Small Business

Venture capital: Down, but not out

Written by Ian Portsmouth

During the happy days of the tech boom, it seemed as if an entrepreneur could scribble any dot-com business plan on the back of a napkin and raise millions in venture capital — then go public within a year. In 2000, Canadian venture capitalists invested $6.6 billion, mostly in Canadian companies, and raised $4.2 billion from investors eager to capitalize on the Net-fuelled frenzy. For Canada’s venture-capital industry, they were the best of times.

By comparison, these are the worst of times. In the 12 months ended Sept. 30, 2007, Canada’s VCs invested $2.1 billion while raising only $1.2 billion. If the downward trend continues, the broader economy will suffer.

“The real concern is whether we are going to be able to build strong, sustainable tech companies,” says Rick Nathan, managing director of Kensington Capital Partners in Toronto and president of the Canadian Venture Capital Association & Private Equity Association. “Where is the next Research in Motion going to come from?”

However, the situation might not be as grave as the figures suggest. Consider the apparent funding gap between venture-backed firms in Canada and the U.S.: whereas domestic companies raised an average of $4.6 million per round in recent months, their U.S. rivals raised $10 million — suggesting early-stage Canadian entrepreneurs work at a considerable disadvantage. But Rick Segal, a partner with JLA Ventures in Toronto, says the difference is more illusory than real: “Canadian deals tend to be cleaner and more conservative than those in the U.S.,” where large early rounds tend to be followed by smaller rounds, and deals are structured in a way that gives firms relatively high valuations that, in many instances, later decline.

Then there’s the increasing influence of foreign funds in Canada, which accounted for 41% of all venture investments in the quarter ended September 30, up from a historical average of 25%. “When foreign investment gets too big, you tend to lose companies to migration,” says Nathan. “They’re easy to move to Boston or Silicon Valley because they’re not built on fixed assets, they’re built on intellectual capital.”

However, Segal doesn’t believe foreign funds will reach the tipping point. “Their share won’t get higher because it would require deploying more of their people to Canada, and they have many other markets to cover as well,” he says. “What would concern me is if U.S. firms were coming here doing €˜recruiting shows,’ makingplacements on the condition that companies relocate.”

One thing’s for sure: Canadian VCs will continue to struggle with fundraising. Although venture-capital flows are cyclical, few Canadian funds existed before the mid-1990s, meaning they have yet to persist through a full boom-and-bust cycle. “Most firms can’t point to their success before the crash because there was no before,” says Nathan.

Time might be the only tonic. If Canada’s VCs can demonstrate the same stick-to-it-iveness of the entrepreneurs in which they invest, happy days will come again.

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