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‘Until we get to equilibrium and virtuous cycle when we’ve got a bunch of success stories ... we’re still not at the halfway point yet,’ says Mike McDerment, founder of FreshBooks. (Darren Calabrese For The Globe and Mail)
‘Until we get to equilibrium and virtuous cycle when we’ve got a bunch of success stories ... we’re still not at the halfway point yet,’ says Mike McDerment, founder of FreshBooks. (Darren Calabrese For The Globe and Mail)

Toronto’s tech startup scene in a ‘blossom state’ Add to ...

Toronto doesn’t have a homegrown unicorn.

While the country’s most populous city hosts between 2,500 and 4,100 active tech startups, none of them has reached the billion-dollar valuation threshold required to hoist them into the coveted ranks of world-beaters.

The city is by no means a tech wasteland. The Canadian unicorns – Shopify, Kik, Hootsuite and D2L – have satellite offices in Toronto, as do U.S. giants IBM, Apple, Google, Facebook and Twitter.

But some of Toronto’s largest homegrown startup employers are not household names in the city. In a business community defined by Bay Street, even fast-growing tech companies such as FreshBooks, Wattpad and Influitive can find it hard to stand out.

“Toronto has global leading companies in financial services, yet somehow we question our ability to do so in technology,” says startup veteran Mark MacLeod, former chief financial officer for Shopify Inc. and, more recently, Toronto’s FreshBooks.

“We definitely have all the building blocks,” says startup veteran Mark MacLeod, former chief financial officer for Shopify Inc. and, more recently, Toronto’s FreshBooks. “We have really great talent, low cost to build [part of that is thanks to the tax credits; part of it is the currency, and] we find and serve our customers from all over the world,” says Mr. MacLeod, who left the cloud-based accounting software company in 2015 to start venture capital firm SurePath Capital Partners.

Indeed, there are tentative signs the sector is beginning to come into its own, with a few high-profile spending announcements and an increasing number of new ventures. A combination of tax changes for foreign investors, an effort to concentrate startups into creative hubs and the success of a few tent-pole companies has created space for more startups to flourish. Those positive examples are giving potential founders the belief that they can stay in Toronto and build global companies.

With a solid foundation in place, most observers agree that what needs to come next is scale, and even companies that have had notable success growing internationally need to get bigger still to really define the city’s tech scene.

“Until we get to equilibrium and virtuous cycle when we’ve got a bunch of success stories, I think if you look at a timeline, we’re still not at the halfway point yet,” said Mike McDerment, who founded FreshBooks in 2003. “I think that’s still probably 10 years away.”

‘Geographic fragmentation’

“The bottom line is we are not at our potential. Nowhere near our potential,” Toronto Mayor John Tory told a collection of the city’s best-connected tech players gathered at Shopify’s industrial-chic downtown office this past Thursday. The mayor had assembled a working group on innovation, comprising venture capitalists, startup CEOs, tech executives, non-profit organizers and city economic development staff to figure out what the city could do to help the sector grow and thrive. Later, he announced plans to work with City of Kitchener Mayor Berry Vrbanovic to pitch the Waterloo-Toronto tech corridor as the best place to start a new company.

“The pool of talent we have here, I am told by people outside of Toronto and outside of Ontario, is as rich as any in the world,” Mr. Tory said. “I really want to know what the city has been doing right, and what we should stop doing, that we might have been doing that’s going to impede.”

One of the leaders of startup capital in Canada is the Ontario Municipal Employees Retirement System pension fund (OMERS), which manages the assets of more than 450,000 current and retired civil servants. John Ruffolo (who was at the mayor’s tech event) is the chief executive officer of OMERS Ventures, a branch of OMERS that added another $260-million to its fund in August (in 2011, it raised $210-million), and he’s a prime mover among those trying to get in on the ground floor of Toronto’s tech scene.

OMERS has invested in companies such as Toronto’s Wattpad and Interaxon, and Vancouver’s Vision Critical, and is one of the rare Canadian venture firms capable of signing really large funding cheques in the $20-million range. So far in 2015 OMERS was part eight eight deals that totalled $80-million (figures include participation by other funds).

