In other words, the venture capitalists left in Canada are the survivors: They made it through the severe downturn. Unfortunately, the number of survivors is few, and the dollars available small. In 1998, 807 Canadian companies obtained venture capital financing at home in Canada; by 2010, that figure had plunged to 357. In absolute dollar terms, the capital invested fell 25 per cent, from $1,511,000 in 1998 to $1,129,000 last year, according to data from Thomson Reuters Canada. Since the global economic crisis began in 2007, exacerbated by the collapse of Bear Stearns and then Lehman Brothers, the decline in capital available to start-ups has been even more stunning: It’s down nearly 50 per cent.
Chad Bayne, a partner in the Toronto office of law firm Osler, Hoskin & Harcourt LLP, whose practice is focused on the technology sector and whose clients include IBM and Google, says the Canadian VC market has changed dramatically over the past decade. “There’s been a general hollowing out in the number of institutional investors,” explains Bayne. “Quite a few years ago, there were a large number of VC players, labour-sponsored investment funds and attractive tax breaks for individuals.” But recent tax law changes in Ontario (where the majority of tech activity takes place), including the phasing out of tax credits connected to LSIFs, have meant that those funds are slowly but surely becoming extinct.
The decline in VC market activity in Canada explains why homegrown entrepreneurs such as Roy Pereira are now looking south – and why U.S. venture capitalists, from San Francisco to Boston, are looking north. “I’ve talked to two lawyers in Toronto who say more than 50 per cent of their funding deals are from the U.S.,” Pereira says, “and I think it comes back to there being a lack of A-round funding availability here. So you’re seeing U.S. VCs take notice – like sharks circling in the water, smelling blood.”
Indeed, in September New York-based Union Square Ventures, a pre-eminent venture capital firm founded by Fred Wilson and Brad Burnham that invests primarily in early-stage companies, was part of a group that invested $3.5-million in a Series A round for Toronto-based Wattpad. Union Square is also an investor in Kik, based in Waterloo, Ontario, which in March completed a Series A round capital raise of $8-million. According to Union Square’s Wilson, however, the firm’s investments in the two digital media start-ups were solely based on the individual companies, not a result of geographic targeting. “We’re not experts in what’s going on in Canada,” Wilson says. “Those are two companies that are working, building on solid ideas, and we found them. We don’t have a geographic focus. We invest in markets we’re interested in, and the fact they were in Canada was of no interest to us.”
While Union Square Ventures was attracted to Wattpad because of the idea, not the location, Wattpad CEO and co-founder Allen Lau, like Roy Pereira, spent a significant amount of time travelling to San Francisco, New York and Boston in search of Series A round expansion capital. “Compared to 10 years ago, there are definitely fewer venture capital firms in Canada,” Lau says. “We’re not in Silicon Valley where there are 50 VC firms to talk to, so you have to get out there and be more aggressive finding investors who are right for you.”
In search of the exits
Since 2008, the main issue confronting the industry has been the difficulty venture capitalists have in recouping their investments through successful exits, be it initial public offerings or acquisitions by larger firms.
“There just haven’t been a lot of notable exits in Canada in the past few years,” Chad Bayne says. “There have been very limited IPOs, so a lot of funds have been waiting to get out of their investments...(social gaming company) Zynga did their first deal up here, so there is activity, but in terms of public markets we’re just not seeing a lot of public companies created.”
In fact, according to Dealogic, 2011 has seen the highest number of global IPOs postponed or withdrawn in history, surpassing the record set in 2008. As of Sept. 15, 215 initial public offerings had either been withdrawn or postponed. Instead of public companies being created in Canada and the U.S., cash-rich companies such as Google, Research In Motion and IBM have this year embarked on a buying spree; through the first nine months of 2011, 26 Canadian start-ups were acquired, according to techvibes.com.