Hello, U.S. Investors: Cross-border investing is building as more U.S. firms realize there are deals to be had in Canada …if they trek their way up to the Great White North. –

When Paul Chen, CEO at Fortiva Inc. in Toronto, went shopping for a Series A round for his fast-growing startup, he received plenty of interest from venture investors on both sides of the U.S.-Canadian border. U.S. firms were especially interested, he says, because Fortiva makes software used to archive corporate e-mail. Such tools are a must for many U.S. businesses, given the regulatory and litigious climate in the United States. Plus, 90% of the market for Fortiva’s products lies on the southern side of the border, according to Goodmans Venture Group in Toronto, which bills itself as Canada’s leading venture advisor.

So it might have seemed natural if the Canadian Chen relied on American dollars to fuel his startup activities. But when it came time to settle on the investors, Chen gave the brush-off to the U.S. money holders. Chen instead went with a Canadian-led investment team of McLean Watson Capital-which had invested $1 million in the company’s seed round-and Ventures West Management. The two firms invested $4 million in the company’s Series A deal in April.

“They knew me, and I knew them, so it was an easy decision for us to make,” says Chen, who had served as an entrepreneur in residence at McLean Watson. Plus, Chen had previously raised $30 million from McLean Watson, Ventures West and the Ontario Teacher’s Pension Plan for his prior company, FloNetwork, which he sold to DoubleClick for $80 million in 2001.

But despite how Chen seemingly has shunned U.S.-based VCs when funding his first two startups, the CEO says he’ll definitely be knocking on the doors of U.S. VC firms next time when the company seeks to raise a Series B round of financing.

Chen is all too aware that U.S. capital is smart money. Chen says U.S. firms are loaded with experienced partners who offer technical insight into the U.S. market that can’t be gleaned from Canadian GPs. “The U.S. market is key for us, so we want to have a good partner when we go into the United States,” Chen says. “It’s a given.”

The same can be said for most Canadian companies. Going forward, many expect that a lot more startups in Canada will be jumping to the United States with open arms in search of financing. It’s not as though there’s a shortage of Canadian VCs. But the pools of cash south of the border cannot be ignored.

U.S. Interest Grows

It wasn’t until the Internet boom of the late 1990s-following the success of Nortel Networks and other high-flying Canadian IT companies-that more and more U.S. venture firms opened their eyes and saw what investment opportunities and potential returns existed on the other side of the border. In fact, for much of the 1990s, U.S. investment dollars accounted for less than 5% of overall venture activity in Canada, according to Thomson Macdonald, a Toronto-based researcher (which is owned by Thomson Financial, publisher of VCJ).

But that percentage spiked to 40% in 1999, at the height of the Internet boom. It of course fell precipitously after the dot-com crash. But U.S. investments in Canada has recovered from the bust and for the past three years has accounted for about 20% to 30% of all VC-backed activity in Canada, according to Thomson Macdonald. And it’s bound to increase even more, says Mary Macdonald, president and CEO of the research group.

“American VCs are finding some great technologies and opportunities in Canada,” she says. “And Canadian companies need a significant amount of (foreign) capital to achieve their potential.”

Among the recent high-profile investments in a Canadian company by U.S. backers came in early 2004 when Aspreva Pharmaceuticals, based in Victoria, British Columbia, raised $57 million from a syndicate that consisted of mostly U.S. firms-Axiom Venture Partners, InterWest Partners, The Sprout Group, Thomas Weisel Partners and Vivo Ventures. The funding was the largest disclosed VC deal last year in Canada (see chart, page 47). But what really turned heads was when the company-which develops so-called “orphan drugs” that are often overlooked by large pharmaceutical companies-launched an IPO of nearly $80 million this year.

Andrew Waitman, managing partner at Celtic House Venture Partners, based in Kanata, Ontario, notes that VCs have few competitors when evaluating deals in Canada. As a result, he says that the valuations are better up north than you would find in the U.S. hotspots.

“It’s a bit of a blue ocean up here,” Waitman says. “It’s not like the red ocean in Boston or Silicon Valley where all of the sharks are tearing the flesh off the fish. We’ve got the best deals, and you get to pick and choose.”

A Cold Place

Can Be Hot

And the bargains are not just limited to emerging growth companies, says Alex Slusky, founder and managing partner at Vector Capital, a private equity firm in San Francisco that specializes in spinouts, buyouts and recapitalizations. The firm last year raised $350 million for Vector Capital III, some of which Slusky says may be invested north of the border. It won’t be the first Canadian investment for Vector. The firm picked up WordPerfect software parent Corel Corp. in a $100 million buyout two years ago and returned the company to profitability. “It had been undervalued and undermanaged,” he says of the Corel investment. And, according to Slusky, the investment had been under the radar because of it’s location in the Great White North. He says that when his team arrived to look at the company in February 2003, the temperature was a minus 35 degrees Celsius.

“Now minus 35 degree is cold, whether it’s in Fahrenheit or Celsius,” Slusky jokingly says. “And I know a lot of VCs here in California wouldn’t even dream of traveling there in February when it’s that cold. But we think Canada is a promising market, especially for software companies. And we’re delighted to compete with so few technology investors up there.”