“Toronto has by far the largest number of startups [in the country], but you wouldn’t know that because the geographic fragmentation is so big and wide,” Mr. Ruffolo said.

That was one reason OMERS opened OneEleven, a downtown office space for startups with a focus on big data. Some of the companies that have put teams in the space include retail-data platform Rubikloud, payment processor Plooto and a customer-data platform for wireless carriers called Statflo. Several companies have moved on already, including financial-adviser service Wealthsimple, which raised $30-million in April.

“We are big believers in cluster theory,” Mr. Ruffolo said. “Now what you’re seeing over the last 24 or 36 months is a very concerted effort to cluster the startups in the downtown core. Getting more and more like-minded people together in single geographic areas creates more robust communities.

“Few cities in the world have both an outstanding financial and innovation sector in the same city. … I think Toronto is uniquely positioned to do that,” he said.

Other clusters of startups have emerged in the city’s growing spate of not-for-profit incubators and accelerators, including Ryerson University’s Digital Media Zone, the MaRS Discovery District and the nine accelerators that University of Toronto operates under the Banting and Best Centre for Innovation and Entrepreneurship (BBCIE).

But a recent report from the Innovation Policy Lab at University of Toronto’s Munk School of Global Affairs on the financial technology (fintech) scene in Toronto warned these clusters need to grow further: “There is not enough high-quality space which is both cheap and co-located near the financial industry, and hence, conducive to collaboration in the same way that such space is available in New York, London and San Francisco.”

Funding boom

Recent changes to the way foreign venture capital (VC) is allowed to invest in Canada has helped break the funding drought that plagued the country’s startups for decades, and many Toronto companies have benefited.

Foreign investments were rare before the 2010 federal budget, in which Stephen Harper’s Conservatives basically eliminated all taxation of capital gains for foreign investors (with some exceptions, mainly for the resource sector). A study of the changes noted that until 2010, investors had to keep 25 per cent of stock sale proceeds in an escrow account, and each individual investor had to apply to the Canada Revenue Agency for an exemption to the taxation rules.

When a venture fund could be using assets from dozens of foreign investors, the rule was effectively “a nasty little withholding tax,” Surepath Capital’s Mr. MacLeod said.

Players who have been around the tech scene for the past 20 years say those changes broke open the funding drought that made the 2000s essentially a lost decade for tech in Toronto.

The tax changes came at a good time for Toronto’s Wattpad, an app that shares stories that can be written and uploaded by any of its 40 million users.

“In the first half of the last decade,” In the past, “if you were a tech entrepreneur [who wanted] to start a company, you could finish your fundraising process locally within two hours, because there were five people you could talk to and maybe two venture firms might be interested in investing in you,” said Allen Lau, CEO of Wattpad, which self-funded, or bootstrapped, until it raised $3.5-million from New York’s Union Square Ventures in 2011. The company has since raised $66.8-million in five rounds of funding from Canadian and U.S. partners.

“Nowadays, four, five years later, if you look at the fundraising announcements in Toronto … many of the investments are coming from tier-one, very prominent VCs in the States,” Mr. Lau said.

Other recent examples of U.S. VC-supported Toronto companies include 500px (Andreessen Horowitz), Influitive Corp. (Atlas Ventures), Varagesale (Sequoia Capital and Lightspeed Venture Partners), and Nymi Inc., formerly known as Bionym (Salesforce Ventures and Ignition Partners).

According to the Canadian Venture Capital and Private Equity Association, in the first three-quarters of 2015 the three most active U.S. venture funds (SR One, Bessemer Venture Partners and ff Asset Management LLC) were involved in 20 deals valued at $234-million. The trend for the year suggests at least a 30-per-cent increase over 2014 in total venture deals, and a 15-per-cent jump in the amount of capital invested.

Canadian venture firms have been beefing up and raising new funds to invest as well, often with U.S. investors. The Canadian venture capital association now has 70 VC members, and 33 of those firms have offices in Toronto (four are local offices for U.S. firms).

Despite recent successes, tech firms in Toronto and the country at large still face funding challenges that hurt their growth prospects.

