A recently released report on the venture capital (VC) activities of the Business Development Bank of Canada (BDC) says the government-backed institution is properly focused but must take steps to improve its performance and effectiveness. Focusing on winners and exits, adopting best practices, attracting more experienced managers, investing larger amounts and taking more risk are among the 15-month-old report's recommendations, which was obtained by the Canadian Press news organization earlier this month through an Access to Information request.

Entitled Analysis of BDC Venture Capital Activities and Strategies and written by Dr Gilles Durufle and Gabriel Youssef, the report paints a generally bleak picture of VC in Canada. Recovery from the meltdown of the tech and dot com bubbles is taking far longer than anticipated. In addition, structural problems reflect the young age of the Canadian VC industry which didn't really develop until the mid 1990s.

BDC has had more than one year to respond to the report's finding and recommendations (see chart), and is reinforcing the triage (prioritization) of its portfolio and undertaking a systematic review of every investment the VC division has made.

"For some companies it doesn't look good," says Jacques Simoneau, BDC's executive VP investments. "We exited several companies last year (in addition to the seven it exited between 2002 and 2007)."

BDC will also be investing $75-million it received in the last federal Budget to participate in the creation of a privately run VC fund. Once operational late this year or early in 2009, the fund will have between $400 million and $500 million for later stage investment — a response to the report's observation that there is not enough available capital for larger series ‘B' follow-on rounds.

The gap between series ‘A' and ‘B' rounds is expected to become more acute as governments begin to withdraw support for labour-sponsored venture capital funds (LSVCCs). Since their introduction in the 1990s, labour-sponsored funds (LSFs) have cost Canadian governments more than $3 billion in foregone revenue. But instead of fulfilling their objectives of maximizing employment, shareholder value and economic development, LSFs have performed badly, achieving an average rate of return of nearly -7% between 2001 and 2005.

The report was undertaken in response to a July/06 directive from then Industry minister Maxime Bernier. Its aim was to analyze BDC's role, relevance and niche as a government policy instrument for VC. It is also intended to assess BDC VC's success in fulfilling its mandate, inform discussion on what its role should be in meeting emerging issues and provide a better understanding of BDC's value proposition in the market and with respect to other government investments.

The context of the report took into account the aftermath of the bursting of the technology bubble and the structural problems facing the Canadian VC industry. While Canada was not hit as hard as the US by the tech meltdown its recovery has been slower with poor returns and overall investment flat or declining, particularly at the seed and start-up stages. Canadian VC performance has generally been poor since its inception with part of the problem due to the failure to adopt best practices developed within the US VC industry and elsewhere.

"In general we're quite pleased with the assessment (of the report) … "VC in canada is a young industry. It's only 15 or 20 years old while in the US it's 50 years old.. Since VC works in 10-year cycles, we've only had two full cycles," says Simoneau. "It's a very important report and many of its findings are useful to us. It shows that we're doing well mostly, but it contains advice on how we can do better."

BDC implemented its current targeted strategy in 2002 which committed it to focus on SMEs in areas where the market fails to provide financial and other services and fill gaps left by private lending institutions. In 2004, the Liberal government provided $250 million so that it could provide pre-seed and seed investment, create specialized VC funds and make direct investments in early-stage and start-up companies. It was directed to:

* focus its commercial applications on key enabling technologies including life sciences, nanotechnologies, environmental technologies, information technologies and advanced materials.

* Build on existing initiatives for commercializing research performed in universities and other research institutions.

* Seek out stakeholders and outside organizations to gauge how it is contributing to leading-edge technologies, regional and sector development and foreign investment in VC.

Despite the poor returns BDC's VC division has experienced to date, there appears to be support for government intervention in the industry, particularly given the increasingly risk intolerant nature of the private sector VC.

"BDC's position in the market has gotten larger as many private players have declined and it's been there consistently. It plays a big role," says Rick Nathan, president of the Canadian Venture Capital and Private Equity Association and managing director of Kensington Capital Partners. "At the basic level, it's an active player in a number of emerging companies across Canada and not just the major markets. It's also an investor in funds of funds which is an important and separate contribution to the market. Right now there are very few doors for companies to knock on."

Simoneau says there are several valid explanations for BDC's poor VC performance but he adds that it's a problem that not exclusive to his institution. "Yes it is a problem and the whole industry has the problem," he says. "We must turn it around."

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