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Paul Lem, CEO of Spartan Bioscience Inc., poses with Spartan RX, a box the size of a shoebox that delivers DNA test results.Dave Chan/The Globe and Mail

Sam Duboc made his name on Bay Street with successful private equity investments in unfashionable companies such as Hair Club for Men. Then he himself fell out of fashion, after the sale of his firm Edgestone Capital Partners to brokerage GMP Capital turned into a disaster for the buyer.

Now Mr. Duboc is working on an ambitious turnaround project: Fixing Canada's woeful venture capital industry.

The Canadian government has earmarked $400-million to kick-start the country's withered venture capital scene, which has suffered from years of underfunding, a shortage of investors with expertise and a systemic aversion to risk-taking.

The effort is a key part of the government's plans to bring the economy back to life. And when federal Finance Minister Jim Flaherty set out to decide who could help make it happen, he asked Mr. Duboc to lead the charge.

"The minister has known for a very long time that I have this strong view that the whole innovation cycle and venture capital is broken in Canada," Mr. Duboc says in his Ottawa office. "This is about reinvigorating an industry that has problems."

The revitalization of the venture capital sector is crucial if Canada is to ensure it's planting the seeds for a new generation of promising startups that can grow into top-flight players in industries from technology and telecommunications to medicine and biotech. Without a vibrant venture scene to nurture small firms with big ideas, Canada's brightest players and companies will be lured to other countries at a time when Canada already faces a sharply depleted tech sector and a barrage of foreign suitors for its corporate heavyweights.

"We really need to concentrate on the startups," Mr. Flaherty said in an interview. "There's a direct return to Canadian society, economy, and future growth by making these kinds of funds available."

The startup sector has attracted and perplexed governments for decades. Politicians have long recognized that startup firms contribute a disproportionate share of job creation and economic growth, and can become the corporate giants of tomorrow. Government backing helped create two of the hottest venture capital zones in the world – Silicon Valley and Israel. But such successes are the exceptions, not the norm.

Startups are risky, fast-paced, unstable, and driven by market forces. Governments are the opposite, and driven by politics. "Many of these programs were designed with all sorts of good intentions [but] were not really useful," said Josh Lerner, author of Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed – and What to Do About It.

In Canada, governments helped to spur on the venture capital industry 15 years ago – but it performed so poorly, most of the smart money went away. "The last 10 years have been just a wasteland from a return point of view" in Canadian venture capital, said Leo de Bever, chief executive of Alberta Investment Management Corp., one of Canada's largest fund managers. "We'd like to do more and we're being pressured to do so" by governments. "But us stepping into that is a bit tricky because the failure rate is so high."

That's what makes Mr. Duboc's job so tricky. As special adviser for the $400-million project, he must figure out how government can deploy the money to launch successful private sector initiatives to revitalize venture capital without repeating any of the mistakes of the past.

"We worry every day about the adverse effects," said Mr. Duboc, who plans to present his recommendations to the minister by December. "At the end of the day, venture capitalists are going to have to perform."

The lure of U.S. VC firms

Ottawa entrepreneur Paul Lem has developed a bedside DNA testing kit that can tell within an hour if a heart attack or stroke victim will respond to blood thinner Plavix or its generic version, or whether a more expensive alternative treatment is needed. His firm, Spartan Bioscience, doesn't yet have regulatory approval, market validation, or enough financing, so he's been meeting venture capitalists in the U.S. and Canada. The difference between the two, he said, is striking.

In Canada, he has to explain his business and industry to venture capital firms (VCs); in the U.S., the VCs know the space better than he does, and offer advice on regulatory considerations, reimbursement schemes, and where to find the best experts to help his business. "I would characterize Canadian venture capitalists as generalists," he said. "In the U.S., they're specialists. It's surprising more Canadian companies don't move down to Silicon Valley, because the depth of expertise and knowledge are so much deeper."

It's a widely shared assessment. "I don't think local Canadian VCs have the benefit of seeing patterns over long periods of time over a wide range of industries or geographies," said Trevor Oelschig, vice-president with U.S. VC Bessemer Venture Partners, which backed Skype, LinkedIn, and, in 2010, Ottawa e-commerce platform developer Shopify Inc. "If they're thinking of investing in a company [in online retail], they've probably seen a few firms in Canada. We have probably seen hundreds, as far away as Australia or Brazil. When we see a spark that's interesting, we often act quicker."

