Espresso Capital

This is a guest blog post by Alma CG

Finance Minister Jim Flaherty delivered the government’s 2013 federal budget on March 21, 2013. Due to uncertain global economic times, relatively modest measures, mainly through existing programs, were announced to support business innovation. The measures work towards a balanced budget by 2015 and reaffirms government’s stance on Prime Minister Harper’s catch phrase “Science powers commerce”.

Economic Action Plan 2013 builds on the foundation that was laid in the 2012 budget to respond to recommendations contained in the Expert Panel Report on Research and Development, Innovation Canada: A Call to Action (also known as the Jenkins Report), which was released in October 2011. In this context, it comes as no surprise that the 2013 budget aims to better balance funding for innovation between direct grants and universal tax incentives, and to improve the administration of the scientific research and experimental development (SR&ED) tax incentive program.

SR&ED Program is here to stay

Despite the changes announced in the 2012 Federal Budget, the Government makes enormous investments in tax incentives to support innovation through the SR&ED Program. As a reminder, the following changes are effective as of January 1st 2013:

• Reduction of the prescribed proxy amount from 65% to 60% for 2013
• Limit qualifying expenditures to arm’s length contractors to 80% of the contract payment for expenditures incurred after December 31, 2012

The SR&ED Program remains the most generous program available for Canadian-controlled private corporations (CCPCs), especially when combined with the provincial R&D tax incentives. In 2011, the SR&ED Program provided more than $3.6 billion in tax assistance to 24,000 companies.

Key measures in the Economic Action Plan 2013 include:

1. Initiatives to ensure the integrity of the SR&ED program

• $15 million over two years to focus more resources on reviews of SR&ED claims for companies where the risk of non-compliance is perceived to be high and the eligibility for the SR&ED claim unlikely
• $5 million over two years to the Canada Revenue Agency to conduct more direct outreach activities with first-time SR&ED program claimants (ex. On-line eligibility self-assessment tool (ESAT))

2. Fostering Business Innovation

• $121 million over two years to the National Research Council (NRC) to help the growth of innovative businesses in Canada;
• $37 million per year through granting councils, in support of research partnerships with industry to create and deploy new technologies, products and services into the marketplace
• $325 million over eight years to Sustainable Development Technology Canada (SDTC)in support of the development of new clean technologies, and drive innovation;
• $80 million over three years to support IRAP’s Digital Technology Adoption Pilot Program (DTAPP, established in 2011) to help small and medium-sized firms adopt digital technology and build digital skills.

In addition to the above-mentioned initiatives, specific key sectors of the economy, such as genomics research, aerospace, and automotive industry have been targeted for additional funding.

While the above mentioned investment allocation amounts appear modest, we look forward to further details, promised to be released in the coming months.

The Alma CG Perspective
A business that is innovative by nature will continue to invest in ideas and solutions to advance its products beyond the R&D, in order to provide longevity to its products, processes and business. These innovations require significant investments. The budget discusses several measures that help Canadian companies foster innovation, some in the form of government grants, and others based on tax incentives.

The SR&ED Program remains the largest single tax incentive source of federal government support for industrial R&D. This is meant to encourage Canadian businesses of all sizes and in all sectors to conduct research and development (R&D) in Canada that will lead to new, improved, or technologically advanced products or processes. In recent years, the review process has shifted towards increasing the demands on SR&ED specific evidence to support the claims. To protect your company’s R&D projects, the preparation of the submissions, and the supporting contemporaneous documentation have become critical in having a predictable and successful claim recovery. In times of scrutiny, it is critical to utilize the services of professionals to help you meet and stand up to the requirements of the program.

The grant programs are aimed at supporting other areas of the economy that will encourage companies to invest in innovation and are geared toward specific economic sectors. This requires a thorough analysis of the qualification requirements and evaluation of your company needs.

Alma CG is one of Canada’s largest independent SR&ED consulting organizations. www.almacg.ca

Guest Blog Post by Bernd Petak, CFO of Mobio Technologies

Espresso Capital Partners (ECP) recently assisted Mobio Technologies Inc. with a
SR&ED secured loan facility to bridge to a then-confidential acquisition transaction with
LX Ventures (TSX Venture: LXV). The facility allowed Mobio to support operations while
finalizing the terms of the acquisition by LXV, and prior to the receipt of a significant
SRED receivable from the Canadian Government.

