Canada’s late-stage ventures held back by growing capital gap: study

Even as venture investment in Canada is increasing, many of the country’s most promising tech companies face a funding gap at key points in their growth cycles, a new study found.

A report released today by Yaletown Partners said late-stage tech companies often lack the capital to leverage initial commercial success and pursue emerging-growth strategies.

Based on an analysis of more than 23,000 North American deals in the past decade and a half, the report found the financing gap for Canadian late-stage companies is most critical in the $5-million-to-$20-million range.

This gap has reduced many innovative companies to bootstrapping their growth. The result is often slower expansion and delayed exits, typically at lower values, relative to competitors.

Conditions have not improved with Canada’s robust VC trends of late, the report found. That’s because substantial dollar flows, reflected in the $2.7 billion invested in 2015, the highest in 13 years, have benefited mostly early-stage companies. Once startups enter a next stage of growth, there’s a very good chance they will run short of capital.

The funding picture for Canadian late-stage companies is perhaps clearest in relation to their cash-rich U.S. peers.

American companies are 2.6 times more likely to raise emerging-growth financings than companies north of the border, the report found. It estimates the Canada-U.S. gap in this area reached $1 billion in the past five years and will continue to increase by at least $250 million a year.

Striking a chord with VCs

The findings of the Yaletown study are striking a chord among Canadian investment pros.

Robert Simon, senior managing partner at BDC Capital, told PE Hub Canada that while a funding gap’s impact will vary by sector and development stage, he agreed that late-stage companies generally face a “competitive disadvantage.”

Robert Simon, BDC
Robert Simon, Senior Managing Partner, BDC Capital

“In our experience, the Series A and B rounds of mature companies are under-capitalized,” he said. “We definitely see Canadian companies raising less money than their U.S. counterparts, mitigated only in part by lower costs. The result is probably slower growth and less satisfying outcomes.”

Simon says that a remedy lies in more Canadian venture resources directed to emerging-growth opportunities.

In February, BDC Capital unveiled its second information-technology fund, earmarked for related funding challenges in the software space. The $150 million BDC Capital IT Venture Fund II will invest in growing revenue-stage companies in mobile, Internet, enterprise, cloud solutions and fintech.

Yaletown also recently launched its own emerging-growth fund. Set to raise $135 million, Yaletown Emerging Growth Fund will invest in intelligent-industry and intelligent-enterprise tech providers with go-to-market strategies.

Simon said a “sufficient number” of funds sized $100 million to $200 million is needed to effectively tackle the late-stage financing gap. He said such funds would help avoid over-reliance on foreign syndicate partners to capitalize deals.

‘Fantastic fund managers in Canada’

Michelle Scarborough, senior vice president of Kensington Capital Partners, agreed with Simon.

“We have a lot of early-stage companies that will need growth funding five years out,” she said. “If they’re well-capitalized, they’ll gain a competitive edge and get there faster. If not, they’ll miss out on potentially higher revenue multiples, and we may not see the talent and capital recycled locally.”

Michelle Scarborough 2
Michelle Scarborough, Senior Vice-President, Kensington Capital Partners

Like Simon, Scarborough says this challenge can be addressed by Canadian funds equipped to support tech companies across the investment continuum.

“We have fantastic fund managers in Canada, and it’s vital they have the capacity to be active across the landscape, investing alike in early-stage companies and late-stage companies,” she said.

Scarborough said the topic should be top of mind in Ottawa as it considers possible follow-up initiatives to the Venture Capital Action Plan, a program established three years ago to leverage private-sector participation in Canada’s VC industry.

VCAP partnered in the creation of four venture funds-of-funds, which together raised $1.35 billion in committed capital. They include Kensington Venture Fund, which closed at $306 million in March.

“It’s important to plan for what Canada’s innovative companies and the venture ecosystem will require to succeed in the years ahead,” Scarborough said. “This is a long game, not a short game.”

Photo of businessman jumping with ball and chain courtesy of ©iStock/cherezoff

Photo of Robert Simon courtesy of BDC Capital

Photo of Michelle Scarborough courtesy of Kensington Capital Partners