The pioneers of Canada’s functional food sector are struggling in their infancy. In a sector dominated by smaller start-ups lacking the financial muscle of their global counterparts, the funds are not always there to offer the necessary education and marketing clout. just-food.com’s Arthur Hanks sees plenty of promise through the sector’s global trends however, and looks the ways to attract capital as the companies grow.


New foods, new technologies, new sciences and old regulations create challenges for companies hunting for capital in Canada’s growing functional foods and nutraceuticals sector.


A snapshot of the sector shows promise and room to grow. As of 1998, sales for natural health, natural products and functional foods were reported to be C$1bn (US$680.8m). Compared to global markets, the Canadian industry consists of small and medium sized firms. Many in western Canada and the Atlantic are start-ups. Prospects of growth are following global trends and are very inviting.


Jim Pratt is the CFO of Sepp’s Gourmet Foods (TSE:SGO) a Surrey, BC-based prepared foods manufacturer who has recently entered the arena with its all-natural “Truly Unique” line featuring flax seed, soy, shitake mushrooms and chicory root as ingredients.


Pratt says, “ As ‘functional foods’ is a new term, a lot of VCs have to be educated about the industry before they will invest.”

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Lacking the precedents


A related issue is that there is a lack of precedents of what a successful company can be and what form it can take.


“Because the industry is in its infancy, we haven’t had a meaningful home run yet that VCs can point to as an example,” says Pratt. “[As with technology stocks] companies have to be able to say: ‘here’s our technology, here’s what we do, we are the next X’ to get VC’s excited.”


Pratt, formerly with a national investment firm, has helped Sepp’s go public through the Vancouver and Stock Exchanges, a number of financing rounds and several acquisitions. He says the investment community can learn a few lessons from yesterday’s high profile “Dot Gones.”


“The technology boom taught us that you make a lot of profit out of IP (Intellectual Property), so choose to invest in a strong management team with a product rather than a management team with a business plan,” he says.


Or to put it another way:


“Scientists won’t get money today by saying that have a great idea for a new food. They need to have the studies showing clinical efficacy, they need prospectus info & they will need the research to back them up.”


Product personality


Kelley Fitzpatrick, President of the 130-member strong industry association Saskatchewan Nutraceutical Network, says that a lot of investor interest depends on technology and personality of the company.


“Besides IP, VC’s are looking innovation and something novel, ” she says “There are too many ‘me too’ products in the market.”


“Investors will want to see some licensing agreements in place. And scientists also have to learn how to take direction from their business partners,” she adds.


Other important caveats: it can be difficult to evaluate new food technologies. And unlike software, all breakthrough food technology has to go through a lengthy regulatory and approval process.


But these breaks don’t stifle innovation and development. Pratt identifies the Vancouver-based Forbes Medi-Tech (TSE:FMI/NASDAQ:FMTI), as a positive example. Following capitalisation and a licensing agreement, Forbes’s cholesterol-lowering phytosterol-based Phytrol™ has recently achieved USA GRAS status, and is now being used in heart-healthy foods being test marketed south of the border.


Lack of regulatory system


Ironically, Phytrol cannot be used in Canada at the moment. The unsettledness of the Canadian regulatory system adds another consideration to raising capital.


(Canada’s Functional Foods regulations have been under development for the past five years. Natural Health Product regulations are closer to finalisation, but on a similar length of track.)


Fitzpatrick says that the lack of regulations put Canadian start ups at an extreme disadvantage.


“We are not harmonised with the US, and this lack of regulations is extremely embarrassing to us,” she says. “If you are a company situated in this country, I suggest you go to the USA for capital.”
 
Deeper pockets of capital and a more progressive regulatory system may offer better opportunities for Canadian companies à la Forbes. “You can do a lot more and say a lot more about your product in the USA, ” says Fitzpatrick. “As well, if it’s an innovative product with no history of safe use in Canada, it may not be allowed. “


Pratt agrees that Canada is a little bit behind the US.  But he is less sanguine about Ottawa’s regulatory shortcomings.


“Though I am a believer in less-government-the-better, the regulatory hurdles in Functional Foods and Nutraceuticals I support. Because it is a new category, its something new, it carries a higher risk,” says Pratt. “You need the independent verification to prove that Functional Foods do what they are supposed to do. Obviously this is the government’s role in this scenario.”


Pratt recognises the benefits of a slow approach in Canada and suggest that it gives the country a chance to get the regulations right. “We have to have a good approach here. We have to know what the ground rules are, and every credible manufacturer will recognise this.”


Government funds


Government and pseudo-government funds can also be a valuable source of seed or match funding. This adds cachet to the start up firm and gives security to private sector investors.


Funds available in Canada include but are not limited to Alberta’s AVAC, Saskatchewan’s AFEF and SOCO, and the nation wide bio-food fund Foragen. But government funds are not found money either and have their own considerations.


“My member companies find that the process is tedious, and commonly government investors want too big a share in return to investment,” says Fitzpatrick. “Government agencies also have a mandate which may not be in the best interest of the corporation — for example, to get and get out within a 5 year period when its still too early.”



Specific challenges, general fundaments


Despite specific challenges in the sector, Pratt believes the fundamentals remain similar to any other industry. Investors will look for strength of management, strength of product and intellectual property, how they are going to make money and an exit strategy. Scientists should protect what they have either through patent or copyright, bring a business savvy partner into the mix and then go the VC route or angel investor route. Yes, and leave the Public Offerings for more mature companies.


Sepp’s itself is a good example of performance of a public company in the food business, “We sell meat pies, which is the most unsexy product around, ” says Pratt. “Our growth is slow but sure — we have the philosophy that it’s a marathon and not a sprint, so build a company based on long-term growth and appreciation. Don’t build your company thinking you can sell out in two years and retire.”


By Arthur Hanks, just-food.com correspondent


Jim Pratt is a member of the Corporate Growth Forum, a federally incorporated non-profit organisation that promotes the development of the Canadian food industry. Their upcoming conference, Moving The Markets (www.movingthemarkets.org) to be held on 19-21 February 2002 in Toronto, will address how knowledge based assets influence the growth and profitability of firms in the Canadian food sector.


Kelley Fitzpatrick is the President of the Saskatchewan Nutraceutical Network, a national leader in functional food marketing, lobbying and stimulating industry growth (www.nutranet.org).