Quebec government considers sweeping recommendations to boost private participation in provincial VC industry

The Jean Charest government is moving closer to making major changes to Quebec’s venture capital industry, eliminating many of the publicly funded funds established during the tenure of the last government and challenging the private sector to assume a much larger role. The proposed changes represent a dismantling of Quebec Inc, the previous government’s highly interventionist economic development model and one in which S&T played a major, defining role.

The recommended changes are contained in the so-called Brunet report, named after its lead author Pierre Brunet, chair of the Canadian Institute of Chartered Accountants. Brunet was asked last July to chair a working group on the role of the Quebec government in venture capital and the report was issued late last year. Hearings are currently underway to gather input on which of its sweeping recommendations should be adopted. The changes could come as early as this spring in the next provincial Budget, historically unveiled between late March and early June.

If the recommendations are implemented, the number of financing vehicles will be reduced from 19 to two — a revamped Société général de financement (SGF) and a scaled-back Investissement Québec. The four Innovatech corporations would be dissolved, including Innovatech du Grand Montréal, which has played a highly effective role in building Montreal’s high tech industries. They would be replaced by a new public-private venture capital organization focused specifically on high tech, in which the provincial government would contribute $1 for every $2 in private sector equity. Under such a scenario, government would seek to cover costs and the private sector would claim all profit while assuming all losses associated with investment and operations.

Another key recommendation calls for the establishment of an ad hoc committee comprised of representatives from government and the business community. The new body would examine existing regulations to see how they can be modified to “support the creation of a private IT expansion fund for amounts over $20 million.”

The expansion phase for both information technology and biotechnology firms is seen as one of the main weaknesses in the provincial financing chain.

It’s estimated that the provincial government injected $4.6 billion in business financing into the economy between 1993 and 2002, creating or bolstering a wide variety of mechanisms including key venture capital organizations.

CHANGES PROPOSED TO SGF AND IQ

As one of the two public organizations recommended for retention, SGF would see a dramatic transition, withdrawing from projects where its contribution is less than $20 million and focus on large scale projects (certain sectors exempted). In a bid to restore it to profitability, it would undertake a multi-year divestment plan to free up liquidity and receive a one-time injection of $200 million in public funds.

The second mechanism slated for retention — Investissement Québec (IQ) — would also be streamlined to focus more on its core mission of loans and loan guarantees to smaller businesses. The Brunet report recommends changes in operations that would reduce IQ’s losses and make it self-financing within four years. It also urges a more selective approach to management support for its special projects, such as the FAIRE program.

The report’s stand on current government involvement in venture capital is in stark contrast to the previous government’s approach to social and economic development. The Parti Québecois regime blurred the distinction between the two and the Brunet report is a clear indication that a “significant cultural shift” is in order.

“Heavy government involvement in the Quebec market has led many investors to pursue goals in addition to profitability, mainly job creation and economic development,” states the report. “This approach flies in the face of normal market rules and makes private and foreign investors more hesitant and tightfisted, which is natural, given that they prefer experienced fund managers whose goal is to achieve returns.”

REPORT REACTION GENERALLY POSITIVE

Reaction to the Brunet report’s recommendations have been generally positive and relatively uniform across sectors. Academics are supportive of the need for more private sector VC investment, as are those funds already active in the market.

Where opinion diverges is on the question of timing. Réseau Capital, the provincial VC association, is recommending the creation of an action plan and a transition period of seven years, to avoid shocks to the existing system that could result in significant losses and company failure. In its presentation to the Public Finance committee, the association says the Brunet recommendations should assist in convincing the private sector to invest more in private funds, but offered the following caveat.

“The sudden withdrawal of major Quebec players before certain specialized private funds have been capitalized would create a vacuum in terms of the provision of funds,” stated the brief. “Réseau Capital recommends that the government ensure that the agencies affected by the revision of the government’s role in providing venture capital funds be able to respect their current commitments to the business community and their financial partners.”

The go-slow advice was reinforced by Innovatech Montréal, which attempted to go private three years ago but was stymied by depressed market conditions. In its brief to the Public Finance committee, its expressed support for the Brunet recommendations and proposed the creation of a “fund of funds” to stimulate increased private sector and foreign investment. But it also had words of caution over its proposed dissolution.

“(Innovatech Montréal) has played a significant role in developing the entire venture-capital industry. Its activities must be viewed from a broader understanding of its mission,” stated the brief. “It is appropriate to consider other means of continuing to develop the capacity for technological innovation within its territory.”

Innovatech Montréal’s role beyond that of a VC was also raised by the Board of Trade of Metropolitan Montreal (BTM). While supportive of a more targeted role for the government, it noted that dissolving Innovatech Montréal would leave a void of scientific and technical expertise in the region.

“The Board of Trade therefore insists that the dissolution of the innovatech corporations be preceded by a transition period making it possible to maintain this expertise in the Montreal venture capital environment,” stated the BTM brief.

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