Oh, Canada:The growth of the venture capital industry is making slow but steady progress in the Great White North –

Unlike the United States venture market, where fund-raising figures have plotted a course headed straight to the heavens and stayed the path for the better part of the past decade, corresponding Canadian figures, compiled by Toronto-based information firm Macdonald & Associates Ltd., trace a more gentle upwards slope of slow but steady growth.

The continued return of Canadian corporations to VC investing and a hot technology sector have served as catalysts for this expansion, which saw total capital under management increase 100% between 1994 and 1998, reaching C$10 billion last year (all figures are in the Canadian dollar, which was valued at $1.48 at press time, unless otherwise noted).

However, the Canadian private equity market also has experienced its fair share of growing pains. Although more deals were completed in 1998, less capital was invested. Canadian firms invested a total of $1.66 billion in 1,074 rounds of financing last year, an increase from $1.82 billion in 931 deals in 1997. By comparison, U.S. firms invested $23.71 billion (U.S. $16.02 billion) in 3,470 rounds. Canadian performance can be attributed to hindering government regulations on labor-sponsored venture firms, which are the most active VC investors in the Canadian market, and some anomalous, large deals completed in 1997, which skewed the figures for that year. Despite the problems and aberrations, many Canadian VCs remain optimistic about their industry’s prospects and enthusiastic about the signs of its maturation.

The Early Bird Gets the Worm

Canadian VCs were quick to downplay last year’s decline in disbursements. Macdonald & Associates attributes the 9% drop-off to a decline in large-deal activity. For example, two Toronto deals, Indigo Books & Music Inc. and Playdium Entertainment Corp.’s Sega City, each raised $25 million in private placements in 1997. In the absence of large deals like Indigo and Playdium, the average deal size in 1998 dropped to $1.5 million, from just below $2 million in 1997.

“There were a couple of things in 1997 that were anomalies,” says Ted Anderson, a senior vice president of Ventures West Management Inc., a Toronto-based early-stage technology investor. “Otherwise, there’s been a pretty steady trend in the number of dollars invested.”

Another factor contributing to the decline in disbursements last year was the rise of early-stage investing in Canada, says Mary Macdonald, president of Macdonald & Associates. Several new seed funds emerged in the last two years, investing smaller swatches of capital and pulling down the average deal size.

Early-stage financings, defined by Macdonald & Associates as deals between $10,000 and $15.5 million, accounted for 41% of the 1,074 deals, but only $579 million was invested in them. In 1998, 39% of all deals were classified as early-stage, accounting for $659 million. The average early-stage deal last year dropped to $1.3 million from $1.8 million in 1997.

“It’s a sign of [the Canadian venture market] maturing,” Ms. Macdonald says. “It shows that investors know how to invest in [the seed] stage.”

Spreading the Wealth

The spread of venture capital investing into more remote areas is another indication of the Canadian industry’s growth. Smaller provinces such as Atlantic Canada and Alberta each saw deal activity increase. Deal flow in Atlantic, dead last in all disbursement and deal figures in 1997, jumped 71% to $34 million last year, to outpace Manitoba and equal Saskatchewan. Alberta saw its local disbursement figure jump 50% to $93 million in 1998.

“At one time, all the funds could be found in Toronto, Montreal and Vancouver,” says Ron Begg, president of the Canadian Venture Capital Association and president of Working Ventures, Canada’s largest nationwide labor-sponsored fund. “Canadian funds are spreading out.”

Despite the emergence of funds in less traditional areas, the big two provinces – Quebec and Ontario – continue to dominate the market, accounting for 73% of all deals and 70% of all dollars invested. The two provinces are home to most of Canada’s labor-sponsored funds, which continue to control more than half of the country’s $10 billion under management. However, each market experienced very different fates in 1998.

The number of deals in Quebec rose 32% to 511 last year, from 387 in 1997. The province also experienced a 15% rise in disbursements, with $630 million invested. Conversely, Ontario saw financings increase to 573 last year from 259 in 1997, but less money invested – $531 million – a drop of 25% from 1997’s $704 million.

Laboring for Consistency

The main reason for the discrepancy between the trends in Quebec and Ontario is the heavy concentration of labor-sponsored funds in the two markets. Labor funds – mutual fund-type vehicles that offer generous tax credit packages to Canadian individual investors – were created by the Canadian government in 1989 to help stir the country’s stagnant venture capital market. However, after five years of unprecedented fund raising with a disproportionately low pace of investment activity, the Canadian government set up a series of restrictions and fines to punish labor vehicles that did not invest quickly enough.

The result has been a rise-and-ebb effect on the Canadian venture market. Labor-sponsored vehicles will go through contrasting periods of fund raising and investing, all but halting on one end while they concentrate on the other.

Some fear that the uneven inflow and outflow of capital in the Canadian private equity market caused by the way labor funds operate under the new regulations will have a negative effect on Canada’s growing technology sector. “It does not allow the market to mature,” says Minhas Mohamed, the founder and general partner of MM Ventures, a Toronto firm specializing in debt financing and venture leasing to Canadian information technology and biotechnology companies. “Good companies don’t get funded, and bad ones do.”