Mobio develops and markets Mobio INsider, an engagement platform that allows large
social media influencers such as musical stars to engage with their fans in a
monetizable way. Mobio delights fans with unique content from the social media icons
they follow. It provides influencers a means to authentically connect with fans while
effectively monetizing their social media base.

In a then-confidential transaction, LXV entered into a term sheet to acquire the Mobio
INsider product and associated assets from Mobio. With the timing of a significant
SRED refund receipt uncertain, Mobio approached Espresso to provide a bridge loan
secured by the receivable. “Espresso provided us with reduced time pressure as we
prepared for a significant transaction with LXV.” said Bernd Petak, CFO of Mobio. “We
were able to confidently fund operations and keep our eye on the long term
development of our product, while successfully closing with LXV.”

LX Ventures is a publicly traded incubator that launches, integrates, and acquires early
stage high growth technology companies. LXV is a group of entrepreneurs dedicated to
developing the next generation of entrepreneurs by providing funding, resources,
mentorship, and access to our global network. LXV is in the business of building
businesses. For further information about LX Ventures, its technology, collaborations
and partnerships, please visit: www.lxventures.com

Espresso’s non-dilutive financing solutions are easy to arrange, economical compared
with alternatives, and can often be structured to minimize interference with other
common business events. “We discussed our confidential impending transaction with
Espresso from the start, and they proved to be a reliable and helpful business partner”
Petak added.

Espresso Capital Partners (ECP) provides short to medium term financing solutions to
companies in the knowledge-based sector across Canada. ECP provides technology
companies with innovative growth funding solutions, including SRED Loans, Lines of
Credit and SaaS RevenueLoans. Through a combination of real-world experience and a
deep network in the tech sector, Espresso Capital Partners is able to provide
entrepreneurial risk capital at key stages of a company’s growth cycle.

We are happy to announce the first close of our $35M Espresso Fund III focused on tax credit financing for Canadian technology companies. We anticipate the total investment program for Fund III will be in excess of $150M.

Espresso Capital has, in many ways, followed a similar path to our clients. We started Espresso Capital to fund credit-worthy technology companies seeking alternatives to dilution from equity financing. We started our first Fund I with only $2M in capital to test the demand for our venture debt services. We refined and expanded the model and the market has shown a significant demand for our SR&ED loans and Digital Media tax credit financings . Our venture debt financings are non dilutive to shareholders and entrepreneurs. The loans are straight forward, fast to engage and easy to pay off without penalties.

Since we started in 2009, we have:

• Deployed over $40M in loans to over 130 clients in Canada

• Bridged clients to successful 3rd party acquisition

• Bridged clients to successful Series A Venture Capital investments

• Provided working capital to high growth companies looking to avoid or delay taking equity

• Provided Line of Credit insurance to companies to ensure they have a quick source of working capital

• Attracted over 40 Limited Partner investors (VC Partners, Tech Executives, Board members)

• Established a new financing model for technology companies in Canada

• Established a strong network of clients and investors working to build a strong technology industry in Canada.

We look forward to continuing our growth in offering innovative solutions for Canadian technology companies looking for help in “financing the next step”.

Espresso Capital Partners (ECP) recently structured a Standby Credit Facility for the benefit of Montreal-based SCL Elements Inc. (http://www.can2go.com). The facility provided the founders and management team of SCL Elements added flexibility during the negotiations of the sale of the company to Schneider Electric SA. SCL Elements was subsequently acquired by Schneider Electric SA –http://www.pehub.com/183061/vc-backed-scl-elements-acquired-schneider-electric/.

SCL Elements Inc. provides building automation solutions for comfort and energy efficiency in commercial buildings. Marketed under the umbrella of the CAN2GO family of products and solutions, SCL Elements works with systems integrators, resellers and OEM manufacturers around the world to offer wired/wireless building automation solutions that optimize energy consumption while increasing the comfort of building occupants.

The company secured a Series A round of Financing in the fall of 2011 led by the Westly Group, a US-based VC investor and has made significant progress over the last 12 months. “Espresso has been an excellent financing partner” said Simon Leblond, President and CEO of SCL Elements. “Espresso Capital proved to be responsive to our particular needs at a critical point in our company’s stage of growth.”

