his or her investment, while the general partner retains full liability for the partnership.

Limited partnership (LP): A legal fund structure designed to raise capital from external sources, in which one or more of the partners has limited liability. The primary relationship in this structure is the general partner (the fund manager) and the limited partner (the capital source). The limited partnership legal structure was created to provide liability protection to "partners" who were seeking investment opportunities, but who did not want to participate in the actual management of the firm. While these limited partners are very much like corporation shareholders, the difference is that at least one partner must have unlimited liability.

Liquidity: The degree of difficulty an investor has in exchanging an asset for money deflated by the price level. The less difficulty an investor has in converting an asset to currency, the more liquid the asset.

Love money: Equity investments made by family and friends of a company's owner.

Management buyout financing: Capital provided to facilitate the takeover of all or part of a business entity by a team of managers.

Management company: The professional manager of a private equity fund or funds.

Merger: The strategic combination of one business entity with another, often with the assistance of private equity.

Mezzanine financing: A specialized form of private equity, characterized chiefly by the use of subordinated debt, or preferred stock with an equity kicker, to invest largely in the same realm of companies and deals as buyout funds.

New investment: The original round of financing in a company. Venture-backed firms typically receive further follow-on financing as they grow and develop in portfolios. New investment is also known as a first-time transaction.

Other investor: See investor types.

Partnership: A non-incorporated business venture of two or more individuals or companies. Profits and losses flow directly and equally to the partners.

Patient capital: This includes certain types of subordinated debt (sometimes called quasi-equity) and forms of risk capital, such as equity investments and retained earnings of owners, investments by family and friends (love money), private equity investments by knowledgeable outsiders (angel investors), private equity investments by institutions and organizations (venture capital), and public equity investments (through stock markets).

Portfolio company: A business entity that has secured at least one round of financing from one or more private equity funds. See also investee company.

Preferred investment range: A private equity fund's preferred scope for making investments. This varies by market segment, with many venture funds preferring ranges below $10 million and many buyout and mezzanine funds preferring ranges between $10 million and $50 million or higher. See also size of financings.

Private equity: The generic term for the private market reflecting all forms of equity or quasi-equity investment (including informal investments). In a mature private equity market, there are generally three distinct market segments: buyout capital, mezzanine capital and venture capital.

Private independent fund: A professionally managed private equity fund that raises capital from external sources of supply, such as institutional investors. Most private independent funds use limited partnerships and related vehicles. See also investor types.

Qualified limited partnership (QLP): The 2001 budget eliminated the 30-percent ownership limitation for QLPs, so a limited partnership may be a QLP even though a limited partner, either alone or as part of a non-arm's-length group, has more than a 30-percent ownership interest in the partnership. However, for the purpose of the foreign property rules, any limited partner or group that holds more than a 30-percent interest in a QLP will be treated as owning a proportionate interest of each property owned by the QLP, including any foreign property. An ownership interest of 30 percent or less in a QLP will remain exempt from treatment as foreign property.

Quasi-equity financing: A type of financing that involves a mix of debt and equity. The equity allows investors to achieve a high rate of return upon the success of the company, while the debt component entails premium prices contributing to the return of the investor.

Restructuring/turnaround financing: Capital provided to an established firm, usually in a traditional sector, that is undergoing financial distress or a major reorganization, but that is perceived as having long-term commercial viability.

Retained earnings: The amount of earnings retained and reinvested in a business rather than distributed to shareholders as dividends.

Return: See internal rate of return.

Risk capital: Informal equity investments (love money and money from angel investors), venture capital and money from public equity markets.

Risk capital financing: Totally unsecured preferred equities normally having a set maturity date and a dividend return attached to them. In contrast, common equities have no fixed maturity date or dividend return but can receive dividends at the discretion of the company.

Secondary Purchase: Share purchases of private and public companies from other investors.

Sectors: Areas in which one might invest. They include the following.

• Information technology: Communications and networking, electronics and computer hardware, Internet, other IT services, semiconductors and software.
• Life sciences: Bio-pharmaceuticals, health care, medical devices and equipment; and medical/biotech software and information services.
• Other information technology: Electrical related, media and entertainment, other technologies, and specialty chemicals and advanced materials.
• Traditional: Consumer and business services, consumer products, manufacturing, miscellaneous and retailers.

Seed financing: Capital provided to facilitate commercialization of new product concepts, often from laboratories, research centres or entrepreneurs. If successful, seed financing may result in a start-up. See also stages of development.

Size of financings: Financial scope of transactions. See also preferred investment range. In the VC realm, there are four categories of deal size.

• Very small deals: Less than $500 000.
• Small deals: Less than $1 million.
• Mid-sized deals: Between $1 million and $5 million.
• Large deals: Greater than $5 million.

Small and medium-sized enterprises (SMEs): Firms with fewer than 500 employees and less than $50 million in annual revenues.

Small Business Investment Company (SBIC): Established in 1958 and licensed and regulated by the Small Business Administration (SBA) in the U.S., SBICs are privately owned and managed investment firms that use their own capital, plus funds borrowed at favourable rates with an SBA guarantee, to make VC investments in small businesses in start-up and growth situations. SBICs are profit-motivated businesses. They provide equity capital, long-term loans, debt-equity investments and management assistance to qualifying small businesses.

Specialized fund: A private equity fund strategy that focusses on specific investment targets (such as sectors and stages of development).

Stages of development: Critical points on the growth continuum for firms assisted by VC and other types of private equity. Typically, a venture-backed company receives cumulative rounds of financing to facilitate its progression from one stage of development to the next.

• Early Stages of Development:
  • Seed stage: A developing business entity that has not yet established commercial operations and needs financing for research and product development.
  • Start-up stage: A business in the earliest phase of established operations needing capital for product development, initial marketing and other goals.
  • Other early stage: A firm that has begun initial marketing and related development and needs financing to achieve full commercial production and sales.

• Late Stages of Development:
  • Expansion stage: An established or near-established company that needs capital to expand its production capacity, marketing and sales.
  • Acquisition/buyout stage: An established or near-established firm that needs financing to acquire all or a portion of another business entity for growth purposes, such as an acquisition for expansion financing.
  • Turnaround: An established or near-established company that needs capital to address a temporary situation of financial or operational transition.

• Other Stages of Development: Includes secondary purchase, or the sale of portfolio assets among investors, and working capital.

Start-up financing: Capital provided to facilitate the first-time establishment of a legal company structure around a marketable product concept. See also stages of development.

Subordinated debt: A financial instrument with qualities of both debt and equity, often used in transactions as an alternative, or complement, to pure equity. This is a non-conventional financing instrument whereby the lender accepts a reduced rate of interest in exchange for equity participation. See also mezzanine financing.

Syndication: See co-investment.

Turnaround financing: See restructuring/turnaround financing and stages of development.

Valuation policy: The method or guidelines a private equity fund uses to determine the value of its portfolio assets.

Venture capital (VC): A specialized form of private equity, characterized chiefly by high risk investment in new or young companies following a growth path (see stages of development) in technology and other value-added sectors. The capital invested usually comes from companies privately held by VC firms, through the underwriting of newly issued stock, convertible bonds or both.

Venture capital firm: A financial corporation established by individuals, institutions or governments to undertake and manage VC investments in high risk businesses.

Venture capital fund: An investment fund established by a venture capital firm, usually in the form of a limited partnership, to attract funds from individual and institutional investors for the purposes of undertaking venture capital investments.

Venture capitalist: A person investing in a company or companies that have an element of risk but that offer potentially above-average returns.

^{Footnote 114} Sources: Macdonald & Associates Limited; Industry Canada.