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Canada’s Venture Capital Puzzle

September 21, 2016
By: 
Charles Plant
Senior Fellow
The Impact Centre, University of Toronto

Canada’s lack of venture capital funding has been denounced consistently in studies and think tank reports, and by the media, entrepreneurs, and even venture capitalists themselves. The general view expressed in the press is that Canada is short-changed by the lack of venture capital; and this hurts our prospects as a world-leading innovator.

But while the general consensus is that Canada does not have enough venture capital, we somehow manage to rank number 4 in the sale of technology companies. CBInsights 2015 Global Tech Exits Report states that in terms of the number of exits in 2015, Canada ranked number 4 behind the US, UK, and India and ahead of Germany, France, China, and Israel. On a per population basis, Canada ranked number 2 behind the US.

How can we have too little venture capital funding but be so successful at selling companies? The answer lies in how we are funding technology companies and what stages we are able to fund.

Seed Stage Funding

Data from reports issued by venture capital associations in Canada, the US, the UK, and Germany demonstrates that although Canada may not have as much funding in absolute terms as the United States (US), we actually fund more companies per 1 million population than the US, Germany and the United Kingdom (UK). If we are funding relatively more companies than other jurisdictions then we cannot have a problem with seed-stage funding.

Growth Stage Funding

The last data available from the OECD shows that Canada (in 2014) was actually third among OECD countries in terms of venture capital as a percentage of GDP. While we surpass almost all other OECD countries (including all European members), we are compared most often to the US, which had almost 3.5 times as much VC funding available as a percentage of GDP. California itself has 15 times as much VC funding as Canada as a percentage of GDP. The rest of the US only has 73% more VC than Canada does on a percentage of GDP basis.

In terms of how this money is split, we find ourselves in middle of the pack in the OECD, behind the UK and ahead of Germany in terms of the percentage of funding allocated to growth and later stages. The US, however, allocates much less of its funding to seed-stage investments than other OECD counties. If we compare favourably in terms of total capital and are at about the average in terms of its allocation between seed and growth stage funding then we can only conclude that we compare favourably with most of the world in funding growth-stage investments.

Later-stage Funding

If Canada has enough seed capital to remain competitive with most other countries, and we compare favourably in terms of growth-stage capital, then how do we do in terms of later-stage investments, and particularly those needed to create Unicorns?

By definition, Unicorns are private VC-backed companies with a valuation over $1 billion. As of the end of July this year, CB Insights reported 168 Unicorns around the world, including the largest, Uber, with a valuation of $62.5 billion.

Canada has two Unicorns, Kik Interactive and Hootsuite while Germany and the United Kingdom each have five. If we compare ourselves to Germany and the UK we appear to be holding our own in terms of Unicorn creation on a per capita basis. And on a per population basis, we compare favourably with most other countries on the list.

Why though, is the US able to create 96 of these 168 Unicorns while Canada can create only two? It is because of the size of their VC funds, which by their size favour later stage funding. The average fund raised by leading American VC funds is about 10 times the size of the funds raised by Canadian firms. An efficient use of this funding would mean investing in perhaps 30 to 40 different companies for an average per company of about $50 million. This is 5 times the amount that a typical Canadian fund can invest in any company. If three VC funds were put together to syndicate a deal, this would amount to about $150 million available for a company, which is enough to create a Unicorn.

Only the US and China have enough money locally in sufficiently large funds to create a large number of Unicorns and the rest of the world must rely, at least in part on VCs from other countries to create Unicorns.

Conclusions

Available data suggests that for seed- and growth-stage VC deals, Canada compares favourably with most other countries in the OECD. However, if we want to have the capacity to create Unicorns locally and not rely on external funding, then we need to create substantially larger pools of capital, ones with the ability to absorb the risk inherent in Unicorn sized deals.