Venture Capital as the building block of Canada’s innovation: a global investor’s perspective

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Article originally published in May 2016 edition of Private Capital Magazine

By Senia Rapisarda
Principal, HarbourVest

When I first arrived in Canada six years ago, the term venture capital was almost inevitably met with both a mix of scorn and sympathy. I was often presented with horror stories about the dismal returns for institutional investors (resulting in a flight from the asset class), the bleeding of the best Canadian companies and minds to the U.S. (therefore very few repeat entrepreneurs able to go beyond the start-up phase), and the lack of engagement of Canadian corporates in emerging technologies as investors or, possibly even more disappointingly, as anchor customers.

Fast-forward to today: things have changed! Thanks to a variety of private and public initiatives — as well as a small group of institutions and resilient individuals crusading for Canadian technology companies — there is core support for a functional venture market as necessary fuel for innovation. As a result, the Canadian landscape has vastly improved and made significant steps towards a sustainable infrastructure of value-added capital. This is key to the future of innovation in Canada and its role as a knowledge-based economy.

HarbourVest opened its office in Canada eighteen months ago as the only international manager chosen to implement the Venture Capital Action Plan (VCAP), the private-public initiative supported by the federal government to revive the Canadian venture market. But HarbourVest has been successfully investing in Canada for over two decades and has more than thirty years of experience in private equity and venture globally as an investor in private funds, secondary purchaser and direct investor. As a result, HarbourVest has seen many economic cycles and gained valuable experience, especially in emerging venture capital markets. This pattern recognition has proven to be a crucial skill in knowing what it takes for a venture ecosystem to become successful.

Favorable Forecast
Looking at Canadian entrepreneurs, emerging fund managers and valuations of technology and healthcare companies, we continue to see opportunity. Canadian venture appears to be at an inflection point and many of the critical quantitative and qualitative metrics are evident, demonstrating that this region has the potential to outperform.

According to data released by the CVCA in 2015, a total of $2.3 billion was invested in Canadian companies — the highest level of investment recorded since 2002. We see this as an encouraging indicator because, despite performance in the VC sector often being counter-cyclical to the amount of money raised by VCs, Canadian companies have been chronically underfunded for the past ten years. More often than not, capital has been inefficiently allocated based on geographical or other non-market-driven considerations.

Nevertheless, with an increasingly connected global venture community, the Canadian venture market will not be immune to — and must be mindful of — a potential future correction. This includes being wary of potential issues such as wounded unicorns (or Canadian narwhals), mutual fund mark-downs of their highest valued companies, scarcity and poor performance of some tech IPOs, inflated multiples and the necessity of down-rounds across many regions, and fund managers and companies that have been less disciplined than they should have been. As Fortune magazine put it, Silicon Valley’s USD $585 billion [liquidity] problem.”

Weathering a Storm
So…what would a global market correction mean for the fledgling Canadian venture market at this point?

While a ripple effect will surely be felt, and dramatic headlines will ensue, it may not be as dramatic in Canada. It could actually be a tremendous opportunity for us to ride the upcoming storm successfully if, collectively, we” (entrepreneurs, investors and government) stay the course and focus on building value in Canadian technology companies for the long-term. Reason being, recently raised Canadian venture funds still have young portfolios which are significantly less inflated by paper returns and have not created unrealistic expectations among their CEOs and LPs. Those fund managers have to be disciplined with valuations based on potential in companies and prioritize sustainable business models during what could be difficult times.

Canadian technology companies have traditionally been frugal and are used to the idea of scarcity of capital. Entrepreneurs in Canada have strong expertise in areas such as data analytics, FinTech, agriculture technology and industrial internet of things (IIoT) that cater to traditional industries, where there is a focus on efficiency to stay competitive and where the me too” factor and presence of wounded unicorns is greatly reduced.

Lastly, venture capital and high-flying tech start-ups have undergone a fundamental urban shift that works to the advantage of Canada’s big cities, which have great universities, diversity and top tech and creative talent, all of which are scarce but indispensable for long-lasting innovation.

The road to engaging the minds and hearts of individual, institutional and, especially, corporate investors in the venture capital asset class has been and will continue to be a long one. It will inevitably require the delivery of compelling financial returns with Canadian-based success stories of building large-scale global venture-backed companies. Only then will this make it a viable and self-sustaining venture ecosystem based on innovation.

To deliver results beyond paper returns will require some time. Venture investing has a long cycle, and the next few years are crucial to ensuring that the foundation of the Canadian venture industry has been built solidly this time. Of course, we couldn’t end this piece without a hockey analogy. Although we may be a little behind, we need to be patient as it’s only the first of three periods. However, the hungry, young but talented individual players and their teams look strong, which should make for very interesting second and third periods.

*Senia Rapisarda is the head of HarbourVest’s team in Canada. She is focused on sourcing and evaluating partnership and direct co-investments in Canada, managing the HarbourVest Canada Growth Fund (a VCAP program), and expanding relationships with clients and investment partners in the local Canadian market.