That's a big disadvantage, but not the only one, for Canadian VC firms. For a brief time in the late 1990s and early 2000s, Canada was a venture capital hot spot. Egged on with incentives from Ottawa and eager provincial governments, individual and institutional investors poured money into Canadian funds to finance risky startups just as the dot-com bubble expanded. A lot of dumb money chased dumb investments, managed by a lot of people who lacked the entrepreneurial smarts to identify and nurture promising young firms. The field was dominated by labour-sponsored venture funds, a creation of governments that gave small investors huge tax breaks – but drew inexperienced managers who charged high fees and bid up the values of small firms, hampering returns and crowding out "good money."

Since the dot-com crash, returns have been dismal. Canadian VCs have barely raised more than $1-billion a year in any of the past five years, and much of that has come from government or quasi-government sources such as the Business Development Bank of Canada. As a result, Canadian VCs are smaller than their US counterparts, have less to invest and a lower appetite for risk.

Three years ago, Silicon Valley venture capitalists Chris Albinson and Anthony Lee were swamped by calls from Canadian entrepreneurs who feared the venture funding ecosystem at home was collapsing. Inspired by the "Own the Podium" program that precipitated Canada's strong showing at the Vancouver 2010 Olympics, the two Canadian expatriates pulled together dozens of the Canadians who worked in the Valley to form a high-end support group for fellow Canadian entrepreneurs. Since then, their "C100" group has actively reached out to mentor Canadian entrepreneurs. "We are starting to make an impact helping Canadian entrepreneurs think bigger and grow faster," Mr. Lee said.

That's one of many reasons for hope in Canada's startup sector. A spate of promising Canadian firms have attracted financing from large U.S. VCs. "Angel" investors – typically flush entrepreneurs and tech executives who provide money and expertise to startups – have returned to the scene. Other experienced entrepreneurs have started "accelerators" to provide seed capital and boot camp training to nascent entrepreneurs. "Companies make mistakes early on that can be life threatening," said Amar Verma, a Toronto-based software entrepreneur and venture capitalist who runs the newly founded Extreme Startups accelerator. "We get them to not do these things." A spate of new mobile app-oriented VC funds led by accomplished entrepreneurs such as Matt Golden in Toronto and Boris Wertz in Vancouver have raised $10-million to $20-million each.

Meanwhile, pension fund OMERS last year earmarked $200-million to invest directly in startups. It has already committed over half of that to 10 firms. "I hope to shame [other Canadian pension funds] with a little competitive pressure" to invest in VC again, said OMERS Ventures CEO John Ruffolo, a former management consultant who has hired experienced entrepreneurs to manage the portfolios. "There's no [shortage] of opportunities to invest in."

What's still missing, though, is capital. Veteran Ottawa tech executive Adam Chowaniec estimates that Canada needs an extra $1-billion a year in VC financing to be competitive with the U.S. Meanwhile, entrepreneurs who get their businesses up and running and need to raise between $1-million and $10-million in venture financing face the biggest funding challenges, Mr. Duboc said. At that level, Mr. Ruffolo said, there are just a half-dozen VCs in Canada capable of funding the space. And he counted just two – OMERS and Charles Sirois' Tandem Expansion – that can write cheques for investments of $10-million or more. "Basically, if you don't hit one of us, you're going to the U.S.," he said – where venture capitalists often pressure Canadian companies to relocate south of the border.

The lesson from Israel

Sitting in his Ottawa office in late August, Mr. Duboc cast the image of a confident "dollar-a-year" adviser bringing fresh outside thinking to government. "An important aspect of the success of Americans is the acceptance, almost celebration, of failure that happens in America," he said. "That does not happen in Canada."

The 50-year-old Mr. Duboc has known success and failure. In the early 1990s, he co-founded Loyalty Group, parent of the Air Miles reward program, then worked as a merchant banker before founding Edgestone in 1999. He and his partners raised more than $1-billion and established the firm as one of Canada's top private equity investors.

Edgestone's star faded after it sold for $155-million in 2006 to GMP Capital, which looked to Mr. Duboc and his partners Gil Palter and Stephen Marshall to stay on. But relations soured; neither side felt the other lived up to their end of the bargain. GMP pushed Edgepoint to raise funds, while the financial crisis put a chill on private equity. "At the end of the day, GMP had a very different view of the way forward than we had," Mr. Duboc said. The three partners left GMP as employees in 2010 but continued to manage the fund. However, with their departure, Edgestone's fees declined, and GMP had to take an $80-million writedown. Mr. Duboc and his partners have since resumed control of Edgestone. A call to GMP was not returned.