Josef Volman, vice chairman of business law at Burns & Levinson LLP in Boston, agrees that it’s difficult to get VCs to travel to Canada, even those from firms in the Boston area, which by airplane is only an hour away from Montreal, Ottawa or Toronto, three entrepreneurial Canadian hotbeds.

His law firm, along with Canada Economic Development, the business development arm of Quebec, recently sponsored its annual U.S.-Canada venture capital pipeline event. This is the fourth year the gathering has been organized.

“The Boston VCs won’t go to Canada, so it made more sense to bring Canadian companies down to Boston,” Volman says.

There, the law firm puts the principals in front of potential investors from area VC and investment banking firms. Volman says he’s been surprised when Boston VC firms claim they didn’t know about the good deals they’ve missed with Canadian startups. Volman adds there is no lack of investment opportunities in Canada, which makes their reluctance all the more puzzling. “They ask, How come you didn’t show me that company,'” Volman says. “And I respond, I didn’t think you weren’t ready to invest in Canada.'”

The reluctance that Volman finds in Boston also is evident a continent away. Kevin Cable, executive vice president of the investment bank Cascadia Capital in Seattle, says that Puget Sound’s VCs have been eyeing the startup landscape in neighboring British Columbia for years, but no one has made an investment-until recently.

“It’s been a case of so close, yet so far,” says Cable, who notes that there’s a hub of business activity in Canada’s western most province. British Columbia boasts more than 5,500 technology companies, and area entrepreneurs start 550 new businesses a year.

But the drought was broken in February when Seattle-based OVP Venture Partners and Vancouver, B.C.-based Yaletown Venture Partners announced they had closed a $5-million first round deal with Victoria-based GenoLogics Life Sciences Software.

OVP General Partner Chad Waite says their investment was only the second made by a Seattle firm into Canada in the past five years. He says he’s kicked a lot of tires, but had been very, very careful to make sure that first investment he made above the 48th parallel matched the company’s requirements of being in the Pacific Northwest, being the first institutional money in a deal and being in the desired area of technology. The GenoLogics deal met all three requirements, he says.

“We’ve come close to making several investments in Canada,” Waite says. “But it always fell apart in the last stages after we did our due diligence. The perception of the market size for the companies’ products we were looking at just didn’t jibe with what we found.”

Steve Hnatiuk, a Yaletown founding partner, says he finds the dearth of investing on the part of Seattle firms odd, considering that Silicon Valley VCs have been closing deals in British Columbia and other Canadian provinces for years-doing deals even during the depths of the last recession.

Still, Hnatiuk says that an increasing number of Seattle investors are driving the 125 miles to Vancouver at least once a month, and he finds himself holding business meetings in Seattle at least every other week to seek out possible participants in upcoming deals.

“We realize that I-5 runs south as well as north,” he says. “We’re down there as much as they are up here, and we let them know we’d welcome syndicate partners with open arms.”

Hnatuik says British Columbia offers a number of attractive factors for U.S. investors. First and foremost, the Canadian dollar is cheaper, so U.S. investments go father. Plus, the province’s white-collar workforce is mostly college educated, and many principals involved in provincial startups are working on their second, third, and in a few cases, even their fourth companies.

Robin Louis, president of the Canadian Venture Capital Association and a partner at Ventures West, says the advantages hold true for all the other metro areas of Canada. Given its edge, he says that Canada’s a better investment than the United States. “We’re healthy, but not overheated,” Louis says. “We’re not seeing the competition-price escalations in valuations that appear to be happening again in the United States, so there are still bargains to be had.”

Indeed, Peter Carrescia, general partner at Montreal-based VenGrowth Capital Partners, says that more investors are starting to realize that Canada “has incredibly interesting ideas, especially in the areas of enterprise software and telecommunications.” For instance, VenGrowth is a backer of Opalis Software, a Montreal-based startup that is developing software tools to automate corporate data centers. VenGrowth invested a year ago when he says there was little competition, either in Canada or in the United States. “But the last time, I looked there’s been a couple of startups in the same space,” he says.

Meanwhile, VenGrowth has watched as a number of U.S. firms have jumped in to co-invest in their portfolio companies. For example, VenGrowth and the Business Development Bank of Canada were the sole backers of Neterion Inc.’s $9 million Series A deal in 2002. Since then, the company-which has facilities in Kanata, Ontario and Cupertino, Calif.-has held two more financing rounds and has raised additional backing from two Silicon Valley firms: JAFCO Ventures and Menlo Ventures. The company, which provides high-speed servers and data storage products, has raised $42 million in three rounds.

Plus, VIMAC Ventures has co-invested with VenGrowth in Nakina Systems, an Ontario-based Internet software developer that has received $10 million to date. Carrescia, though, says Canadian firms and companies are increasingly learning that the U.S. backing is essential, because of the expertise the firms bring to the deals.

“Where you see U.S. dollars is when a company has to get from the early stage to the next stage,” said Carrescia. “Canadian companies are often undercapitalized, so when they have to turn the rocket jets on, they have to turn to U.S. firms for closing the cash gaps that exist.”

Note: Unless noted, all dollar figures in the editorial stories and charts are U.S. currency.