Key players work to fill Quebec’s growing need for seed and pre-seed VC investment

Quebec venture capital (VC) is displaying impressive resilience following the shock of the 2000 tech meltdown and dramatic changes in the industry’s fund composition prompted by a change in government. Following the withdrawal of many private funds from early-stage investing, several publicly supported players are stepping up to the plate while others are in limbo due to government-mandated restructuring.

The recent slowdown in deal flow has stranded many small firms and investment opportunities without financing, but the situation is beginning to reverse. While there is concern that the government of Jean Charest has taken too long to complete the industry’s restructuring, many are optimistic that the ingredients for a surge in new investment and company formation is underway.

That optimism was on display in Montreal earlier this month at the first Emerging Technology Venture Conference. Twelve emerging firms from Quebec, Ontario and British Columbia were showcased and one — Montreal-based Silk Display, a developer of plastic liquid crystal displays — received $1 million in funding from MSBI Capital before the conference was over.

Tempering the enthusiasm, however, is the dwindling number of VC players willing to invest in seed and pre-seed opportunities. Many VC firms that once invested upstream have retreated to less risky ventures and to focus on their current portfolios. That leaves organizations like MSBI, the Business Development Bank of Canada (BDC) and a handful of others with the task of making the necessary investments to position firms for the traditional VC market.

“Companies need to achieve significant milestones before VCs look at them or they go to VCs,” says Robert Inglese, BDC’s VP technology seed investments. “There is a good pipeline of opportunities. It’s difficult to get to series ‘A’ financing but when companies get there, the series ‘A’ players are hungry for business. They are looking for good deals and searching for the next investment opportunities but they are not prepared to go very early.”

The most recent data for Quebec show that in Q2/04, VCs invested $159 million of which $122 million was in later stage deals. The share of investment made by government funds continues to decline, from 32% of the total in 2002 to 14% for the most recent quarter.

BDC has emerged as a key VC player in Quebec and across Canada for firms seeking to bridge the early-stage commercialization gap. In the past two years it has invested $18 million in 15 seed or pre-seed opportunities representing a variety of technologies. Five have been made in Quebec and 60% are in university spin-offs. The last federal Budget provided $250 million for new venture investment, including $100 million specifically targeting seed and pre-seed. Another $100 million will be devoted to fund-of-funds investment, while the remaining $50 million is for direct early-stage and start-up investment.

FILLING THE EARLY STAGE GAP

Seed and pre-seed investing is also the space where MSBI Capital is active. MSBI was started with $11 million from Valorisation-Recherche Québec (VRQ) and now has $46 million in capitalization. It has invested $7 million in seven university spin-offs and expects to commit the remaining $39 million over the next three years. MSBI associate partner Chris Arsenault says VC firms investing at such early stages must be willing to devote more time and resources than was expended before the dot com bubble burst.

“In every case we have management at the seed stage whereas five years ago you would see VCs investing in very early and seed-stage deals with no management,” says Arsenault. “We think differently. You need management from day one or you’ll never start commercializing.”

MSBI is one of four valorisation organizations initially capitalized by VRQ to add value to technology opportunities emerging from Quebec’s universities and affiliated research institutions. SOVAR is a sister organization to MSBI —responsible for Laval Univ and the Centre hospitalier de Québec — and it has recently established a partnership with BDC. SOVAR identifies prospects at the research laboratories of Laval Univ and other research institutions within the Quebec City region. Inglese says the BDC-SOVAR partnership allows for cost-sharing of much of the required pre-seed work before BDC makes an investment decision.

“We fund projects at the pre-seed stage including market studies, market validation, and beginning the search for management to complement the founder scientists. We can also prepare an action plan to bring the project further to where we can finance the project,” says Inglese. “We try to channel the projects to the partnership and now we have other players involved. Fond Action is investing for the first time at the seed stage. It’s something they haven’t done before but being with BDC and SOVAR they are now doing that.”

GOVERNMENT DELAYS

The accomplishments of MSBI, BDC and others are being offset somewhat by changes to the provincial VC market initiated by the Charest government. Decisions to reduce the provincial government’s role in the VC industry were made following the release of the so-called Brunet report, named after its lead author, Pierre Brunet, chair of the Canadian Institute of Chartered Accounts (R$, March 18/04). Those changes involve the repositioning of several major funds, the spin-off of Sofinov from the Caisse de dépôt et placement du Québec, and the dissolution of Quebec’s Innovatechs, including Innovatech du Grand Montréal.

Ironically, two attempts were made to privatize Innovatech Montréal by its president Hubert Monseau. But they were thwarted by the previous Parti Quebecois government. With the long delay between the change in governments and actual decisions on changes to the VC industry, the value of its portfolio has plummeted, making it more difficult to find a buyer.

“(Monseau) had a plan to adopt but it should have been done at that time so that today he would be in a better position to take advantage of the opportunities that are here right now,” says Inglese. “If you look at the environment today, there are great companies at great prices, fair prices. It’s time to invest, it’s not time to restructure.”

While Inglese and others say the delays in restructuring the VC industry have caused damage, some significant changes are imminent. The government’s proposed fund of funds — Fonds d’intervention économique régional (FIER) — should be in operation this fall. The plan is for the government to inject $200 million into FIER, augmented by at least $100 million from private sources. Details are still being finalized, but FIER is expected to cover the whole VC spectrum from early stage to later stage, with funds dedicated to specific regions.

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