Mr. Duboc says he lived up to every commitment he made. "Good deals go bad, and when they do, and people have to write off sums of money, everyone will snipe and say, 'Not my fault,' " he said. "The world simply changed, and no one could perceive it in 2006 when the business was sold."

Back in Ottawa, Mr. Duboc has the full confidence of Mr. Flaherty, and is working through submissions from more than 200 entrepreneurs, investors and funders he met this summer across Canada and in the U.S. There are many ideas to sift through. The C100 suggest financing university co-op programs like the one at the University of Waterloo, which has produced many Silicon Valley stars. They, like others, caution against spreading the money too thinly over too many provinces or industries. Some, like Mr. Chowaniec, say $400-million isn't nearly enough to make a dent.

While Mr. Duboc isn't revealing his recommendations yet, he and Mr. Flaherty draw some inspiration from Israel's successful "Yozma" (Hebrew for "initiative") program, which gave birth to that country's venture capital industry 20 years ago.

As Israel absorbed a massive inflow of skilled Russian immigrants in the early 1990s, the government decided to help the many startups that struggled to grow. So it offered through Yozma to invest $100-million in 10 venture capital funds – as long as they could raise matching dollars. In return, they could buy out the government's stake at cost plus interest within five years. Nine did, and the program was a huge success. Today there are about 70 VC funds, with the 10 largest managing more than $540-million (U.S.) each, according to Dun and Bradstreet Israel.

Both Mr. Flaherty and Mr. Duboc are quick to point out the vast differences between Israel and Canada, but it's clear the Canadian program will involve some degree of risk-sharing, with government money released to private VCs that can raise other funds, then invest as they see fit. The idea is that with taxpayers underwriting the risks of sophisticated investors, venture investing will rise and startups can flourish. "At the end of the day, it's a risk-reward equation for everybody," Mr. Duboc said. "We have to increase the reward and lower the risk."

But some say venture capital is just too risky for Canadians. That's the conclusion Sam Zaid, who started two firms in Ottawa, reached when he set out to launch his third, Getaround. His idea – allowing car owners to rent out their vehicles online – was too "aggressive" for Canada, he decided. So he moved to Silicon Valley in 2011, launched his business and has rolled out in a handful of U.S. cities. Mr. Zaid has no idea if it will catch on or if it can even make money. Canadian VCs have told him, "prove to us you have a business model and can get revenues." Mr. Zaid instead raised more than $17-million (U.S.) from such U.S. high-tech luminaries as Yahoo CEO Marissa Mayer and Google's Eric Schmidt.

It takes a strong stomach to invest in startups, but Silicon Valley is full of people who do. "That's where people dare to dream big and they'll fund you earlier based on a vision and a dream, rather than proving revenue or a business plan," Mr. Zaid said. Such leaps of faith have turned out well for investors in Amazon, Skype, Facebook and others. In the Valley, "people want to fund things like behaviour change, changing how people think about things like cars. In Canada, there isn't investor appetite for that." If there was, would he return? "Definitely."



Some U.S. venture capital has found its way into Canada, investing particularly in tech companies. Some examples:

Shopping around

Shopify Inc., an Ottawa-based company that provides its online shopping platform for business to sell goods on the Web, counts U.S.-based Bessemer Venture Partners among its funders.

Secure investment

Fixmo Inc., which makes security software for mobile devices and is based in Toronto and Sterling, Va., raised $23-million in new funding last year, with Kleiner Perkins Caufield & Byers of Menlo Park, Calif., among its backers.

Novel idea

New York-based Union Square Ventures, which has previously invested early in online successes such as Twitter, Tumblr and online craft sales site Etsy, recently led a $3.5-million investment in Toronto-based Wattpad, which allows anyone to author an e-book or read one.

Tweet deal

Domestic OMERS Ventures put $20-million into Vancouver-based HootSuite Media Inc. in a landmark deal earlier this year, but the company, which provides a social media management system for businesses, counts San Francisco-based Blumberg Capital among its primary investors.

Seeding the cloud

Desire2Learn Inc., which provides cloud-based online learning platforms and is based in Kitchener-Waterloo, Ont., just last month announced an $80-million round of funding, with U.S.-based New Enterprise Associates as well as Canada's OMERS Ventures.

Follow Sean Silcoff on Twitter: @SeanSilcoffOpens in a new window

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