VC Makes Canada Hotter than the U.S. –

Unlike those of us below the 49th parallel, Canada did not suffer the indignities of the orange street wear of or endure the ubiquitous aggravation of the hand puppet. Because they largely missed the boat on the dot-com era, Canadian venture capitalists largely missed getting shipwrecked as well.

“During the euphoric years we fell significantly behind the United States in both capital invested as well as fund-raising,” says Brad Ashley, president of the Canadian Venture Capital Association (CVCA) and managing partner with Pariveq Capital Funds. “Come the tech wreck, the U.S. VC market has continued to tumble. What happened in Canada is that we had four successive quarterly drops and then we’ve had stabilization and an up-tick.”

VC investing in Canada dropped from the second quarter of 2001 to the third quarter of 2002, but it picked up in both the third and fourth quarters (see chart, next page). After bottoming out at $307.4 million in the second quarter, Canadian venture capital disbursements jumped to $339.3 million in the third quarter and spiked to $511.2 million in the fourth quarter-almost exactly where they were in the first quarter of 2002, according to the CVCA and research firm Macdonald & Associates.

Overall, Canadian venture capitalists invested $1.7 billion in startups in 677 companies in 2002, down from $2.6 billion in 743 companies the prior year. Even though the market contracted, it went back to its 1999 level, unlike the United States, where the venture market contracted all the way back to its 1998 level.

It’s true that Canada’s numbers look tiny when compared to the United States’ (where VCs did 2,700 deals valued at $21.2 billion last year, according to the PWC/VE/NVCA Money Tree Survey), but Canada’s venture business looks healthier when you focus on the size of the declines. To wit, the number of U.S. venture deals fell 44% from 2001 to 2002, but the number of Canadian deals fell just 9% percent during that time. Likewise, the total dollar amount invested by U.S. VCs dropped 52% from 2001 to 2002, but it decline 35% in Canada in the same period.

Canadian startups have seen a decrease in capital from U.S. venture firms, but while overall dollars dropped sharply since the gluttonous days of 2000, the makeup of foreign dollars coming in to Canada as a percentage of dollars invested has fallen only slightly. In 2001, 29% of money invested in Canadian startups came from foreign countries, mostly the United States. In 2002 that figure slipped to 27%.

“I think Canadian entrepreneurs hung in there pretty well with U.S. VCs,” Ashley says. “They know there are still attractive investment opportunities here for them.”

Speaking recently at the Go North 2003 conference in Montreal, Canadian native Barry Stewart, a managing director of New York City-based Dolphin Equity Partners, assured Canadian entrepreneurs that American VCs are looking for good value wherever they can find it. “Our firm looks for the same thing in Canada that we look for anywhere else,” he told the crowd. Stewart, who has one Canadian portfolio company so far, kept his calendar full of meetings with potential portfolio companies at the conference.

Other VCs at the conference shared Stewart’s emphasis on investing in good companies wherever they’re located. “The bottom line has not changed in 500 years, since Christopher Columbus went around Europe looking for venture capital,” said Mikko Suonenlahti, a director with 3i.

Martin Morency, CEO of investment network RFM, a sponsor of the Go North conference, predicted that next year’s event would be filled with European VCs looking to get into Canada and that half the presenting companies would come from outside Canada. “Things are definitely changing,” Morency said. “It is not business as usual.”

At least two foreign firms have opened shop in Canada in the past few months. Boston’s Venture Investment Management Co. (VIMAC), a private equity investor with more than $100 million under management, recently opened an office in 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 closed two funds that are both designed to bring technology from around the world to Japan. In February the firm closed two side-by-side funds: the Entrepia Fund II LP and the Le Fonds Entrepia Nord SEC, based in Montreal, for a total of $50 million. The two funds will be invested together in the same companies at the same pace. Entrepia decided to raise two funds so one could be Canadian.

In yet another sign of piqued interest in the Great White North, Boeing Phantom Works this year made its first Canadian investment. The Boeing R&D unit invested $10 million in Montreal-based venture capital firm TechnoCap. Boeing Phantom Works made the investment to take advantage of TechnoCap’s access to technology north of the border. “We are very interested in Canada,” says Miller Adams, director of Technology Planning & Acquisition with Phantom Works. “Our goal is to bring good technology into the company.” He adds that he expects Boeing to make another investment in a Canadian venture capital fund active in the manufacturing sector before the close of the year.

Despite the renewed interest in Canada, the market still has a long way to go. One of the main things holding it back is the lack of institutional investing in the asset class. The overwhelming majority of Canadian pension funds do not invest in venture capital funds. The government has had to pick up the slack: About half of Canada’s venture funds are labor-backed funds, which are made possible by government tax credits. These funds are restricted to investing in Canada or in the particular province that they were raised in, and they are also mandated to keep investing at a certain pace (see “Canada’s Joe Millionaires,” opposite page). The Canadian government also recently made it easier for people to invest in venture capital by lowering some of the barriers to cross-border transactions, such as tax laws that taxed foreign investors at a higher Canadian tax rate.

Another challenge for the Canadian venture industry-one all too familiar to the U.S. venture industry-is a weak telecom sector, which has soaked up about 28% of Canadian VC investment. “In the next 12 to 18 months I think we’re going to see a lot of bad news in the industry,” says Jean-Yves Lagarde, a general partner with Boston Millennia Partners. “We haven’t seen a lot of the reorganization and rationalization in the telecoms that we need to. You’re starting to see an acceleration of [venture-backed communications] companies realizing that they’re not going to make it.”

Overall, Canadian VCs seem more optimistic than their U.S. counterparts. And that has translated to a willingness to stick it out longer with their portfolio companies, says Les Lyall, a senior vice president with Working Ventures, a labor-backed fund with $264 million under management. “One of the distinct characteristics between American and Canadian venture capitalists is that we tend to be willing to stick with a company when it goes through a rough spot, more so than our American counterparts,” he says. “We’ve done well for our shareholders when we’ve adopted that kind of strategy.”