Given the enormous political and economic surprises that took place in 2015, hazarding a forecast for 2016 can seem risky, even foolhardy. That being said, throwing up one’s arms and hiding one’s head in the sand is never an option. The very process of considering how the future could unfold itself unlocks mental doors, thereby reducing the shock value of the truly unforeseeable.
With these thoughts in mind, four major drivers of what will happen in, and to, Canada’s private risk capital industry in 2016 can be identified. They are:
• The election of a new federal government hell-bent on undoing its predecessors’ policies;
• An explosion of activity, most evident in fintech, that is threatening to Uberize existing participants across a range of industries;
• The struggle between the proponents of Green and Clean vs. Black and Dirty;
• The Innovation Imperative, when set against grindingly slow growth in the economy.
The Ottawa scene
As is amply evident, there’s a new sheriff in town. The federal Liberal government that was elected last October has a host of priorities that distinguish it markedly from its predecessor. And, since the election, the government has set about dismantling the policies and the symbols of the ancien régime in single-minded fashion. For instance, long gone is any reference to the Harper government’s signature policy regarding venture capital, namely the Venture Capital Action Plan (VCAP), now a policy in search of a name.
While there has been much speculation about the possibility of a VCAP II, the federal government is unlikely to countenance such a model in 2016. That’s because of the VCAP’s close association with the Harper government and because VCAP I remains a work in progress, with half the funds of funds selected by the previous government still looking to get to final closes.
In much the same vein, two other VC initiatives of the Harper era will also probably be allowed to die quietly, namely the Start-Up Visa and Immigrant Investor Venture Capital pilot projects, neither of which have lived up to their initial promise.
The new government has committed to re-introducing the federal portion of the labour-sponsored venture capital corporation tax credits, thereby reversing a decision made by its predecessor. This commitment appeared in the Liberal campaign platform. It was re-iterated in a letter from the Prime Minister to the Minister of Finance and in the government’s responses to Opposition questions in the brief pre-holidays sitting of Parliament.
While fingers are crossed in labour-sponsored fund circles because of lingering uncertainties, it will be exceedingly difficult for Ottawa to back down from this commitment and so the measure is likely to be re-introduced in the 2016 budget. However, it remains to be seen whether the government will introduce a modified version of the program which dates back to the Mulroney era as the federal Finance Department remains deeply skeptical of its value.
Uberizing everything, including the financial sector
Despite the best efforts of regulators, who more and more resemble the famous Dutch boy with his finger in the dyke, disruptive change is bursting all over Canada’s financial sector. This can be seen in the rise of debt and equity crowdfunding, and in the explosion of investment in what has come to be called fintech.
Established industry players are now looking nervously over their shoulders at new competition from the likes of an Apple or a Google, and the raft of startups in everything from payments systems to foreign exchange.
2016 will likely see the emergence of several more joint bank technology initiatives as is now occurring on the blockchain-Bitcoin side. The days of a single major financial institution going it alone are gone forever, which will likely pose challenges on the competition policy front.
Additionally, the bank-insurer wars of years past are headed for history’s trash can with the emergence of the new Dark Force of technological disruptors. Even though fintech experiments in insurance have lagged other areas, notably payments and P2P lending, Sequoia’s recent US$13 million investment in an insurance disruptor is a sign that no area of financial services is immune to disruption. For this reason, there’s likely to be a plethora of insurance fintech experiments receiving funding.
The ready availability of food products at hardware stores and computers at pharmacies are evidence of the blurred lines between formerly distinct retail categories. These blurred lines will become increasingly prevalent throughout the private risk capital industry.
Thus private equity in Canada will follow the trend in the United States, where buyout funds have become more active players in the later-stage venture space. At the same time, because VC remains a hard sell to institutional and high net worth investors, venture funds will increasingly seek to brand themselves as growth equity or early-stage PE funds.
Exempt market dealers will also establish crowdfunding portals. 2016 will witness the growth in influence of cross-over investors such as hedge funds and wealth managers who are being increasingly attracted to the PE space in the ceaseless quest for alpha and non-correlated returns. Added to the mix will be up to half a dozen more special purpose acquisition companies (SPACs), yet another innovation that has lately arrived on the Canadian scene. Finally, there are more and more hybrids which may have fund of funds operations, direct VC investments, as well as infrastructure and hedge fund activities.
It will be harder and harder to tell the players without a scorecard!
I estimate the whole private risk capital industry is poised to grow by as much as 20 percent in 2016. This will occur for a host of reasons, including the weak performance of Canadian public capital markets last year. In addition, recently-released securities regulations on crowdfunding will contribute to growth, as will greater capital availability in the VC and PE spaces.
Significantly, every industry, not just finance, now realizes that it can be disrupted by the unrelenting advance of technology. This, in turn, will cause all manner of businesses to invest in potential unicorns in their fields. To the delight of governments, the mountain of cash that larger corporations have been accused of sitting on will now increasingly be deployed to R&D as well as to investments in earlier-stage companies.