The Facility provided a ready source of non-dilutive funding, if required, giving SCL Elements more flexibility to fund its working capital needs as it continued to expand its customer base while it achieved a key company milestone. Espresso Capital is pleased to have played a role in helping another great Canadian entrepreneur fund his company’s operations by providing an innovative capital-efficient funding solution.

Espresso Capital Partners (ECP) provides short to medium term financing solutions to companies in the knowledge-based sector across Canada. ECP provides technology companies with innovative growth funding solutions, including SRED Loans, Lines of Credit and SaaS RevenueLoans. Through a combination of real-world experience and a deep network in the tech sector, Espresso Capital Partners is able to provide entrepreneurial risk capital at key stages of a company’s growth cycle.

Fiduciary Duties are potentially compromised and it just has bad optics

I am a manager of a Fund that loans money to technology companies. Separately, as an individual, I am an active independent director on the Board of several technology companies. Periodically, our Fund does not loan to a company as one or more members of their own board of Directors decides to make the loan directly. I had been thinking this is no big deal as someone on the potential client’s Board stepped up and made a loan to the company, often on terms similar to, or even better terms than the arms length commercial loan my Fund was offering.

In thinking about my personal fiduciary duty as a member of a Board, it struck me that there is an inherent potential conflict if my company took a loan from me directly. This might appear self-serving as the Board member is ‘competing’ with my Fund but the issue goes deeper than that. Having a person that is both a Director as well as a debt stakeholder, puts that person in a position of conflict. Directors have a fiduciary duty to make decisions in the ‘best interests of the company and its shareholders’. There is a potential for significant conflict when Directors are debt holders as debt will take priority over equity shareholders in the case of liquidation or near insolvency.

Breach of Fiduciary Duty
In practical terms, there are two ways a fiduciary can breach its duty (:Chan v Zacharia[1]):

1.       Being in a position of a conflict of interest. A person is in a position of conflict if:·         ’A reasonable man looking at the relevant facts…would think that there was a real sensible possibility of conflict’: Boardman v Phipps.[2]·         Conflict may arise between duties owed to different principals: Beach Petroleum NL v Kennedy.[4]

2.       Making an improper gain from his position.·         Making any sort of gain is prohibited, regardless of whether it harmed the principal, whether it was even available to the principal or, whether it actually benefited the principal as well: Keech v Sandford; Parker v McKenna; Boardman v Phipps.[5]

The Canada Business Corporation Act spells this out in more detail http://laws-lois.justice.gc.ca/eng/acts/C-44/page-45.html#docCont

In 2004, the Supreme Court of Canada said: In a unanimous decision, the Supreme Court of Canada held in Peoples v. Wise that directors of Canadian corporations owe a fiduciary duty to the corporation and, in particular, do not owe fiduciary duties to creditors of the corporation.

A board member that has made a direct loan to the company, even with the best of intentions, clearly has the potential of breach as they are making a gain of interest charged on the loan. Even if the loan is at nominal or no interest, the loan security ranks ahead of equity shareholders who the Director has a fiduciary duty to have in their best interest. Of course there may be mitigating circumstances where the company is hitting the wall this Friday and they need an emergency midnight loan to stay afloat. Under these less than ideal circumstances, you could make a good case that commercial options were not available in the short time available and therefore the Director who made the loan, did so in the best interests of the company and shareholders. Hopefully, company management would not put the company and Directors in this awkward position and management should be working with commercial debt providers long before this situation arises.

It is governance best practice that directors will take themselves completely out of the consideration of a particular matter where there may be a perception of conflict or a perception that they may not bring objective judgment to the consideration of the matter. In appropriate circumstances, directors will declare their position and absent themselves not only from the vote, but also the discussion. However, directors should be aware that abstaining from voting, except in certain limited circumstances, may not protect them from liability under the corporate statutes.

The upshot is that Directors put themselves at potentially personal risk by making direct loans to companies where they are on the Board of Directors. More importantly there is certainly a very high risk of the perception of potential conflict. Best practices would indicate management should only consider commercial, arms length, debt offerings for the company and not put their Directors at risk of conflict with their fiduciary duties.