Canada flies high

There is indeed many a thing that can attract foreign investors to the Great White North. The world’s second-largest country after Russia, with close to 9.9 million square kilometres of land area, Canada also has around 9% of the world’s forests and half the world’s natural lakes – all testimony to an abundance of natural resources.

Consisting of 10 provinces and three territories, Canada is home to a diverse and multicultural population, with immigrants accounting for just over a fifth of its 37 million inhabitants and representing around 200 ethnic origins. In 2017 alone, the country had a net immigration of close to 250,000.

Keeping its doors open, local investors agreed, stands out as one of Canada’s most precious assets. Paul Sestili, a San Francisco-based general partner at Rogers Venture Partners, the corporate venturing unit of Canadian telco Rogers Communications, said: “Canada is one of the most welcoming countries in terms of policy, and frankly in terms of the quality of the people. It is generally a very open and friendly place.”

Sestili’s opinion was reinforced by Barrie Laver, managing director at the Royal Bank of Canada (RBC), who said: “A defining characteristic of Canada is its strong global reputation and its immigration-friendly climate.”

The election of Prime Minister Justin Trudeau and the Liberal party in 2015 heralded a switch in the country’s approach to immigration. Standing out as a place wide open for exchanges, both on human and financial levels, Canada has increasingly placed itself in stark opposition to the US, which has instead been marked by an increasingly inward-looking and closed foreign  policy under President Donald Trump.

This split could provide the land of the maple with a golden opportunity to try to gain ground on its dominating southern neighbour. Sestili added: “The fact that Canada is welcoming to immigrants – something the US is currently struggling with – means it is likely to see its venture activity grow, with an increasing number of entrepreneurs likely to choose to locate there instead.

“Silicon Valley is, of course, and will continue to be, a very important place, and we ought to continue looking at deals there. But at the same time, there is no other market that is more competitive, which forces us to look to other markets to find high-quality deals that are more appropriately priced. Canada is one of them.”

This brings to light another one of Canada’s key incentives – providing quality deals and entrepreneurs more cheaply than other VC activity hubs. “Canada’s currency and valuations are making deal pricing incredibly attractive compared with the US, Asia and western Europe,” said Richard Osborn, managing partner at Telus Ventures.

Neal Hill, vice-president of market development at BDC Capital, investment arm of the government-owned Business Development Bank of Canada (BDC), added: “Canada’s labour rates are lower compared with many other G7 or G20 countries. Considering the quality of local higher education institutions, you basically get a community of highly-qualified engineers that cost way less than in the US or the UK. Wage rates just tend to be inferior here, making the overall cost of doing business cheaper, and therefore attractive.”

With all these advantages, it is up to Canada to take advantage of the momentum playing in its favour. The government is aware of this, having put in place a number of support programs and tax incentives to boost the local venture ecosystem.

The government’s role

Canada’s government has been active in supporting the country’s VC sector. Some significant investments have, for instance, been made by BDC through its venture arm BDC Capital. Over the past two years, the unit has taken part in several large venture rounds, including a $153m round for IT company Big Stew Systems alongside Cisco Systems, General Electric and others, and a $120m round for healthcare group Clementia Pharmaceuticals alongside EcoR1 Capital, New Enterprise Associates and others.

But the government’s major contribution has perhaps been the launch of two largescale investment programs – the Venture Capital Action Plan (VCap), and its new version, the Venture Capital Catalyst Initiative (VCCI).

Launched in 2013, VCap was a $400m program created to encourage private investments in early-stage companies, with goals to help small and medium-sized Canadian businesses grow and prosper, according to BDC. Looking to boost the creation of VC funds supporting smaller structures, VCap pledged that for every $2m committed by the private sector, the government would contribute an additional $1m, up to a maximum of $100m per fund.

Hill, who as part of his role at BDC oversees the development of the two programs, said: “The idea is to use public money to fund incentives to attract money into funds of funds. The government’s money goes in first, and goes out last, which means private money has amplified returns and lowered risks.”

According to BDC, between 2013 and 2016, the structure backed four private sector-led funds, which resulted in $900m in private investor capital being added to the ecosystem across four funds of funds – Teralys Capital, Northleaf Venture Catalyst Fund, Kensington Venture Fund and HarbourVest Canada Growth Fund. In addition, as of April 2016, a total 19 venture capital funds had benefited from capital raised through VCap, translating into investments in around 100 Canadian companies.

