Buyout funding surges, venture capital flat

Canada’s venture capital industry showed some signs of improvement in 2006, though posting remarkably flat levels of capital investment, according to the annual report of Canada’s Venture Capital and Private Equity Association (CVCA).

The real surprise came in the buyout market, which the CVCA reported for the first time this year. Fundraising efforts by buyout firms hit an all-time record in 2006, topping $6.4 billion, four times more than the $1.6 billion raised by venture capitalists.

In 2005, buyout firms raised $1.4 billion, and set their previous record in 2003 by raising just over $3 billion.

“The buyout markets are showing dramatic growth in Canada, following global trends,” says Rick Nathan, president of the CVCA and managing director of Kensington Capital Partners. “Money follows returns; that’s true in any financial market. Performance in buyout has been very strong. Top quartile buyout funds in Canada were running net returns of 18% and up [in 2006].”

But even the record-setting amount raised last year did not meet the market’s needs, as the value of reported buyout deals reached $10.9 billion US, or about double the $6.4 billion raised in Canada when converted to local currency. The number of transactions also spiked, rising from 60 deals in 2005 to 90 in 2006.

Private equity buyout data can be tricky to judge, however, since details are not always disclosed and many smaller deals may not even be reported. Therefore, the $10.9 billion US figure is conservative.

“The stuff that is underreported is probably the smaller deals involving mid-market firms,” Nathan says. “It might affect the total volume of transactions that we report, but impact on the total dollar value is not likely that significant.”

Another emerging trend in buyouts is the increasing role of foreign investors, mirroring the much-reported “hollowing out” of corporate Canada by publicly listed foreign firms.

In 2006, Americans were behind 38% of buyouts (or $4.1 billion), as measured by value — nothing really new there. But non-U.S. foreign investors virtually came out of nowhere, making up 35% ($3.9 billion) of the value of Canadian firm buyouts. Only 27% ($3 billion) of buyouts were backed by Canadian private equity firms.

“If we want to maintain Canadian ownership of the companies that are being acquired by private equity firms, we need to do even more fundraising,” Nathan says. “We need to grow stronger Canadian investors for Canadian companies.”

But Canadian buyout firms were far from locked out of the market; they were simply taking a more global approach. Canadian investors took at least 70 companies private on a worldwide basis, paying almost $13.4 billion.

The level of venture capital being invested remained steady in 2006, at just over $1.6 billion, but the number of companies receiving financing fell to its lowest level in more than five years.

That’s actually a good thing, says Nathan, pointing out that the CVCA has been encouraging the VC community to invest larger sums in fewer companies. Larger investments in small companies can mean the difference between just getting by and actual success.

“I see this as a very positive trend,” he says. “In the past, Canadian entrepreneurs have suffered somewhat, relative to their competitor companies in the U.S., by having less capital available for growing their business.”

In Q1 of 2005, venture capitalists disbursed roughly the same amount of capital as in Q4 of 2006, slightly more than $420 million. The number of financings in Q1 2005 topped 220, while the number of deals in Q4 2006 was only 137, meaning the average financing value climbed from roughly $1.8 million to about $3.1 million, an increase of 72%. The historic average for financings is $2.7 million.

On a full-year basis, the average investment in 2006 was $4.2 million, compared to a $3 million average in full-year 2005.

“I should point out that this remains well below the comparable level in the U.S.,” Nathan says. “In the U.S. capital market, the average investment is just over $10 million US per company.”

He notes that one interesting trend developing in the VC space is the growth of financings for the environmental — or “clean tech” — sector, which saw an 83% increase in disbursements, though still accounted for only $119 million.

Foreign investors made up 33% of venture capital disbursed in Canada, up from 25% in 2005. American investors alone deployed $549 million.

Among North American jurisdictions, Ontario fell from seventh place to ninth in terms of overall disbursements in 2006, behind states such as Colorado and Maryland, while Quebec fell from ninth to the 10th spot. There was one bright spot in Canada, however, as British Columbia climbed from 20th to 17th, behind Minnesota and Florida but ahead of Arizona and Connecticut.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(02/13/07)