After a strong 2015, VCs are getting more selective about startups

The number of venture capital deals declined sharply in the last quarter of 2015 as investors pulled back and got more cautious

Laptops crowded onto a table covered with cables and water bottles

VC-hosted hackathons are a way for investors to spot developer talent and new ideas. (Luke MacGregor/Bloomberg/Getty)

A recent joint report from professional services firm KPMG International and U.S.-based CB Insights that analyzes global trends in venture capital in 2015 also gives a glimpse into the investment activity of Canadian venture capital firms.

For starters, the report shows that, in 2015, domestic companies were the biggest beneficiaries of Canadian venture capital investing. The top three homegrown companies that attracted the most venture capital investing were Aeryon Labs (the Waterloo-based drone-maker raised $45.9-million in growth equity), Coveo (the web-search company hailing from Quebec City raised $35-million in Series D funding), and Cymax (an online furniture retailer based in Vancouver raised $25-million in Series A funding).

Domestically, venture capitalists from Toronto did the most deals—13 rounds, worth $60.41 million total. Ontario’s capital was followed by Vancouver, which clinched eight deals, but at higher valuations: the total value of those deal was $60 million. Halifax came third, doing five deals worth a total of $13.1 million.

Canadian VCs were also one of the leading investors in companies developing digital health products, investing in 4 deals worth a total of $3.4-million, placing third below India, which invested $52.9-million and the U.S., which brokered 74 deals worth $918.5-million.

Chart showing number and value of VC deals conducted in Canada, Q4 2014 to Q4 2015

In the backdrop of all this, the report notes, the volume of venture capital investment in North America dropped off sharply in the final quarter of 2015, after enjoying three consecutive quarters of growth.

Investments peaked at $20.8 billion in Q3 and fell to $14.1 billion in Q4. In terms of actual deals finalized, it amounts to a decline from 1220 in Q3 to 1026 in Q4. While early-stage companies also struggled to get funding in last quarter of the year, the pulldown is more or less being blamed on by “a significant decrease” in the number and value of mega-rounds in the region, meaning companies that secure $100-million or more in a single round of financing.

According to the report, investors were spooked by a string of IPOs that fell short of expectations, concerns over whether valuations have reached bubble territory and uncertainty about whether the crop of new companies can actually generate revenues in the long term.

Driving the rise in VC investment was investors’ fear of missing out on “great growth companies,” with the highly competitive market forcing them to “[jump] into bigger and bigger deals earlier in 2015.” In light of last year’s data, the researchers predict that VCs will become more discriminating heading into 2016:

“Looking ahead, we expect to see more divergence and investors focused on investing in companies that have key fundamentals in place—positive cash flows, realistic burn rates and efficient operations. At the same time, with the anticipated slowdown and rising interest rates in the US, there will likely be an increase in M&A activity, even though VC activity may decline.”

But increased interest in mergers and acquisitions coupled with a lower loonie could fuel more interest in Canadian tech startups:

“Investors will likely be drawn to Canadian companies with proven track records and products, according to [Steve McCartney, of Waterloo-based incubator Communitech]. Those firms could include Plasticity, which makes a tool to monitor workplace happiness; drone maker Aeryon Labs; and Clark Robotic Systems. (McCartney has no position in any of these companies.) Fluctuations in currency can happen in a matter of moments, but going through rounds of venture capital investment can take months. The low dollar might simply prove an added incentive to close a deal that’s already underway, says McCartney.”