Venture capitalists itching to invest

(July 27, 2004) Canadian venture capitalists (VCs) and private equity investors are eager to deploy their cash, if they can just find a promising business opportunity to fund, according to Deloitte’s Canadian Private Equity Outlook survey.

The industry as a whole is flush with cash, following a period of slim pickings for quality investment opportunities in the first quarter of the year. But with the market for initial public offerings showing promise again, VCs are competing over the quality deals that they do manage to find.

“Some of this increase in competition arises because we have recently seen a 32% drop in capital invested, from $588 million in the last quarter of 2003 to $401 million in Q1 2004, creating some pressure on equity funds to invest their money,” the Deloitte report says.

Not only has the overall value been cut, but the number of deals signed dropped to 165 from 237 in the fourth quarter of 2003.

“The larger VCs that have a specialization are able to offer the companies depth and additional resources on the next round, possibly another round or introduction to their U.S. contacts for larger deals,” says Kathy Jeramaz-Larson, vice-president and COO of Macdonald & Associates, a Toronto-based private equity research firm. “I think a lot of them are seeing some good deals right now, but I think a lot of them are bidding on the same ones.”

The competition may ease up in the future, as 63% of respondents believe there will soon be a round of consolidation among VC funds.

Earlier in the year, many VCs were content to manage their current portfolio of companies, taking a pass on more risky investments which came their way. Now, 45% of respondents are looking for new investments, compared to 37% in the third quarter of 2003.

“The available funds searching for quality investments, coupled with the strong income trust has triggered a flurry of activity likely to continue for the next three quarters,” said Michael Badham, a partner at Deloitte. “Any business opportunity which has the potential to go IPO through an income trust is of strong interest to private equity investors.”

“We’ve had a number of IPOs in Canada,” says Jeramaz-Larson. “They haven’t been stellar, but they’re a lot better than what happened last year — we’ve had an increase.”

Perhaps the most surprising aspect of the report, however, is where investments are being made. Typically, when one thinks of venture capital investments in Canada, one thinks of software or communications technology. But the leading sector for investment is manufacturing, attracting the attention of 18% of respondents, while the above mentioned sectors attract 17% and 16%, respectively.

“Manufacturing could be the current hot spot, driven by investee companies looking for efficiencies and growth via capital investment as opposed to increased labour spending, causing them to seek out debt and equity financing,” the report speculates. “Manufacturing companies are seeking out debt and equity financing for expansion.”

The Deloitte survey shows 55% of VCs are optimistic toward economic prospects over the next six months, with only 8% expecting a decline. This represents a very slight negative shift, from 60% and 4% respectively in late 2003.

“Competition in the investment environment remains tough as firms continue to invest, focusing on growth capital and the strong income trust market. Some market indicators, however, such as the recent corrections in the S&P/TSX Composite Index and the expected interest rate increases in the United States, should result in an increased level of predictability and a more stable economic environment through 2005.”

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