Riding Out the Correction: How Canada Can Come Out on Top
By Kim Furlong, Chief Executive Officer, CVCA
The current investment climate presents a unique challenge for companies looking to grow and scale their operations. The worldwide surge in interest rates has rippled through the global economy and hit capital markets hard, while quantitative tightening has dried up the flood of liquidity that made it relatively easy for companies to borrow. Here in Canada, many businesses are already seeing tighter credit conditions and are reporting that rising financing costs are holding back their investment plans.
The question is what we do about it. While headlines paint a bleak picture, particularly for tech companies, there are upsides for both investors and companies. The actions we take as we enter the 2023 economic correction will dictate how we emerge as the global economy rebounds. We can follow other countries down a path of cutbacks and retrenchment OR we can make strategic investments to ensure that Canadian companies will come out of this roaring.
The Opportunities for Canada’s Entrepreneurs and SMEs
This is not a crisis like 2008/2009. It’s true that a higher cost of capital means making tough choices, but I believe we should take advantage of the opportunities presented by the current economic conditions. First, as some larger companies rethink their operations, others now have less competition for customers and talent. It’s an environment where smaller companies can gain market share and attract top talent.
While there are differing opinions on what has driven the spree of layoffs across tech, the labour challenges have not subsided and skilled workers are still hard to find.
As a result of these layoffs, companies can act fast, recruiting top talent that may have previously been out of reach. This can be particularly beneficial for startups, as they often have limited resources and need to be strategic in their recruitment efforts. The talent pool is a great advantage for those looking to grow and scale their operations and compete with larger companies in the industry.
Mergers and acquisitions are likely to dominate the exit environment for the next few years. Canadian companies should be buying. Just like the economic corrections before, many assets will become undervalued, and provide much more attractive opportunities to make strategic acquisitions. Portfolios can leverage the use of acquisitions to quickly enter new markets and gain access to new customers, diversifying revenue streams and reducing dependence on a single market or customer.
How Private Capital Can Help Companies Thrive
VCs are often the first to provide funding to startups, helping them grow and scale their operations. By providing funding and support to startups, VC helps to create new companies and jobs, ultimately benefiting the overall Canadian economy. VCs can also drive better performance amidst an economic correction. While some investors pull back, astute VC investors will stay the course and benefit as they have less competition for deals and can potentially secure investments at lower valuations, leading to higher long-term returns.
But the focus should not only be on tech startups, but rather on all Canadian SMEs. Private equity firms are focused on value creation. PE firms have talented and disciplined investors that can provide the resources that companies need to get through the downturn and blossom. PE firms offer an advantage during an economic downturn, as their investments are typically less impacted by volatile public market conditions. The efficient allocation of private capital across the entire landscape of Canadian companies is an essential instrument of continued economic growth.
Going Private and Finding the Right Partners
Another important consideration in the current environment is that while going public may have been an ideal exit strategy, it’s not the only path.
Going public can be a costly and time-consuming process, and it’s not always necessary for a company to achieve its growth objectives. Instead, companies have alternative options such as staying private, taking on strategic partnerships, or seeking co-investments. Going private means companies can operate without the pressure of meeting quarterly earnings targets and focus on building their business for the long term. Companies are able to easily make strategic investments and acquisitions without worrying about how it will impact their stock price.
The Risks to Innovation and our Future
The government also needs to step up and do its part to ensure the continued flow of capital to businesses. If we do not invest in small businesses and innovation during a time of monetary normalization, we risk falling behind in more ways than one. Canada’s economy is closely tied to the global economy, and not doubling down could lead to lagging in areas such as tech, leaving us susceptible to market changes, and risks growing a sustainable economic future.
In OCED’s Policy Responses to the Economic Crisis: Investing in Innovation for Long-Term Growth, authors of the report examined the success of two countries that went all-in on investment during tough times.
During the 1990s, Finland went through a severe economic crisis where their output decreased by 10% and unemployment rate increased four times. Finland increased spending on research and development to help the economy recover. This helped lay the foundation for a strong rebound and put the Finnish economy on a path of growth.
In Korea, during the late 1990s, the Asian financial crisis led to downsizing among large companies and a decrease in corporate R&D spending. The government of Korea responded by increasing their R&D budget and using the crisis as an opportunity to develop a technology-based small and medium-sized enterprise sector. Policies were implemented such as government-backed venture funds and tax incentives to improve the environment for startups and support research. This led to a rapid increase in the number of corporate R&D labs and SMEs, which helped fuel long-term growth. The country is now the 10th largest economy in the world.
Canada too has been through this before. Thomas Park, Lead Partner at BDC’s Deep Tech Fund, co-founder of the Asian Canadian Ventures Collective, and CVCA member, recently wrote about his concerns about Canadian innovation losing out to other countries. While written for Deep Tech specifically, the sentiments ring true across the startup ecosystem.
“Downturns mean that the most resourceful founders stay the course, highly specialized talent becomes available, and the best investors remain in the market,” said Park, who also calls on Canada to hold nothing back on Innovation.
“At this critical fork in the innovation road, Canada can either meekly validate the trend of a long winter for deep-tech startups, or choose to become a bold outlier and global leader. With a lot on the line, I hope we pick the right path: one that leads to new and exciting Canadian commercial and innovation success.”
It’s time to choose the path of being a bold outlier.
First, it’s time for the government to be strategic and apply the success of the Venture Capital Catalyst Initiative (VCCI) to a new program for sectors that present growth opportunities for Canada: life sciences, cleantech, and agtech. To be clear, the amount attached to these specific programs needs to be bold. Next, we can overhaul and expand Canada’s R&D programs to laser focus on commercialization while building our ability to develop the deep tech that could transform our society. Finally, it’s time for Canada to set the goal of becoming the best place on earth to invest and build a business: simplifying the tax code, incentivizing technology and investment, and slashing regulation.
In the coming weeks, CVCA will outline a series of recommendations to transform Canada’s competitiveness and innovation ecosystem. I think it’s time for business and government to work together in alignment: identifying our strengths, increasing our risk appetite, and focusing on building rather than surviving. No one has a crystal ball but during this period of great unpredictability, choosing to take bold action can only result in Canada emerging from this moment better and stronger.