U.S. venture capitalists are increasingly looking for opportunities north of the border, thanks to strong growth in Canada's technology sector and the maturation of its startup culture.
Lars Leckie, managing director at San Francisco-based investment firm Hummer Winblad Venture Partners, says a few big Canadian success stories have investors taking notice. Mr. Leckie, who grew up in Canada, points to the 2011 acquisition of Fredericton-based Radian6 by Salesforce as one example. That deal, worth more than $300-million, saw three early stage investors split profits exceeding $195-million off a $9-million investment.
Mr. Leckie is also one of the co-chairs of the C100, a non-profit organization that promotes Canadian companies in Silicon Valley. Its director, Atlee Clark, says Radian6 and other recent acquisitions such as Q1 Labs, Layer 7 and Go Instant "indicate to investors that there might be some hidden gems in Canada."
Charles Hudson, a partner with Palo Alto, Calif.-based SoftTech VC, says his company "didn't have a specific Canadian strategy" before meeting Waterloo, Ont.-based video marketers Vidyard at California startup accelerator Y Combinator. "We didn't know about the tech base at Waterloo," he explains. But his investment in Vidyard led to more contacts with Canadian companies and more investments, including one in educational technology startup Top Hat Monocle.
"I don't think we're alone," Mr. Hudson says. "More and more Canadian companies are showing up on people's radar."
In 2012, six of the 25 largest venture capital deals in North America involved Canadian companies, according to Peter van der Velden, president of the Canadian Venture Capital and Private Equity Association (CVCA). Of those deals, five involved U.S. investors. The largest was an $80 million investment in Desire2Learn, a Kitchener, Ont.-based learning management system developer, by OMERS Ventures and New Enterprise Associates.
Overall VC investment in Canada dipped slightly in 2012, to just under $1.5-billion, according to Industry Canada. But that level is the second highest since 2007 and remains above the $1.1-billion reported in 2010. About half of the 2012 investments went to IT companies, according to the CVCA. And 2012 saw the highest percentage of new investments in 15 years, the CVCA adds.
The level of foreign VC investment in Canada – around $300 million in 2012 – remains significantly lower than it was in 2007, Mr. van der Velden says. "The VC business and private equity are really driven by broader market trends," and the 2008 recession had a major impact on the amount of financing available.
According to a report prepared for the CVCA by Thompson Reuters, foreign VC investment, the majority of which comes from the United States, was down in 2012 after rising in 2010 and 2011. However, while the report shows a significant drop in the amount of VC funding going to the clean technology sector, the IT sector is showing growth and the overall number of companies receiving VC financing reached a five-year high.
Robert Simon, senior managing partner of the Business Development Bank of Canada's IT Venture Fund, says the market is "right-sizing."
"If you have too much money it drives up valuation and drives down returns," he says, which leads to irrational behaviour.
With the IT sector increasingly focused on software, companies need less capital. "The cost of starting a company has dropped dramatically," says Boris Wertz, who runs Version One Ventures, a Vancouver-based early stage investment fund, and who has co-invested with U.S. VCs, including Mr. Hudson.
Mr. Wertz says lower startup costs are also allowing Canadian tech companies to stay at home, rather than move to Silicon Valley. "Raising a lot of money requires being close to investors," he says. "Now, location doesn't matter."
Mr. Wertz, who is originally from Germany and moved to Canada when his online rare-books marketplace was bought out by a company in Vancouver, says staying in Canada can help companies keep costs down. "There's a crazy war for talent in (Silicon) Valley."
He says this has led to oversized salaries and has made retaining talent a challenge.
Ms. Clark agrees. "If you're (in the Valley), Google is going to steal your best engineers if you're not careful."
In addition to the lower costs, Mr. Hudson says the Canadian government's pro-startup policies, along with Scientific Research and Experimental Development (SR&ED) tax credits are helping companies entice investors. Changes to the Income Tax Act, made in the 2010 federal budget, have also made foreign investment easier. The changes meant that foreign investors who are exempt from Canadian taxes under a treaty no longer have to file a return and then apply for an exemption certificate.
Mr. Wertz says the old rules "put quite a bit of a burden on American funds."
Canadians are also finding opportunities for co-investment with Americans. According to Mr. Simon, 75 per cent of investments made by the BDC's Venture Capital IT Fund have co-investors from the United States.
Mr. Hudson says having local co-investors is "crucial." He looks to his Canadian partners not only for additional capital but also for their access to local talent. "They know where to poach," he says.
And while U.S. investors used to come in for later rounds, following on the heels of Canadian investors, he adds "increasingly now we're coming in at the same time."
"There's optimism right now," says Jeff Grammar, a partner at Montreal-based RHO Canada Ventures, who is originally from Boston. "The infrastructure exists, you don't need anything else, it's up to us, the VCs, to prove that we can build sustaining companies and have U.S.-style returns in Canada."