Last year, the value of venture capital investment in Ottawa dropped to its lowest level in eight years as investors, fully invested in their portfolios, continued to wait for exits so they could raise new funds.

Despite the sluggish activity, Ottawa-based Epocal Corp. closed the third-largest funding deal among local firms since the second quarter of 2005, raising US$31 million in series C financing from Genesys Capital Partners and Highland Capital.

The company, which is currently being sued by another medical diagnostic firm, Abbott Point of Care Inc., over alleged patent infringement, says it will use the financing to commercialize its blood diagnostic platform and develop its proprietary immunoassay technology.

Epocal CEO and founder Imants Lauks explained the formula his company followed in raising venture capital financing and the discipline required along the way.

OBJ: What steps did you have to reach before pursuing each subsequent round of funding?

LAUKS: We follow, generally, a standard recipe of financing in stage rounds of a high-tech deal. Our Series-A was to put together the business plan, file for early patents, build the core team. That led to Series-B, which was used to expand the core team, finance building a lab, do the development and de-risk the product going through clinical trials and essentially set up for product launch and commercialization, for which you raise Series-C money. And Series-C then pays for building a sales and marketing effort and doing a technology transfer to manufacturing, building the plant, capitalizing and building the necessary operating departments.

Each step along the way requires progressively more money and at each step of the way, you are de-risking the technology and able to raise the money at a higher valuation. That is every man's venture capital recipe. Obviously, that is easy to say and we actually have managed to do that. We haven't had a down round, we've escalated the price per share in every round quite considerably and that has been tough to do in the venture capital climate of most of this millennium. Post the bubble and post-9-11, the VC markets have been, relatively speaking, below historical levels. They were at a real dip in 2001-2002 when we first started. They recovered somewhat, but they are still not at anywhere close to the levels of investment of the mid to late '90s.

OBJ: Your company raised much more in 2007 than other Ottawa firms. What factors contributed to that?

LAUKS: I don't think we raised an abnormal amount of money. Any company that is at our stage in high technology needs to raise tens of millions. Now, if that money is not available to them, they have to tread water. They can't proceed with a commercialization plan, it just costs that amount of money to do all those things. There are many ways of proceeding if they cannot raise the money. They may have to sell some of their assets, partner with another company that will put investment in, so you are essentially selling rights. But you have to do something that obviates the need for raising that kind of money. Certainly, if you look at other years, there would have been more companies that were able to transition through the commercialization stage because they could get the money.

I think we were one of only a small handful of companies that raised multiple tens of millions. I can't tell you the specific reason. One may be that there just weren't any other companies in the development stage that were at the later stage ready to raise the bigger amount. The other conclusion might be that there were plenty of those companies but they were treading water because they couldn't attract the investment that they needed to move through the commercialization stage.

OBJ: How can a company founder ensure they retain control over their business and still go through the VC process?

LAUKS: I think a founder that believes they have to control the process and exudes that need is going to find it tough to get venture capital financing.

If that founder is indeed important and is doing what they need to do to build value for the investor, then he will have de facto control, and the investor knows it because he will be the goose that lays the golden egg. If that founder requires to keep control so that he can maintain his position even in the light of woeful underperformance or a lousy idea, then an investor won't tolerate that. I don't think it is a practical problem.

The control that both sides of the deal exercise is a subtle one that needs to be understood to properly work.

OBJ: What lessons have you learned along the road of raising VC financing?

LAUKS: I think there is a great danger of overpromising to investors. Investors like to invest in experience because they know the management team and the founder aren't looking at these things with starry eyes. They are looking at the knowledge of what it takes in the real world to get the job done. I think overpromising leads to bad habits, misspending of funds. It is very important in the model we talked about, this phased approach, to crawl, to walk and then to run. If you overspend early trying to run and trip up, then you have to raise significantly more money, but the valuations aren't there. Then you go into down rounds and existing investors. New investors come in and they dilute management and dilute old investors. Feelings are hurt, everyone's on edge. I think it is important not to get ahead of yourself.

There is no shortage of money out there. There is a lot of financing sitting in the hands of VCs that is underemployed because they haven't necessarily found the kinds of deals they are looking for. VCs always complain about having too small a deal flow that they can invest into. Once they have determined to invest, there is a pressure by them for you to deploy as much of their money as you can and the pressure therefore is sometimes to overspend. And management and the founders and the early investors must be disciplined to invest early on in a very parsimonious way.

THE EXPERTS SAY

Our whole system is broken in Canada where people are waiting to see the outcome of companies that are in the pipeline before they continue to invest. The U.S. has a discipline that has been in place for dozens of years where the pension funds continuously invest in venture capital and wait for the outcomes over time. They don't do a bunch and then wait until those come out before they do some more. They continually invest because they know that it is a process that takes time.

The problem that we do have is that a lot of these companies are later-stage companies which also require capital for getting prepared to do an IPO. And that money, the later-stage money, is also scarce.

We may create a self-fulfilling prophecy of the companies being unsuccessful because they can't raise money, even at the later stage. We have both an early-stage and a later-stage problem.

In Canada, in general, companies are going to get sold. They are not going to be sold to Canadians, because Canadians don't have the money to buy them. We don't have a strong enough indigenous tech industry yet. And if you go through all the things that have been bought, they have generally been bought by Americans, sometimes by Europeans. And then they make the money and we spent quite a bit of Canadian venture capital getting them there.

Pat DiPietro, managing general partner, VenGrowth Asset Management Inc.

Every tech centre has an ecosystem. That ecosystem takes multiple things to make it work. It takes skilled advisers who know how to do deals, it takes entrepreneurs who have done it before and know how to take a company global and it takes money. And when you take away the money, part of the equation, it is very difficult to have a self-sustaining ecosystem.

We need our more senior tech companies to show a return and get the investors a return. And if there are more hundred-million-dollar companies, there will be more money in venture in Ottawa.

I don't want to sound negative, but you've actually seen the opposite. There has been no real IPO activity this year at all. There has been no big M&A activity, nothing that's over a hundred million that I'm aware of.

That said, the positive side is that there are some good companies. You talk to people in the venture community, they have some portfolio companies they really believe in. But so far in 2008, there is no sign we're going to have a big win.

Ottawa is still a very healthy place to do business in Canada. But I think the whole community has to come together on this ecosystem and really look at how we can help bring venture money, and money in general, to Ottawa. People like OCRI and others are working very hard on this, but the community really has to pull together. It's a community issue.

Bob Ford, partner, Gowling Lafleur Henderson LLP law firm