Ontario moves to reverse declining VC investment with creation of fund of funds

Modelled on Israeli Yozma fund

The Ontario government is investing $90 million in the long-awaited Ontario Venture Capital Fund (OVCF) to establish an anticipated $270-million pool of venture capital aimed at promising early-stage, tech-based companies. Commitments of $75 million in private equity from four major institutional investors brings the preliminary total to $165 million.

The fund-of-funds concept means the OVCF will be private sector led and designed to address the province's lack of high-risk capital and the paucity of management expertise required to add value for subsequent VC investment. In the coming weeks, fund backers will select a fund manager from applicants to a letters of intent solicitation held earlier this year. The successful fund manager is also required to invest equity, bringing the round one total to at least $180 million for a one-to-one ratio of public and private funding.

"My goal as a minister is, it should be two-to-one," says John Wilkinson, who was appointed on October 30th to head up the Ministry of Research and Innovation (MRI). "If we have pools of capital, that will send a very strong signal to venture capitalists around the world that we believe what's going on here … is business getting a good rate of return. That's what it's all about."

As the central plank in the Ontario government's Ideas to Market strategy, the OVCF marks a different model for Ontario's approach to early-stage company funding and formation. Alberta is also contemplating a similar approach following recommendations from a recent Task Force on Value-Added and Technology Commercialization (R$, September 19/07).

inspired by israeli fund

The primary inspiration for the OVCF is Israel's Yozma Group of VC funds. Yozma was created in 1993 and is credited with transforming the domestic landscape for private equity investments in technology areas where Israel has global leadership. The OVCF plans to include up to 12 individual managers with their own funds to create new funds and invest in existing entities, thereby expanding the pool of capital under experienced management available for early-stage tech plays.

"The success or failure of this is dependent upon our (the government's) ability to accept that it's market-based investments," says Wilkinson. "Traditionally, 20th century thinking is that government puts money out there from an economic development point of view and this is different. This is what we learned from the Israelis … This isn't about a bunch of politicians and bureaucrats making decisions over where the money goes. These are business people who understand, fund managers and senior vice presidents of investments for those companies. They the ones who are having a say. That's who we're listening to."

There's little doubt that the VC market in Ontario is in trouble. Amounts invested are far below those enjoyed before the tech meltdown of 2001 and existing VC funds are becoming more risk averse, typically preferring to make follow-on investments rather than seeding new and early-stage plays.

Another worrisome trend is the influx of foreign VC in the Ontario market. In the first three quarters of 2007, 55% of all VC invested in Ontario came from US and other foreign funds, which often require head office functions be transferred out of the province.

"The VC market in Canada is not robust enough. Financing and advice is not as good as it could be and certainly not as good as in the US," says Alan Hibben, CEO of RBC Capital Partners. "The province is trying to get more funds and fund managers out there … The technology base of the country is not the issue. If you ask, do we have enough management talent and broad enough entrepreneurial view, the answer is less positive."

move away from labour-sponsored model

Since the mid-1990s, Ontario has used labour-sponsored investment funds (LSIFs) to stimulate VC investment. Despite raising an estimated $2.7 billion in the province, LSIF returns have been poor, prompting the province to phase out the generous tax credit it offers to attract retail investors.

"We have to make sure that jobs that are going to come from (innovative) companies stay here in Ontario and are not drawn down to Massachusetts, Texas or California," says Wilkinson. "They should be right here so that's why we think there's a public policy interest for us to be involved, and as a catalyst as part of that solution to re-energize the venture capital market here in Ontario."

Last month, a group of venture investors called on Ontario to reinstate the LSIF tax credit, citing a dramatic decline in venture investment since the decision to phase out the incentive was made. They highlighted Ontario's decision to phase out LSIFs as the primary reason for weak VC investment, and cited high provincial corporate tax rates and "lethargy on the part of pension fund investors" as contributing factors.

For those outside the LSIF sector, the opinion of LSIFs is decidedly less positive.

"LSIFs are part of the mix but it's not a well thought-out mechanism," says Hibben. "That structure is magnificent is you are a fund manager. They made enormous sums."

For Hibben, the OVCF represents a far more effective approach to addressing the shortage of VC and management expertise.

"This is a good start. It's difficult to get governments to be effective in creating a venture capital industry," he says "Money is only one of the essential ingredients. There's management talent, the overall business climate, the intellectual property structure and the tax structure. There's also the view that we don't have enough rich people in this country."

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