Who says bigger is better?

Fusion Capital specializes in financing small private tech firms--and bringing them down to earth.

Any technology entrepreneur still dreaming of the high-profile, big-money IPO–or an investor hoping to hitch a ride on a tech-stock rocket–ought to take a look at our Investor 500 package. The Canadian tech universe is fairly small, and it's not filled with many red giants; nor are many new stars discovered each year. That isn't to say there aren't a lot of high-quality tech businesses in Canada. But they're mostly smaller software firms that have scant hope of ever trading publicly. Five years after the boom went bust, misconceptions about the prospects for Canadian technology companies remain. One of the biggest is that an IPO is the best way to go.

Fusion Capital Partners Inc., a Toronto-based private equity investment banking boutique for high-tech firms, sees a lot of entrepreneurs with stars in their eyes. Founded by Mike Middleton and Peter van der Velden in 2001, Fusion finances deals between small private tech firms and venture capitalists; it's known for working very closely in long-term relationships with its clients, mostly enterprise software and wireless companies. One speciality is bringing entrepreneurs down to earth. “For some reason, everyone seems to [think] they've got to have a $100-million company in three years, or five years,” says van der Velden. “That's just crap. There aren't many $100-million technology companies.”

The Fusion guys are realistic about what it means to be a Canadian tech company. To reach that magical $100-million mark, it takes more time, and a lot more investment capital, than most companies have–and in most cases, an IPO is probably out of the question. In 2004, $260 million was raised by tech companies on the venture exchange. By comparison, venture capitalists pumped seven times that amount, or $1.8 billion, into Canadian enterprises–US$688 million of which came from U.S. VCs. According to U.S. statistics., a VC-backed company is 10 times more likely to be acquired or merge than it is to go public. “We look at our clients and the space we play in,” says Middleton, “and we really do believe that 98% of these companies will get a successful exit by selling their company. That will be the liquidity event for them.”

These days, a company is probably not a legitimate IPO candidate unless it's already a good size, has strong growth, and targets a growing North American or global market–think 20-20 Technologies Inc. of Laval, Que. (TSX: TWT), which went public in December. The market just isn't right for others. Mutual funds are consolidating and institutional investors are growing, so that makes it difficult for them to buy shares in a company with a small market float, while brokerages won't provide coverage and the stock will basically trade by appointment. At the same time, a public company opens itself up to competitors, customers and even its employees, and has to give up valuable cash flow from Scientific Research and Experimental Development tax credits. There's a lot more to be lost going public than gained.

The Fusion guys think that the best hope for most tech companies lies in building a solid business with $25 million to $50 million in sales, and to get acquired at a high valuation. And there have been plenty of those in Canada. The trick, they say, is to build tactical value by dominating a niche: a specific market, customer base, or geographic region. But while going public is rarely the best plan, it does help if you structure your company as if it were public, with an independent board, an audit committee, a reputable auditor and a sophisticated lawyer. Make it all as transparent as possible. If not, a lot of public U.S. companies will shy away. “They've got so many Sarbanes-Oxley issues now,” says van der Velden, “they don't want to buy someone who's going to blow them up.”

If this sounds bleak for the Canadian tech scene, it's not. Fusion is a big believer in those it works with. “We're just not convinced that most of our clients are going to become $100-million businesses,” says van der Velden. “They're just going to be really great niche companies that are going to have really great value for some acquirer down the road.”

That's not a bad thing for entrepreneurs, the economy or investors. But it's something to consider when you're searching for a new tech company worth investing in: the very best might never have gone public.