Less cash for Canadian start-ups: CVCA

Venture capital investment dropped sharply in the second quarter of 2007 to $426 million, representing a decline of approximately 30% from the $606 million invested in the previous quarter and a 12% drop from Q2 2006, according to a report released by Canada’s Venture Capital & Private Equity Association (CVCA) and Thomson Financial.

Rick Nathan, president of the CVCA and the managing director of private equity fund company Kensington Capital Partners, says a robust first quarter brought venture capital investment in Canada to just over $1.0 billion for the first half of the year, significantly more than the $853 million raised in the first half of 2006.

Nathan says one quarter’s performance is not enough to judge whether venture capital will continue to head downward, but he does see some fundamental shifts happening in the Canadian marketplace — foremost of which is a lack of domestically raised venture capital. It appears the start-up market is becoming heavily dependent on direct foreign investment from private venture funds, particularly from the U.S.

“There’s no shortage of opportunities; there’s no shortage of entrepreneurs with great ideas and strong early-stage technology companies,” he says. “What’s happening is that there is a lack of capital here. The U.S. venture funds are viewing it as a market with very little competition for them to come in and find good early-stage companies. Their overall market share has been growing significantly in the last year and a half.”

The CVCA notes that in the companies they support, U.S. venture funds are investing more, with an average funding level of $9.8 million per company, 2.3 times the Canadian average investment of $4.3 million. The CVCA notes that this differential has been steadily narrowing in recent years after reaching a peak of 4.3 times in 2003. Ultimately, Nathan believes that the same resources are available to Canadian venture capital funds as are available to their U.S. counterparts due to a lack of confidence in investing in start-ups.

“Canadian venture capital investment never really recovered from the dot-com/telecom boom. When we got to the floor of that crash, which was roughly 2001 and 2002, since that point in time, the U.S. market has grown slowly and steadily, roughly 10% a year,” he says.

The difference, he points out, is that the U.S. venture capital market has a much longer track record — of about 25 years — which has been mostly positive, so venture capital funds have been able to tap into the enormous pools of wealth offered by large albeit conservative institutional investors such as pension funds.

“We just haven’t seen that in Canada. It’s been pretty much a flat-investment environment. So many people got hurt during the crash, they’ve been reluctant to invest,” he says. “Institutional money is the main source of capital in the States. In Canada we have a few other sources. There is some government money; there is some retail money that comes from labour-sponsored funds. We likely will not build a strong foundation here until we see greater participation from the Canadian institutional market. They want to see stronger performance before they commit more capital.”

The CVCA report also notes there’s been a significant regional shift in start-up investing. Quebec led the country in venture capital investment during the second quarter, pulling ahead of Ontario, which declined dramatically.

Seventy-one Quebec companies received $149 million in venture capital investment during the quarter. Total investment in Ontario amounted to $131 million in 34, a sharp decline from the $309 million of the first quarter, and a drop of 35% from the $201 million during the second quarter last year. Quebec was the 11th most invested in the North American economy; Ontario was 14th. British Columbia also cracked the top 20, at 17th place.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com