Daniel Klass, founder of venture capital firm Klass Capital, which has built up a portfolio of Toronto startups, said one of the issues that dog Canadian capital is an aversion to risk. “We’re not trying to have two successes and eight failures, we’re trying to be 10 out of 10,” he said.

That aversion to risk hurts, too, when it’s time for companies to repay their investors.

Toronto was once ranked among the top-10 tech ecosystems in the world, but in the 2015 Compass Startup Ecosystem Report it slid to 17th, in part because of a perceived lack of “exit options,” through buyouts or public offerings. Compared with other centres, Toronto companies just aren’t keeping pace in the race to convert sky-high valuations into real wealth for investors.

Many companies now find it too easy to get seed funding to try and make a single product into a company, to try and hit singles and doubles and not worry about home runs, Mr. Klass warns. On-base percentage doesn’t create the biggest rewards in the venture world, and singles and doubles don’t create the conditions that attract new entrepreneurs to step up to the plate.

“A lot of companies just plateau; they just can’t get over that hundred-million-dollar valuation,” said Chad Bayne, a partner in the Toronto office of law firm Osler, Hoskin & Harcourt LLP. “To basically build small little companies that get taken out effectively for their teams and not their technology, that’s not exciting. And that’s not what as Canadians we should be striving for.”

Hometown advantage

Entrepreneurs and investors speak highly of the linguistic and ethnic diversity of Toronto’s talent pool, which is also boosted by its close proximity to several world-class engineering schools and universities. Mr. Tory referred to talent as the next gold rush, and believes Toronto is sitting on a talent gold mine that, with focus and luck, can help the city build the economy of the future.

“People live where they can get a great quality of life, and a big part of that is making sure you can have a good job, or that you can start up and run and flourish a business; the two go hand in hand,” he said on Thursday. “Toronto is the economic, innovative and financial centre of this country. As Toronto does well, so Canada does well.”

Those elements make the city a popular place for Canadian veterans of Silicon Valley looking to return home and set up their next company.

“When you’ve done it as many times as I have, you absolutely have a playbook and a team, [and] once you’ve done it once you kind of want to do it again,” said Mike Serbinis, who founded DocSpace in 1997, selling to San Mateo, Calif.’s Critical Path in 2000. He returned from Silicon Valley to found Kobo in 2009, selling that company to Japan’s Rakuten for $315-million in 2011. Kobo is now the No. 2 maker of e-readers in the world.

After the sale he founded Three Angels Capital to invest in startups in Canada and the Valley, and earlier this year launched League, a startup offering health-care services, which he is running out of the MaRS building.

“I think it’s a matter of winning begets winning. … We need to generate more wins … those companies that have those exits go on and create the next company. We had a bunch come out of Kobo.” That includes Figure1, the fast-growing “Instagram for doctors” that crossed 500,000 users in September, co-founded by former Kobo developer Richard Penner.

“Silicon Valley didn’t get there overnight,” says Mr. Serbinis. “Things will be very different if we have this conversation in a couple years.”

Matt Golden, managing partner at Toronto’s Golden Venture Partners, which has invested in Wattpad and Influitive, agrees.

“When you see other entrepreneurs get meaningful exits it shows the dream,” he says. “We don’t have a Google or a Facebook here, but I think we’re in that blossom state. In the next number of years we will have some amazing model companies.”

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TORONTO'S BIGGEST STARTUP INCUBATORS AND ACCELERATORS

Ryerson DMZ

Since its creation in 2010, the DMZ (formerly called the Digital Media Zone) says it has hosted 206 startups, which have raised $80-million collectively, creating as many as 1,833 jobs. More than 80 companies are based there now.

U of T BBCIE

The University of Toronto’s Banting and Best Centre for Innovation and Entrepreneurship operates nine accelerators. In its first year of operation, it has supported 226 startup teams and helped incorporate 70 companies.

MaRS

The Investment Accelerator Fund operated by MaRS has invested in 101 startups, 60 per cent from Toronto, which have gone on to raise $395-million. The rest of the organization continues to evolve its mission to help commercialize Ontario researchers’ work in health, cleantech and IT in the face of funding challenges and increased scrutiny on its outcomes.

 

Editor’s note: The name of the MaRS Investment Accelerator Fund has been corrected in this article.

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