The Future of Venture Capital in Canada

There are a number of reasons why the Canadian venture capital industry is sputtering, but there are also solutions.

There’s no doubt that Canadian entrepreneurs like Jim Balsillie, Mike Lazaridis, and Terry Matthews have created world-class technology companies. There are wonderful things going on in Waterloo and Ottawa around these leaders.

Yet Canadian venture capital, especially in financial centers like Toronto, has been a failure. Why? There are four reasons:

1. It’s not just us.

Worldwide, venture capital won’t see a heyday like the late 1990s for quite some time. The VC markets in San Francisco, Boston, and New York are far smaller than they used to be, so it’s no surprise that Canadian VC has shrunk as well. Much like newspaper editors who expect people to pay for content again one day, digital leaders in North America have a wistful memory of the first dot-com boom, when companies like Boo.com, Streamline, and Scient burned through hundreds of millions of dollars per year chasing an updraft that wasn’t supposed to end. That’s just not going to happen again for at least a few decades, and it will involve a technology not yet invented, and likely not invented in North America.

All financial funds thrive on two things: putting a lot of money to work so that their management fees are enough to survive on, and getting handsome exits (IPOs, sales to larger companies) so that their investors make money and they get a good cut of that. The problem is that start-ups just don’t need the kind of money they used to. Most of the angels I talk to are being approached for $250K or so. Partially, that’s because that’s all start-ups can ask for, but it’s also true that things are cheaper now. Cloud computing and other ASP approaches have meant that infrastructure costs have plummeted, and competition from overseas developers have driven down development costs. Add to that a much, much larger pool of online-savvy talent than there was ten years ago, and you can develop a full online business for under $1,000. Businesses that I saw funded ten years ago for $1 to $2 million would now cost under $10,000 to get off the ground.

There are also far fewer financial exits. It used to be that you could IPO, or sell your start-up to one of a hundred different software companies or a dozen different portals. Now, there are no IPOs and the exits are primarily to Microsoft, Google (AdMob, Appjet) or Apple (Lala). Money doesn’t like to have such limited exit plans.

2. We Blew It.

VCs in Canada have a poor track record and haven’t earned further investment. Investors that put money into now-defunct VC funds are not all that interested in putting their money in the same place. Try googling the CVCA presentations from ten years ago to see names from a bygone era. Of the labour-sponsored funds, only GrowthWorks (nee Working Ventures) really remains, and of the independent funds, only Albright is really still active. And the recent activity of both has been largely confined to follow-on investments. Ten years ago, wealthy Canadians discussed investments in eBay and Yahoo at black-tie dinners. Five years ago, it was real estate. Now, the wealthy have money in China, gold, or in safe-haven investments like government bonds.

3. Conservatism is one of our most prized assets.

During the recent financial meltdown, Canada drew international praise for its financial conservatism. Our prime minister flew around the world being lauded for his foresight in keeping risky financial instruments in check. The reality, of course, is that’s just the innate nature of Canadian banking leaders.

People don’t change behaviour that’s been praised. So understandably, Canadian private equity is largely sitting out this round of high-risk investments. Long-time observers of the Canadian VC industry have noted that far more Canadian start-ups are being funded out of Boston than Toronto.

The surprising hero in this drama? The federal and provincial governments, who, through long-term initiatives, have set up tax credits and grant programs for cultural content and innovation. Programs like SR&EDs, Telefilm, and the OMDC are more geared toward projects than companies, but they still provide a welcome oasis for cash-strapped start-ups. And of course the Mars Discovery District is in a class of its own for providing funding, facilities, and advice. Political conservatives may bemoan the socialist leaning of our government, but when it comes to helping Canadian start-ups, government funding has been the most consistent north star.

4. Canadians don’t lionize entrepreneurs.

Important parts of the online world were virtually invented in Canada, yet media coverage is limited. The CPA world, where advertisers pay only for actual sign-ups, is dominated by companies like Azoogle (now Epic), Incentaclick (now CX), Neverblue, and Maxbounty, which are all based in Canada. Media companies like VerticalScope and RedTagDeals have also managed to achieve sizable success with nary a mention.

Why don’t we hear more? Because neither global media or Canadians themselves seem to care about Canadian stories. Similar to the world of music, where Alanis Morrissette and Avril Lavigne didn’t get noticed in Canada until they were being talked about by U.S. media, Canadian success stories aren’t “real” until they’re in the New York Times, Wired, FastCompany, or TechCrunch. I can think of only two recent examples of Canadian media properties designed to lionize Canadian tech entrepreneurs: Profit Magazine and Amber McArthur’s show on CityTV. Despite admirable journalism, Profit Magazine has managed to survive only through a sponsored controlled-circulation deal: few buy it at the newsstands. And Amber McArthur’s show was cancelled a few years ago because, despite having a fervent online following, no one actually watched it on TV. Canadians just don’t seem to want to read about tech stars who make good.

So what is a Canadian with a good tech idea to do? Two choices: move to San Francisco (the Albert Lai approach), or stop whining and start building (the Rick Segal approach). The first is self-explanatory, so let’s talk a bit more about the second.

Every week I meet a Canadian would-be entrepreneur who tells me about their dream and then bemoans the lack of local capital. In general, my advice is as follows.

First, no one invests in a PowerPoint presentation anymore. Use your own money and time to build some working version of what you have in mind. You can outsource all kinds of work to India and elsewhere for very little money to do this. The first version of your business will be wrong in some substantial way, and it’s unrealistic to ask an investor to shoulder that burden.

Second, seek the “angel economy.” If you know angel investors, that’s terrific, but I’m talking about people who have full-time jobs and will work for you on the side. This turns out to be very, very common, and can cut your start-up costs dramatically. Even using a friend’s office or spare room can get you going for pennies.

Third, investigate government programs. In general, the government funds projects, not businesses, so think about your company in terms of what projects might be applicable to various cultural or research funds. Some of these programs are tax credits, however, which can take years to collect. That doesn’t mean you shouldn’t apply to them, but know that they won’t have an immediate effect.

Last, seek professional money when it seeks you. When you have an idea with a hook, and enough real success (revenues, traffic, press, etc.) to merit attention, it’s time to do a real search. The first time someone asks you if they can invest, start reaching out to VCs in Canada, Boston, and San Francisco, and angels. But be warned, if you jump the gun on this, they’re unlikely to take your call the second time around.