Most Quebec-based firms were in fund-raising mode in 1997, lowering the disbursement numbers in the process. Last year, those firms started to put that money to work. Ontario firms concentrated on fund raising in 1998 and invested more in 1997.

“Ontario is experiencing a real tightening of liquidity, and it’s reflected in the disbursements numbers,” Ms. Macdonald says, adding that labor funds are very important to the market and fund raising precluded investing last year.

It remains difficult, however, to gauge how exactly the government-imposed penalties have affected the way labor funds invest. “Other than anecdotal evidence, can you say the new regulations have really skewed the market?” Mr. Anderson asks. “Most of the [labor] funds have ignored the penalties … [rather than] do stupid things to get money out the door.”

In fact, labor funds have fallen behind corporations in terms of disbursements. While controlling about half of the $10 billion in venture capital under management in Canada, labor vehicles invested only $456 million last year, a 32% decrease from 1997. Corporate investors, meanwhile, invested almost $500 million, an increase of 34%. Corporate investors funded 30% of all deals last year, while labor vehicles backed 21%.

Tech Drives the Market

A burgeoning interest in technology-based businesses continued to affect Canadian venture investors last year. The computer-related sector, spurred by strong e-commerce and software industries, dominated more than one-quarter of all venture disbursements, securing $387 million in 244 rounds of financing – an increase of 28%.

“Canada has really evolved its technology sector,” Mr. Anderson says. “Ten years ago, we were just investing in good ideas. Now we have critical mass. The money is following the maturation of an industry.”

Surprisingly, however, the Canadian biotechnology sector has reaped the second-largest percentage of 1998 venture dollars. While their U.S. counterparts struggled in 1998, Canadian biotech firms flourished, attracting $235 million and 14% of all disbursements, a 42% increase from 1997.

Quebec’s increased pool of available capital likely had a positive effect on the biotech industry, Ms. Macdonald says. Montreal-based McGill University’s strong life sciences program and local government tax breaks intended to spur research and development in the province have attracted several biotech-focused funds there.

“Canada has some world-class science centers … a reasonable entrepreneurial base, and the rate of start-ups is higher than in the U.S.,” said Steve Burrill, chief executive of San Francisco-based biotechnology investor Burrill & Co. The firm, which the Royal Bank of Canada backed with $10 million as a limited partner, will scour Canada for good deals, although it has not invested in the market yet.

And behind the strength of the technology and biotech industries, Canadian investors believe the VC market will grow. “The … [VC] infrastructure has grown quite significantly this decade,” says Mr. Begg, adding that there is a healthy capital inflow and that Canadian VCs are becoming more outward- looking, seeking foreign co-investors that portfolio companies can leverage when they expand internationally.

“Canadian VCs are becoming more aware that venture capital is a global asset class,” he explains.


Early-Stage Activity Increases

1998 1997

Financings Investment Amount Financings Investment Amount

Stage # % # % $(M) % # % # % $(M) %

Early Stage 440 41 666 44 579 35 367 39 596 44 659 36

Expansion 487 45 684 45 880 53 424 46 585 43 949 52

Acquisition/Buyout 36 3 49 3 77 5 39 4 57 4 98 5

Turnaround 28 3 38 2 22 1 59 6 75 5 36 2

Other 83 8 92 6 97 6 42 5 53 4 79 4

Total 1074 100 1,529 100 $1,655 100 931 100 1,366 100 $1,821 100


Computer-Related Leads the Way, but Biotech Strong

1998 1997

Financings Investments Amount Financings Investments Amount

INDUSTRY # % # % $(M) % # % # % $(M) %

Biotechnology 123 11 217 14 235 14 79 10 166 12 203 11

Medical/Health Related 85 8 135 9 153 9 56 7 127 9 180 10

Communications 69 6 102 7 150 9 59 7 114 8 140 8

Computer Related 244 23 377 25 387 23 191 24 358 26 466 26

Electronics 93 9 139 9 182 11 61 8 115 8 119 7

Energy/Enviro.Technology 23 2 32 2 17 1 37 5 47 3 53 3

Industrial Automation & Equip. 27 3 40 3 34 2 17 2 29 2 35 2

Total (Technology) 664 62% 1,042 68% 1,160 70% 500 63% 956 70% 1,197 66%


Consumer Related 74 7 81 5 98 6 56 7 68 5 97 5

Manufacturing 149 14 174 11 194 12 112 14 155 11 222 12

Miscellaneous 187 17 232 15 204 12 126 16 187 14 305 17

Total (Traditional) 410 38% 487 32% 496 30% 294 37% 410 30% 625 34%

Total 1,074 100% 1,529 100% $1,656 100% 794 100% 1,366 100% $1,821 100%

Source: Macdonald & Associates Ltd.