Neal Hill, consulting partner at VC firm VIMAC

NATURAL CONVERGENCE INC.'S $12-million venture capital deal last week continues a healthy run for local high-tech financings and could lift spirits in the city's embattled telecommunications sector.

In the second quarter, the amount of VC money flowing into Ottawa more than tripled from the first quarter to more than $60 million, according to statistics from OCRI.

Since the beginning of the third quarter in July, the pace has quickened.

In July, IceFyre Semiconductor announced a roughly $13-million financing round, Workstream Inc. made a private placement of stock also expected to raise about $13 million, Objectworld Communications Corp. scored $1 million and Mobile Knowledge won $4 million in new financing. Last week, life sciences firm DNA Genotek announced a $1.4 million angel round expected to be enough for the company to achieve profitability.

But the highlight of the summer thus far has been Tropic Networks Inc.'s fourth round of financing announced July 28. At $41 million, it ranks as the largest local VC deal in 18 months.

"I think there's a cautious return to an expansionist mindset," said Neal Hill, consulting partner at VIMAC and a VP at Cognos Inc. "That is growing interest and confidence in making venture investments again."

He attributes that growing confidence to three factors.

First, the public markets have returned to a state of "relative health" in which an initial public offering is once again seen as a viable exit strategy in addition to a merger or acquisition.

Second, a lot of money has built up on the sidelines as VC funds held off on making new investments. "There's some urgency beginning to build to get that money to work," he said.

Finally, he said, venture capitalists have worked through their "portfolio problems" caused by the "orgy of investment" during the height of the tech boom at inflated valuations. Many startups failed or ended up on life support and venture capitalists were forced to devote a lot of time and effort to turn them around.

"I think most VCs can look around now and say: 'OK, I've got my portfolio under control, I've taken my writedowns, I've close companies, I've stopped investing in others and I can go look for new investments again,'" Mr. Hill said.

FINAL PIECE OF PUZZLE

For Natural Convergence, the financing is the final piece of the puzzle that co-founder and COO David Cork expects will drive the three-year-old telecom startup to profitability in the second half of next year.

"We've got quite a number of customers that are successfully into market trials and two of them are moving out of trials and into deployments this fall," Mr. Cork said. "I'm hoping to be able to announce a couple of those customer wins in the next couple of weeks."

The second-round financing included all of the company's earlier investors as well as high-tech billionaire Terry Matthews, who will serve as a strategic investor through his company Wesley Clover.

Boston-based VIMAC Ventures led the round, which also included Jefferson Partners, BDC Venture Capital, Desjardins Venture Capital, Primaxis Technology Ventures, RBQ Inc. and Purple Angel.

The next obvious hurdle for the company will be filling its vacant CEO position. Last February Mr. Cork gave up the CEO's chair in favour of Dan Milliard, formerly CEO of the now defunct Group Telecom. However, Mr. Milliard's contract was not renewed. Mr. Cork is once again running the company, still with the title of COO.

The vacant CEO position will be one of many issues addressed by the company's new board, which will be put together by the end of the month.

Mr. Cork said the latest financing marks Natural Convergence's transition from the startup and product development phase to the revenue and profitability phase.

With that shift in focus, the board is being remade. The company's VC investors, which dominated the old board, will now hold only two of seven seats. Mr. Matthews has the option to nominate two others. The remaining seats will be filled with the right industry players to help the company achieve its growth strategy, Mr. Cork said.

The company's flagship product, Silhouette, is a hosted application that allows small businesses to easily transform their phone services from a typical public branch exchange system to an Internet Protocol system.

"Hosted solutions appear to be something that the majority of small businesses would gravitate towards simply because they don't have an IT department," Mr. Cork said. "They can outsource it and put it all with one guy – their e-mail and their voice services as well as any Web services."

Silhouette hit the market last November and began generating revenues for the company shortly after.

Mr. Cork said the company has a two-pronged growth strategy – accelerate its customer deployments and exploit Mr. Matthews' global contacts.

"Terry has some incredible connections on a global basis so he's already busily promoting us into half a dozen different international opportunities that could just leap frog us well beyond what our aspirations were," Mr. Cork said.

However, he remains cautious on ramping up the company's headcount, preferring to wait until customers have committed before adding new sales support or technical staff.

Until now the company's sales focus has been exclusively North American, with most of the interest coming from phone and cable companies south of the border.

"In Canada they're still kicking the tires a little bit," Mr. Cork said. "Terry, already through his efforts, has brought us into some opportunities both in Europe and Caribbean Latin America."

NAILING A NICHE

Hill said Natural Convergence is hitting the market at the right time with the right product to take advantage of the growing demand for Internet-based phone services.

Silhouette is aimed at the small business market so often neglected by other telecom equipment and software makers. It is meant for offices with as few as four voice telephone lines and is scalable up to 100.

In addition to that small business focus, Mr. Hill said VIMAC was impressed with the fact that Silhouette is a hosted product. That means the phone company can provide the service to the business owner remotely without having to install any hardware on site, avoiding the need for the "box in the closet."

"You don't have to buy a switch, a PBX and stick it in your closet to replace the one you already there," he said. "You just call up the phone company and say: 'Got 23 people here. When can we turn this on?' The answer is, hopefully, 'tomorrow morning.'"

From VIMAC's perspective, no one else in the marketplace is providing such a hosted Voice over Internet Protocol (VoIP) offering for small business.

Another Ottawa startup that is largely focused on the same market is Centrepoint Technologies. Centrepoint also enjoys a singular position in the market, offering its VoIP technology to small business customers. However, its Talkswitch product is not hosted and requires that box in the closet.

Mr. Hill believes hosted solutions have more market appeal, but acknowledged that there is solid demand for either type of product.

"There's room for Centrepoint and there's room for Natural Convergence addressing the same generalized market," he said.

Another local startup eager to target that "same generalized market" is Nimcat Networks with its Peer Telephony Exchange technology. Bill Dunnion, Nimcat's director of product line management, said peer telephony is a hosted solution like Natural Convergence's Silhouette, but with one key difference. Rather than being a service hosted by some third-party phone company, all the necessary hardware and software is contained within the individual phones without having to have that "box in the closet".

"Since our solution can realistically be bundled with a service contract, sold over the phone and drop-shipped to the customer we are seeing a lot of industry interest ..." Mr. Dunnion said.

"Ultimately, the customer has to make a rent vs. buy decision and I am confident that the market is large enough to make both of our companies wildly successful," he added.

Natural Convergence is often compared to larger U.S. players such as Broadsoft, Cilantro and Vocal Data; however, the hosted products from these companies still focus on larger business customers.

"Our research has told us that carriers are starting to realize that (small business) is a very important market for them," Mr. Hill said. "They've kind of taken it for granted."

According to research from Allied Business Intelligence, the market for VoIP technology is expected to grow from a "seedling market" of US$46 million in 2001 to US$36.5 billion by 2008.