Deborah Baic/The Globe and Mail
Startup veteran Albert Lai is the sort of businessman who should be leading Canada out of the recession.
To fund one of his early startups, Mr. Lai turned to Canadian venture capital.
But for his latest venture, Kontagent, a social media analytics service, he didn't even bother trying.
Instead, Mr. Lai, who has sold two startups for seven-figure payouts and splits his time between Toronto and the San Francisco Bay area, turned to U.S. investors.
He doesn't need anyone to tell him the VC system in Canada is broken. "As an entrepreneur, the odds are already stacked against you," Mr. Lai, 30, said in an interview. "By being in Canada, the odds are even worse ... that's not to say that there isn't great talent here, there's just a lot of great talent that gives up and they relocate."
Mr. Lai is not alone.
Canada's venture capital industry was going from bad to worse and suffering from a litany of systemic problems long before the global economy took a nosedive last summer. Now, those on the front lines of financing the next generation of Canadian startups are worried the situation is growing increasingly bleak in a country where venture fundraising has declined every year but one since 2001.
As Finance Minister Jim Flaherty encourages banks to reopen the lending taps, venture capitalists in Canada are struggling to step up and fill the funding void.
In the meantime, many entrepreneurs are being forced to head south of the border for startup cash.
"If the word isn't 'broken,' it's 'highly challenged,'" said Kirk Falconer, director of private equity research at Thomson Reuters Canada. "It's important to say that global venture capital is challenged. ... There's a worldwide dilemma at the moment that is reinforced several times in Canada for the primary reason that we have a highly challenged supply side."
Between 2003 and the first three quarters of 2008, venture capital investment as a percentage of gross domestic product plummeted in Canada, while investment rose sharply in the United States, according to a recent study by Canada's Venture Capital & Private Equity Association.
VC investment in Canada fell 35 per cent (from 0.13 per cent to 0.085 per cent of GDP) in those five years, according to the report. In the United States, investment jumped 17 per cent (from 0.18 per cent to 0.21 per cent of GDP) over the same period.
Canada's venture capital community only reached critical mass in the mid-1990s, but many of the firms that raised money in the early years of the technology boom weren't able to fully capitalize on the investments they made. That led to a situation where further fundraising became more challenging, kicking off a vicious cycle of lower returns and diminishing investments.
Making matters worse, the market for acquisitions and initial public offerings has all but dried up in the face of the global recession, rendering the prospect of raising a new sizable startup fund even more difficult.
Indeed, those in the venture capital community worry the Canadian system is in need of serious repairs.
"We have very few domestic VC firms that have capital available to invest today," said Kevin Talbot, a managing partner with both RBC Venture Partners and the BlackBerry Partners Fund, a $150-million fund established last May.
"The reason is that they have not had the historical returns to justify continued investment by their institutional investors."
Mr. Talbot said the Canadian market faces particular challenges: Canadian VC funds are too focused on homegrown companies while ignoring more competitive businesses in other countries; those companies that do become successful often sell out too quickly; and Canadian universities simply aren't churning out entrepreneurs the way their American counterparts are. "My office is literally on the University of Toronto campus, and if my office was on the Stanford [University]campus, I would have lineups out the door of engineering and computer science students who would be pitching me their ideas," Mr. Talbot said. "Our university students go to school with the thought process of exiting and getting a job somewhere, not doing a startup."
Canadian venture capitalists need to follow the lead of VC communities in Boston and Silicon Valley, where large funds often make 100 bets, knowing that only 10 will succeed, hoping that one of those 10 evolves into the next Google Inc., said Rick Segal, a partner with JLA Ventures in Toronto. "The country doesn't embrace failure," Mr. Segal said. "Somebody doesn't say, 'This person started these things and they made mistakes, but now they're experienced, so let's try something again.' It starts from there. There's a natural tendency not to take a shot and see what comes out of it."
Although Kontagent's Mr. Lai feels the situation is improving in Canada, largely because the cost of starting Web-services businesses has fallen considerably. As a result, some smaller VC firms, such as Montreal Start Up, are stepping up to invest in smaller-scale and early stage startups.
At the last month's Mesh technology conference in Toronto, Mayor David Miller said Canada's largest city is suffering from a critical shortage of venture capital.
"We do very well providing financing for stable organization in Canada ... it's okay with some startups in places, but the gap in between - when somebody has shown that they can grow and get bigger - is really difficult and we need to do much better."