By Richard Rémillard
With the current retrenchment of venture capital worldwide and also in Canada, it may be an opportune time to reflect on the state of the industry north of the 49th parallel.
Quite apart from the challenges posed by the collapse in valuations, the Canadian venture capital industry has four distinguishing characteristics:
- Domestic participants continue to play a secondary role overall with Q2, 2022 data showing an approximately 30% market share;
- In contrast, US funds account for the vast bulk of foreign investing activity while non-US foreign investors remain barely represented;
- Retail investors in the asset class are virtually absent in three of the four largest provincial markets, namely Ontario, British Columbia and Alberta;
- Corporate Canada is also underrepresented in the asset class – yet another instance of the oft-observed private sector business disinvestment in the country;
- Federal and provincial government entities and those backed by government financial support play the leading role amongst domestic funds. For instance, BDC alone accounts for approximately 10% of all venture capital investments.
Concerning the last point, the official version is that this extensive government activity is an unalloyed benefit to Canada, to the venture capital industry and to venture-backed Canadian firms in the broad technology sectors, including life sciences and clean tech. Funds and firms are able to access capital that otherwise would be unavailable and the economy as a whole reaps the rewards of an increasingly vibrant innovation economy. So: win-win-win.
However, an alternative perspective suggests that the status quo structure of the industry is suffering from the largely unintended consequences that have arisen and which may be impeding the further growth and development of venture capital in Canada.
Government generally enjoys a lower cost of capital than do firms in the private sector. This may have been of lesser importance in the just-deceased era of record low real interest rates but will be of increasing salience today and tomorrow as the great interest rate reset takes hold. As a result, Canadian corporations, ever suspicious of government, are likely to be even more wary of going head to head with government-backed funds in the months to come and ‘crowding out’ allegations may once again come to the fore.
Canada has seemingly paid little attention to attracting non-US foreign venture capital. On the one hand, either ease of access to US funds (and these funds’ corresponding interest in Canada) together with red flags around Chinese, Russian and Saudi capital seem to have bred a certain complacency . Or, our efforts at attracting material amounts of venture capital (either directly or via funds of funds) from Europe and elsewhere in Asia (Singapore, Korea) have been met with failure. As a result, Canada has a ‘dangerous dependence’ on the whims of US funds.
Finally, retail investors are largely absent from venture capital and only play a significant role in two provinces, Québec and Saskatchewan, where the Mulroney’s government’s experiment with Labour-sponsored venture capital corporations continues unabated. In this regard, it has been observed that venture capital as an asset class resembles something of a ‘gated community’, where only those individual investors who pass certain income and asset tests are allowed entry.
The concept of a ‘gated community’ has taken on more relevance today with the leading candidate for the leadership of the official Opposition Conservative party (Mr. Pierre Poilièvre) proclaiming his own opposition to ‘gatekeepers’ in key sections of the Canadian economy, including the central bank and municipal governments.
Gatekeepers, according to the Cambridge dictionary, are those who, ” …have the power to decide who gets particular resources and opportunities, and who does not.” As well, gatekeepers receive remuneration (‘tolls’) for their services. Government entities, by providing financing directly to venture capital funds and indirectly to funds-of-funds which, in turn, also invest in venture capital funds, have been set up as the ultimate gatekeepers of the domestic industry. The gatekeeping, nominally to ensure that capital flows into the most deserving funds (i.e., best-performing from a returns basis) has increasingly been targeted at financially-rewarding those who subscribe to the values and policy priorities of government. One need only scan the VCCI-2 RFP language or the mandate of British Columbia’s $500 million InBC vehicle (“InBC is an impact investment fund with a triple bottom line…”).
An alternative framework for the industry would be to put in place a structure that would be designed increase opportunities for retail investors and attract corporate and non-US foreign funds by taking those public sector vehicles private. For instance, BDC Capital, Ontario Capital Growth Corporation and Alberta Enterprise Corporation could be taken private and listed on one or more public stock exchanges via IPO’s. Stock ownership would be open to retail, corporate and non-US foreign funds. There is precedent in spinning out individual funds as BDC has already divested itself of two of its direct investing vehicles, namely Framework Ventures and Amplitude Ventures. In addition, it would be worthwhile closely examining the US BDC (Business Development Company) vehicle for its application to Canada. The approximately 50 US BDC’s that are publicly-traded have a market cap of US $57 billion and were expressly set up by the Congress in 1980 to fund US small and medium-sized firms and appeal to retail investors.
As one provincial Premier recently remarked concerning health care, ‘The status quo is not an option.”
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