Canadian VC investment strategy hurting VCs and Canadian innovation: Report

Innovation in Canada will be seriously compromised unless domestic venture capitalists start throwing  big bucks into Canadian firms, suggests a new report. Big funding is one of the secrets of success of US firms, whether in Silicon Valley, or in other technology hubs in the rest of the US. In contrast, it is a challenge to get large funding tranches from Canadian VCs.

According to a report titled The Rich Get Richer: Are Canadian VCs Inadvertently Limiting their Returns?, author Charles Plant summarizes the formula for success of well-funded companies as follows: the more funding companies get, the faster they grow; the faster they grow, the more funding they get.

This pattern of success can be seen mostly in Silicon Valley companies, where the VC market is more mature, more experienced, and where VCs have larger portfolios. In contrast, Canadian VCs are more conservative in their funding strategy — they fund later, less frequently and with less funds.

This funding strategy ultimately hurts the Canadian VCs themselves and leads to loss of opportunities for Canadian firms because Canada is losing companies to US and other foreign companies that acquire them and turn them into global, world-class companies.

Plant, a senior fellow at Univ of Toronto’s Impact Centre, says that Silicon Valley companies are attracting more VC funding while other companies from the rest of the US are the next most attractive to VCs.  At the bottom of the priority order are Canadian companies.

“When you have lower growth, you can’t attract later-stage capital. … They (venture capitalists) are going for the best deals, and the best deals for them are the companies that grow the fastest,” says Plant, in an interview with RE$EARCH MONEY.

The report — one of a series produced by The Impact Centre — covers 587 US and 131 Canadian VC-backed or public companies. These companies include so-called unicorns — fast-growing private companies worth US$1 billion or more — a rare find for VCs. The report includes 90 unicorns from the US and only two from Canada. The report cites a recent report by the Business Development Bank of Canada that recently analyzed the internal rate of returns for VCs in Canada versus the US. It found that, while returns in companies in which BDC participated have been positive for the last two years at an average return of 4%, they’re dwarfed by the average of nearly 10% by US VCs.

In an earlier report, Plant notes that Canadian VCs are good at picking winners to invest in. However, they’re not good at growing these companies. In contrast, US and other foreign firms are good at investing in winners and finding firms to acquire. Their VCs, which are more mature and experienced and have more funds than Canadian counterparts, are good at growing acquired Canadian firms into world-class companies. Large companies are good for the economy, Plant adds, since empirical studies have shown that larger companies do more R&D, develop more patents, and generate better productivity.

The Rich Get Richer report notes that the average Canadian VC deal was only US$4.9 billion in 2016 whereas the average US VC deal was almost double at US$8.5 million. Plants says with limited VC funding available in Canada, VCs spread out their investments thinly to grow more firms and limit risks in their portfolio. However, this strategy is inadvertently hurting the VCs themselves because of their lower return on investment.

“We believe that Canadian VCs are inadvertently limiting their own returns. They are making strategic decisions to  finance companies later, less frequently, and with less money than companies in the US, thus potentially generating low returns that may be largely driven by their own practices,” the report states.

Plant adds that Canada is losing out in innovating because Canadian companies get acquired before they complete the innovation process. He says the innovation process is not complete until companies get their products out there in the market to be consumed by users who get value out of them. Some Canadian firms are attractive enough for acquisition simply because of their technologies and their potential customer base.

“We have great discoveries in Canada, but they get sold to US (and other foreign) companies to commercialize, so we haven’t finished up the innovation,” Plant says. “This is Canada’s failure – the failure to get things out in the marketplace.”

“Unless Canadian VCs start funding companies at levels on par with those seen in the US and particularly in California, we will continue to experience lower growth rates, the earlier sale of companies, and lower VC returns,” the report states.

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