U.S. Investors March To Quebec –

In 1775, during the American Revolution, the Continental Congress ordered the American army at Lake Champlain to invade Canada. The not-yet-infamous Colonel Benedict Arnold and Brigadier General Richard Montgomery took Montreal and lay siege to Quebec City. But Quebec’s fortifications were superb, and an American army that had been advancing easily was stopped cold by the harsh Canadian winter. The siege lasted for months until the American troops were finally repelled by British reinforcements.

Today, it’s American venture capitalists who are advancing into Quebec, but the reception they’re getting is anything but combative. A far cry from the British conscripts sniping behind stone walls, the current Quebec greets American VCs with low burn rates, a well-educated population, and a government that couldn’t be friendlier to entrepreneurs.

“There are lots of sound programs and a tax policy that is conducive to doing business,” says Bob McNeil, a general partner with San Mateo, Calif.-based Sanderling Ventures and chairman of Montreal-based Gemin X Biotechnologies. “The business environment is conducive to entrepreneurial companies in general. All in all [investing in Quebec] has been a good experience for us.”

From a VC funding perspective, Quebec has survived the current downturn better than Canada as a whole. Venture disbursements in the region dropped 27% to $519 million in 2002, according to Macdonald & Associates, compared with a nationwide decline of 35% in the same period. Last year the region captured 29% of all venture capital raised in Canada. More impressive is that Quebec saw 344 companies get funded in 2002 compared with 333 in 2001, while Canada as a whole saw that overall number drop by nine percent.

Moving Up North

Not surprisingly, a number of U.S. VCs are moving north of the border to take advantage of Quebec’s investment opportunities as well as its cheaper cost of labor. Over 400 American companies have been established in the province, and U.S. investors account for 66% of Quebec’s foreign investment.

Boston’s Venture Investment Management Company (VIMAC), a private equity investor with over $100 million under management, recently opened an office Montreal. VIMAC’s first major institutional fund received a $3 million investment from Montreal-based venture capital corporation Innovatech Grand Montreal. Joining VIMAC with new digs in Montreal is Entrepia Ventures, which recently closed two side-by-side funds for a total of $50 million. One of the funds is earmarked for Canadian investment.

With the Canadian dollar valued at approximately $1.40 to the U.S. dollar and Quebec’s labor costs about 30% lower than the U.S., the inexpensive price of doing business there is one of Quebec’s major selling points.

“Canada as a rule has cheaper labor than the U.S., and Quebec is probably cheaper than Ontario,” says Ron Patterson, a partner with Winnipeg-based MM Venture Partners, who at press time was ready to close a deal with a Quebec-based portfolio company. He adds that Quebec has been relatively insulated from some of the cost of living increases over the past few years. “You’ve not had the big run-up in housing prices there. A person can earn half of what they earn in the Boston or New York markets and probably have a better lifestyle,” he adds. MM Ventures has 10 of its 40 investments in Quebec.

Tax provisions play a big role in keeping the labor costs down, as companies doing research and development in Quebec can earn tax breaks from both the provincial and federal governments for up to 40% of the salaries of workers doing research and development and up to 100% of the expenses. “Companies are not expensive to buy and to run because of the huge tax credits,” says Daniel Laporte, a vice president with Montreal’s Solidarity Funds FTQ.

The government has also played an important role in developing the biotech sector.

“What stands out particularly related to Quebec is biotech. The government has made a concerted effort to fuel and fund a lot of these opportunities,” says Roger Flugel, a Sanderling associate, referring to the government’s Bio-Levier program. The $72 million per year Bio-Levier program matches foreign investments with loans up to $14 million, provided there is a minimum of $5 million investment.

“I think the venture capital model in Quebec and Canada is somewhere between the European model and the American model where the public sector still has a role as an investors in venture capital funds,” says Mikko Suonenlahti, a partner 3i based in Boston. Having deals in other parts of Canada, 3i is now starting to source deals in the province for the first time. “That’s good news because there is a lot of capital available for developing technology,” he says, referring to the Quebec and Canadian governments’ programs for encouraging investment and technology development.

Meanwhile, another advantage Quebec has is its longstanding relationship with France, with whom it shares a language and a culture. “I think one of the advantages Quebec has is closer contacts with Europe. You need to be international one way or another. If you’re from a bilingual or bicultural background, that certainly helps,” says Suonenlahti, who sits on the board of Ontario’s SiGe Semiconductor. “Montreal is a very sophisticated financial center.”

Indeed, lower-cost labor there doesn’t translate to lower quality. Quebec is home to a disproportionate number of research universities, such as McGill University in Montreal. According to the Quebec Government House’s business development and venture capital office, Montreal is home to 60% of Canada’s engineering firms. “The people are good, hard working. They have good universities. We’ve dome lots of trials there, and a lot of the research there is top notch,” says McNeil. Adds Patterson: “It’s not a really transient labor force. People don’t want to leave Quebec.”

Challenges Remain

While Quebec has a plethora of skilled workers that can staff high-tech companies, the province is short on entrepreneurial managers that can access markets and capital in the U.S. and abroad. Whereas serial entrepreneurs are abundant south of the border, venture capitalists regularly complain about the dearth of upper management available in the province. “There’s a scarcity of management teams when you compare it to the U.S.,” says Suonenlahti.

Part of addressing that problem means holding senior managers to a higher standard. “The demand has often been to have Francophones in senior management rather than best people, but I think that is starting to change,” says Patterson. “People are realizing that to grow companies, you need the best management. I know there is a real want to build up the best management pool. They can hire from the outside and have those people come in and work to train a crop of Quebec people to be senior management.”

Adds Laporte: “We have to attract, especially in life sciences, more people with business and marketing experience.”

And despite the recent interest in Quebec, there are still plenty of U.S. VCs unwilling to make the trek to visit companies in Canada. Montreal-based Aegera Therapeutics, a research and development biotechnology company that is raising its Series C round right now (and fully expects to make its targeted $25 million) is finding it difficult to attract non-Canadian investors. “As an American who moved up to Montreal I was expecting a sufficient market,” says Aegera CEO Michael Atkin. “There’s a very parochial [culture] that I hadn’t counted on.”

And some say the same government-backed pools of capital that have helped grow venture capital have strangled the mechanisms of the venture markets that weed out inefficient companies. “Life’s a double-edge sword,” says Patterson. “It’s great that there’s this money from the government that is not as demanding as pure capitalistic dollars. Companies and management teams can take this capital for granted, because these funds are there to create jobs. They’re hitting benchmarks just by staying in business and creating jobs rather than generating profits. Companies are not getting killed off, which wouldn’t have happened in a more pure capitalistic system.”

But while the government’s support can’t be overstated, Quebec has its share of private investors as well. About one-third of the capital raised in the region-$790 million of $2.3 billion, to be exact-comes from private investors. The real question is whether the interest in Quebec is a short-lived, cost-saving driven trend, or whether the VCs invading this region are here for the long haul. “The venture funds which are there are somewhat modest in size,” says McNeil, “so getting deep pocketed players is a little more challenging, though some of them are quite good. It’s not like having billion-dollar fund next to you.”

That said, general partners like McNeil aren’t planning for a short stay in Quebec. “We know we’re going to be there for the long run,” he says.