Canadian venture capital industry displaying encouraging signs of sustained recovery

Canada’s venture capital (VC) industry appears to be experiencing a gradual return to health after the dramatic downturn in financings over the past three years. The latest data from Macdonald & Associates Ltd indicate that the level of investment has increased for the second quarter in a row, spurring cautious optimism that the recovery can be sustained.

For the quarter ended ending June 30/04, $375 million was invested in 202 Canadian companies, up 48% from the $274 million in the same quarter last year. While that’s a far cry from the $1.85 billion invested during the dot com-fuelled fourth quarter of 2000, it represents a return to 1997 levels before the high tech enthusiasm and the dot com mania grabbed hold of the VC industry (see chart).

“One swallow doesn’t make a spring but the expectation is that investment is picking up gradually after 12 quarters in which investment of VC declined,” says Dr Robin Louis, president of the Canadian Venture Capital Association and president of Ventures West Management Inc. “For the third and fourth quarters we think there will be real growth. We’ve been pretty busy here (at Ventures West). The typical pattern is a summer slowdown and then a surge in the fourth quarter driven by labour sponsored funds which have pacing requirements.”

IT DOMINATES QUARTER

In the latest quarter, 54% of all disbursements were captured by the information technology sector, compared to 40% in Q1/04. The IT sector saw $203 million invested in 81 companies, compared to $163 million in Q1/04. Within the IT sector, semiconductor firms were particularly strong, capturing $55 million, followed by computer software companies with $52 million.

Biotechnology firms attracted just $55 million in Q2/04, a steep drop from Q1/04 when $178 million was invested. Louis says variation between quarters is normal and points to the longer term track record of the sector.

“The percentage of VC going into biotech has increased from 15-20% in the late 1990s to 30% right now,” he says. “There’s a recognition that Canada has biotechnology strengths coming of our universities, especially Vancouver and Montreal.”

Despite the encouraging growth of VC investment, Louis says there are two areas that are of concern. One is the level of VC being raised by the industry. In Q1/04, the industry raised $317 million, meaning there was a net outflow of capital in the industry.

The second area of concern is the sheer size of the Canadian VC industry and its ability to provide sufficient financing for later stage investments.

“Big amounts for later stage funding is hard to come by in Canada. The industry is about half as large as it should be compared to the US,” says Louis. “Companies being formed in Canada have to be competitive to those in the US. But where the money goes in Canada versus the US is very different. About 20% of US VC goes to early-stage companies whereas in Canada it’s close to 50%. The trouble for Canada is, you’ve used up half of the money and there’s not much left to fund those companies at the later stages.”

With continued softness in sectors such as IT and biotech, non-technology industries account for a significant share of disbursements. In Q2/04, they accounted for $108 million or 29% of the total, compared to 18% during all of 2003.

NEW SOURCES WELCOME

Louis says any initiative that injects more money into the industry should be viewed positively and he welcomes proposals such as the roundtable report sponsored by the Advisory Council on S&T (see lead article).

Q2/04 data show that more than half of the firms receiving VC were at an early stage of development, accounting for 41% or $154 million in disbursements. Of that early-stage funding, however, seed-stage firms received only a small fraction. The data lends credence to the emerging consensus that a critical gap remains at the seed and pre-seed stages, requiring public participation to ensure that those firms are able to secure financing.

Labour-sponsored venture capital corporations and other retail funds account for the single largest share of investment in Q2/04 at $135 million or 36% of the total. The share of disbursements made by US VC experienced a quarter-over-quarter drop from $163 million or a 40% share in Q1/04 to $64 million or a 17% share in Q2/04.

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