When Sunil Sharma, managing partner of Extreme Venture Partners in Toronto, attended the Atlantic Venture Forum in Halifax in June, one thing that caught his attention was how “capital efficient” Atlantic Canadian companies are.
In other words, he perceived they can do more with less capital investment than their peers in other locations.
Aside from the non-dilutive financing available to Atlantic Canadian startups, Sharma noted commercial leases and core business expenses are less than in a market like Toronto, and wages for technical people tend to be lower.
That’s the impression, but is there data to support the notion that it’s cheaper to establish a startup on the East Coast of Canada? EY, the global business services consultancy, and Entrevestor have teamed up to do a comparison.
We’ve created a hypothetical company that we’ll call TechCorp. This five-year-old enterprise has a Software-as-a-Service product that is attracting global clients, achieving C$3 million in revenue in calendar 2015. It has 10 employees, and one exec must attend meetings events in San Francisco four times a year and twice annually in New York.
We wanted to estimate TechCorp’s annual costs if it were based in Halifax, Toronto or SiliconValley. So, on the facing page you will see the three respective income statements. We’ve assumed that the company accrues $3 million in revenues in 2015 regardless of location, based on the theory that a SaaS company can access customers around the world regardless of where it’s based. But our research has shown that on the cost side, there are definite advantages to being in Atlantic Canada. The total costs are 15 percent less in Halifax than in Toronto and 46 percent less than Silicon Valley.
“While there are benefits to locating a business close to capital, mentors and customers, we’ve found that companies can hold costs down by being based in a smaller center,” said Pamela Achenbach from EY Halifax. “The talent pool and talent cost in the East Coast of Canada is an advantage and it’s not just entrepreneurs who benefit from this. The more businesses choose to do business from our region and invest capital, the greater the collective gains to our communities and economy.”
The big factor in the cost analysis is payroll. TechCorp (CEO, CFO, CTO, two sales people, four developers and a support person) pays about 80 percent of its annual expenditures to its staff. And the biggest difference is in developers. According to PayService data secured by Nova Scotia Business Inc. and the Halifax Partnership, a software developer with five years’ experience makes approximately $58,000 in Halifax – which is about 42 percent less than in Silicon Valley and 14 percent less than in Toronto.
Across the company, the payroll in Halifax is about $682,000 – a saving of almost half from the payroll in Silicon Valley and 15 percent from Toronto, clearly a significant opportunity to save funds.
Those sorts of savings are also seen in professional services like lawyers and accountants. You pay about 10 percent more for these services in Toronto and a whopping two-and-a-half times as much in Silicon Valley.
The final result is that annual costs in Halifax are $834,900, in Toronto $981,900 and in Silicon Valley $1.56 million. These cost savings give Halifax a small advantage in pre-tax profit over Toronto, though the profit is largely the same once taxes are taken into consideration. The profit in both Toronto and Halifax is about 75 percent higher than in Silicon Valley.
The complete income statement shows a breakdown of all costs, and we should highlight that travel costs from Halifax are the highest. So if a company has to travel a lot to the U.S., the cost advantages would be eroded. This could be an important factor as the company scales and sales calls (even for a SaaS company) become more important.
And one final factor that we admit freely is that there are definitely huge intangible benefits to being in Silicon Valley. You’re closer to thought leaders and to mentors who have built companies that changed the global industry.
And of course there is far, far more capital in northern California than in the other two centres. Certainly there are strong benefits for locating a business in Northern California, but the big question is how much the entrepreneurs are willing to pay for that advantage. In the growth stage, companies like TechCorp will likely find that better capital retention is also a critical factor for success, and that can strengthen the decision to locate to a smaller centre.
TechCorp Projected 2015 Income Statement
|Dec. 31, 2015 (C$)|
|Salaries & employee benefits||3||681,700||803,100||1,289,500|
|Professional fees (accounting & legal)||7||50,000||57,600||127,300|
|Misc. (supplies, insurance, marketing)||8||10,000||10,000||10,000|
|Income before income taxes||2,165,100||2,018,100||1,445,100|
|Provision for income taxes||9||571,000||438,000||534,000|
|Net Income for the Year||1,594,100||1,580,100||911,100|
See accompanying notes
Note 1: USD converted into CAD at a rate of 1.31 based on December 31, 2015 forward rate curve
Note 2: Assume global market and global buyer - no revenue differential
Note 3: Assume common equity holdings at CEO and CTO level with a market based salary (Source: PayScale August 2015
Note 4: Based on 2000 sq. ft. grade A space (data source: Cushman Wakefield)
Halifax: $33.85 psf/year
Toronto: $41.35 psf/year
Silicon Valley: $38.16 USD psf/year
Note 5: Assume one trip per qtr. to Silicon Valley (4 trips per year), two trips to NYC. $100/day for taxi, food etc. duration 5 days
Note 6: Midsized office, heated by electricity. Servers running 24/7 with extra workload during working hours.
Note 7: Fees determined based on industry rate cards by geographical region
Note 8: Assume negligible cost differential by region
Note 9: R&D incentives for 2 developers are netted against tax expense
This article was originally published in our latest Entrevestor Intellignce report.