This frenetic activity will be aided and abetted by the roll-out of private placement markets as well as enhanced competition to existing public markets from abroad, namely Nasdaq.
There will be a renewed push from the business community to get the Canadian Cooperative Markets Regulatory system (CCMR) up and running in 2016, despite the best efforts of proponents of the status quo whose most effective weapon may be to simply point out that this initiative was one of the Harper government’s. In the absence of a strong voice from business, the CCMR may ultimately be consigned to the ashcan of “their policies, not ours”.
All this movement will make it both easier, and more difficult, for those looking to raise capital in the year ahead. On the one hand, there are more players ready to consider investing in areas outside their traditional domains and more opportunities provided by the evolution of private capital markets.
On the other hand, identifying the proliferation of new players and determining which may best fit a particular firm or fund for can result in significant costs. However, in the ongoing battle for advantage over deal pricing, terms and conditions, between capital suppliers and those seeking capital, that advantage will now favour the latter as a result of the rise in supply, not to mention the continuing low cost of debt.
Green is the new black
Canadian governments, led by Ottawa, will display a newly-found activism across a range of environmental policy areas with greater resources available to Sustainable Development Technologies Canada (SDTC), and the establishment of a green infrastructure bank and green bonds. Governments will need to invest considerable sums in programs and tax measures to enable Canada to meet its Paris climate agreement commitments.
Governments will expect the private sector to follow their lead by holding out the prospect of a stable, predictable policy environment. That being said, private venture investments in cleantech will continue to lag well behind volumes in IT and life sciences. This means that government will turn to its own policy instruments, such as the crown corporations, to pick up the slack.
What’s more, and in parallel, governments will also begin to eliminate the tax and other policy preferences that underpin the carbon-based economy. This means that, despite the current lower valuations for oil and gas assets, there may not be much upside to investors as governments will strive to capture any rise in energy prices for themselves and the new, cleantech economy. In short, investor hold periods will likely be longer, favouring those with the longest-time horizon, namely the investment arms of Canadian pension funds.
Innovation: the most over-used word in 2016
The overall economy in Canada will remain sluggish in 2016, with sub-par growth, despite massive infrastructure spending and loose monetary policy. The oil and gas industry will continue to struggle under the combined weight of weak prices and governments intent on enforcing more stringent environmental regulations. As a result, the Canadian dollar will continue to trade well south of 75 cents vis-à-vis the U.S. dollar and inflation will remain subdued, as will real and nominal interest rates.
So, foreign private risk capital will continue to flood into the country looking for bargains in what might be labeled a reverse snowbird phenomenon. The proportion of foreign VC and foreign PE investment levels is set to cross the 50 percent threshold in 2016, and political alarm bells will ring more insistently.
At the same time, institutional investors will need to further increase their allocations to the alternatives asset space, including later-stage venture. This trend will further heighten the competition between pension funds and private equity funds.
Pressures will also grow for a policy response above and beyond the present commitments to infrastructure, and to tax cuts as ways of stimulating economic growth. Governments will seek to remedy the growth and productivity conundrums bedeviling the Canadian economy by means of a full court press on technology development. This will focus on the key areas of cleantech, IT and life sciences.
There already is a glimmer of this approach coming out of British Columbia and its recent announcement that it would be seeking a private manager for its new $100 million venture initiative. The chosen manager will also have a mandate to develop the province’s innovation system.
Inevitably, government will attempt to prime the growth pump through promoting investment in emerging technology sectors, at the expense of tax and programmatic measures that favor extractive industries. At the federal level, this will be achieved by collapsing the various boutique tax credits instituted during the Harper years and replacing them with growth-oriented tax measures, including:
• More favorable treatment for capital gains;
• Adapting its position on stock options in favour of a more flexible treatment for those building the companies of the future;
• Adoption of British Columbia’s angel tax credit;
• Revamping the SR&ED program.
There will be growing pressures for a wholesale review of the tax system set against this backdrop of stubbornly low growth and the perceived need to promote an Innovation Economy. With the federal Finance Minister set to announce a slate of independent economic advisers, we are likely headed towards the re-establishment of the late, oft-lamented Economic Council of Canada tasked with addressing the major medium-term economic challenges facing the country, including its poor productivity record.
All in all, it can be said with considerable confidence that 2016 will not be anything like 2015 for Canada’s private risk capital industry.
Overall, it will be better, but there will be a different suite of winners and losers this year than last. Cleantech, long-hold investors, crown investment agencies, plus those raising capital are likely to be in the winner category, while investors in extractive industries and those banking on the former federal government’s policies and programs will likely be among the top losers.
Richard Rémillard heads Remillard Consulting Group, a firm that specializes in research-based solutions to public policy issues affecting the financial services industry. He has over two decades of experience with financial trade associations, including the Canadian Venture Capital and Private Equity Association and the Canadian Bankers’ Association.
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