Venture financing shifting focus

The fourth quarter of 2005 offered a bounce in the venture capital industry, with rising distributions compensating for a soft third quarter, according to data collected by Thomson MacDonald and presented by Canada’s Venture Capital & Private Equity Association (CVCA).

Nationwide, reported Q4 disbursements totaled $520 million, up from $292 million in Q3. Due to the competitive nature of the venture capital industry, some firms do not participate in the annual survey.

On a year-over-year basis, the venture capital industry managed to end the year roughly level with 2004. The industry invested about $1.83 billion in 591 companies last year, compared to $1.84 billion in 581 companies in 2004. This levelling off reflects a similar trend in the U.S.

“It is encouraging to see a rebound in venture capital investment activity nationally in the fourth quarter,” said Rick Nathan, president of CVCA and managing director of Goodmans Venture Group. “However, it is important to look beneath the surface to identify the significant regional shifts taking place in our markets.”

While the cross-country picture for the VC industry last year appeared to present little change, there was a definite shift in where capital is being invested. For three quarters of 2005, Quebec was home to the largest portion of VC distributions — a position traditionally held by Ontario.

The government of Ontario’s decision to eliminate tax credits for labour-sponsored funds may have been a contributing factor to a sudden downturn in venture capital activity in that province.

In a typical year, Ontario’s retail VC funds see a spike in fourth quarter investment activity, as managers rush to meet their disbursement requirements. In 2004, for example, Q4 disbursements more than doubled to $104 million — and 2004 was a relatively slack year. In 2005, however, Q4 disbursements totaled only $41 million — roughly the same amount as in the three poor quarters of 2004.

In Q4 2004, Ontario was home to 48% of venture capital investments, while Quebec companies received 30% of disbursements. By the end of 2005, Quebec had received 39% compared to Ontario’s 38%. On a full-year basis, Ontario companies saw their share fall from 45% to 41%, while Quebec rose from 35% to 39%, while total disbursements remained essentially flat.

In-flows to VC funds actually improved in 2005, gathering $2.21 billion in capital compared to $1.67 billion in 2004. That marks the first increase since the 2001. But Nathan says Canadian VCs still tend to spread their money too thinly.

“A lot of people are calling for greater investment in seed-stage and early-stage companies,” says Nathan. “I think that part of the challenge in our market is that we have too much of our capital going into those early deals and not enough follow-through. There’s clearly a shortage of later stage capital.”

In the U.S., venture capitalists tend to invest more cash into few companies, ensuring they are fully funded. There are also usually more rounds of financing, Nathan says, whereas in Canada, the companies tend to be sold sooner, rather than receiving additional financings.

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