By Richard Rémillard
The Canadian federal government released its Request for Proposals (RFP) for fund-of-funds and fund managers wishing to apply for its Venture Capital Catalyst Initiative-2 (VCCI-2) program in mid-May. This program follows upon the Venture Capital Action Plan (VCAP) of 2013 and the VCCI-1 of 2017. All three versions have had the express purpose of strengthening the Canadian venture capital (VC) industry by injections of public monies in partnership with private capital sources.
VCCI-2 sets out a more ambitious target for attracting private capital than did VCCI-1 in that VCCI-2 requires fund-of-funds applicants under the $350 mm. Stream 1 to secure $3 of capital for every $1 from the federal government while VCCI-1 established a $2.25 to $1 ratio. At the same time, the financial incentive provided by Ottawa under VCCI-2 does not appear as generous as that under VCCI-1. Private capital remains the first to be paid with contributed capital returned plus 5% preferred return per annum under the VCCI-2 whereas the VCCI-1 fixed the amount at plus 7% per annum.
In addition, VCCI-2 requires detailed, intrusive some might find, reporting requirements regarding what the government refers to as Diversity, Equity and Inclusion (DEI) measures that are designed to address perceived, and admittedly, real shortcomings in the treatment accorded certain disadvantaged groups, particularly but not exclusively, women. Quite apart from the cost incurred in all this monitoring and reporting, it is assumed by the government that its own commitment to DEI will not have a negative impact on the private sector’s assessment of the attractiveness of the VCCI-2 from a financial returns perspective. The VCCI-2 DEI measures could be seen as a domestic companion piece to another initiative of Ottawa, namely the $300 million Equality Fund which was established to invest in womens’ movements in the global South and whose partners with Ottawa include one Schedule 1 bank and one venture capital fund.
This suite of DEI measures has been substantially expanded from the general call for greater gender parity under VCCI-1. Taken together, achieving the $3 to $1 target leverage ratio may prove difficult, if not unrealistic. As such, critics may point to similarly optimistic forecasts of private sector participation in other programs, notably the hotly-contested Canada Infrastructure Bank, wherein the federal government predicted the private sector would advance $4 for every $1 of public monies, a target that yet remains to be achieved.
Stepping back and looking at the forest not the trees, VCCI-2 reveals the essential small ‘c’ conservative of federal venture capital support policy going back to Prime Minister Harper’s VCAP nine years ago. The identical fund-of-funds overall structure, the goal of leveraging public monies with private capital and permitting a level of co-investment under VCCI-2 were also previously present. Of course, the world in 2022 is vastly different than it was even in 2017 let alone 2013. A prime example of the inflexibility of the program design has to do with the list of industries in which successful applicants are forbidden to invest. These include the usual cast of suspects, namely tobacco, alcohol, gambling, pornography and weapons.
With respect to the last-named, its exclusion from the approved list is passing strange. Global tensions are at record highs with the war in Ukraine and sabre-rattling between the US and China in Asia to say nothing of ongoing challenges presented by Iran and North Korea. In the wake of the Ukraine war, Canada has committed to raising its defence expenditures under NATO and appears newly-cognizant of the threats posed to its Arctic sovereignty. Ukraine has also shown the salience of new weapons such as drones as well as the importance of cyber technologies that can have both offensive and defensive applications. It is not clear why weapons developers would be considered persona non grata under the VCCI-2.
VCCI-2 is also a very big “L” Liberal entity that strongly reflects the ethos of the current federal government. Of course, it has long been criticized for neglecting National Defense and has been the subject of intense criticism on the procurement front and so the prohibition against investing in weapons firms under the VCCI-2 seems to provide further evidence of Ottawa’s reluctance in dealing with military hardware. That ethos extends to what it calls DEI which is a very important component of VCCI-2 and even includes a small $50 million amount for five to ten managers in this particular space. The political risk to the fund of funds, their LP’s and their investee companies and funds that choose to sign on to the VCCI-2 is that that very participation signals their concurrence with the political priorities of the current regime in Ottawa and in so doing makes less likely any future support program under a different government whose own priorities are likely to differ.
Fundamentally, VCCI-2 assumes that it is a needed program despite the world having undergone a 180-degree turn since 2013. It is incontestable that the VCAP was a necessary reaction to the nuclear winter in which the venture capital industry found itself. Similarly, the VCCI-1 successor program could also be considered useful in helping the industry gather strength. However, the past few years, and even with the eruption and persistence of COVID, have borne witness to strongly increased capital flows into the industry from a myriad of domestic and international (mainly U.S.) sources. The real issue is whether these inflows will continue unabated. Skeptics may point to the tech-laden NASDAQ which is in bear market territory which has prompted private asset holders to lower tech portfolio holdings by double-digit numbers and which may spillover into venture capital’s attractiveness as an asset class. On the other hand, technology adoption is fast becoming pervasive across multiple industries from financial services to agriculture as the Fourth Industrial Revolution unfolds. In this world, capital is likely to continue rushing into the venture space and a VCCI-2 may simply be redundant.
About Richard Rémillard
Richard Rémillard is President of Rémillard Consulting Group (RCG), a unique, Ottawa-based, bilingual consulting firm specializing in providing private sector, government & trade association clients with creative, research-grounded solutions to business issues and public policies involving the Canadian financial services industry. For more information: firstname.lastname@example.org
Source: Private Capital Journal