With all the above funds now being close to fully committed, the government recently created a new program similar in size and function – VCCI. The new structure makes $400m available to boost late-stage venture capital. BDC projects that the initiative could help inject around $1.5bn into the local market – private and public funds combined.

Announced as part of the 2017 budget, VCCI fits into the government’s larger Innovation and Skills Plan, which should “help develop innovative high-potential startups, and build Canada as a world-leading innovation economy that will create jobs and grow the middle class”, according to an official statement.

The federal department of Innovation, Science and Economic Development of Canada said 2016 was the seventh straight year of growth for VC in Canada, with the highest level of VC money invested in startup companies since 2001. The Canadian Venture Capital and Private Equity Association (CVCA) attributed much of this growth to VCap’s impact.

RBC’s Laver said: “The current government has made innovation and reorienting the economy around it a very high priority. It is notably supporting investment in university programs, as well as investment in a number of key sectors.”

Another recent announcement was the Innovation Supercluster Initiative – a $950m federal funding program to be distributed over five years to support Canadian “superclusters”, defined as “made-in-Canada Silicon Valleys” and hotbeds of innovation, research and business activity. The initiative aims to “build world-leading innovation ecosystems, secure Canada’s future as an innovation leader, and accelerate economic growth”, the government announced, and, more generally, attract worldwide talent, technology and investment.

The five funding recipients were announced in a public address by the country’s minister of innovation, Navdeep Bains. These will be the Ocean supercluster, in Atlantic Canada, the Scale.AI supercluster, based in Quebec, the Prairies-based Protein Industries supercluster, British Columbia’s Digital Technology supercluster, and the Advanced Manufacturing supercluster in Ontario. Each of the five superclusters should, in turn, support around 300 local businesses.

A number of Canadian government grants and loans have also been made available for small businesses in the areas of hiring and training, research and development, capital investment funding and business development. Among these are the Scientific Research and Experimental Development Program, a federal tax incentive for companies conducting research, and the Industrial Research Assistance Program, providing entrepreneurs with funding and advisory services in the development of their innovation and technology.

A number of other tax incentive schemes are also in place to encourage investment in venture, whereby, for instance, corporations qualifying as Canadian-controlled private corporations (CCPCs) can get preferential tax treatment and lower tax rates, while CCPC shareholders can claim capital gains tax exemption, tax deferral or federal tax credits under certain conditions.

Looking at the data, it appears the results of that sustained support have already started to show.

The numbers

According to GCV Analytics, Canada was the eighth-largest country by number of corporate-backed deals last year with 51 reported. The country ranked ninth in terms of total deal value at $910m. Although these figures are far behind the US, China and India, it is worth noting the market size of these countries – the US had a GDP of $19.4 trillion in 2017, China $11.9 trillion, India $2.4 trillion and Canada $1.6 trillion.

Canada’s VC and corporate venture capital (CVC) market has grown strongly over the past few years. According to the CVCA, from 2013 to 2017, the amount of invested money grew from C$1.9bn ($1.5bn) to close to C$3.6bn.

Hill said: “Five years ago, venture capital as an asset class in Canada was showing negative returns and was not profitable for investors. This has now changed, with internal rates of return (IRR – a measure of fund profits) having gone from minus 7% a year to plus 4% or 5%. This is a good baseline indicator of a general improvement of the market.”

CVC figures alone have also risen, both in value and volume. According to GCV Analytics, since 2013, the number of CVC deals per year increased consistently, from 10 to 23, to 45, to 47, to peak at 51 last year. Deal values followed suit, with a sharp increase from $312m to $789 between 2014 and 2015, reaching $793m and $910m in the following two years.

RBC’s Laver said: “It has only been over the last several years that private capital started coming back into the industry. That goes hand-in-hand with successful exits, and a growing community of founders who have ‘been there, done that’.

“The last five years in particular have given way to a substantial maturing of the market, with an increasing number of quality managers and entrepreneurs, and an improvement on all the metrics that matter, such as dollars deployed, number of exits, or investor type.”

In a recent report on the state of VC in Canada, the federal department Western Economic Diversification Canada (WD) claimed that in 2015 “VC investment in Canada was, in absolute terms, second-highest of the G7 countries, trailing only the US. As a share of the economy measured by GDP, Canada’s VC market also ranked second in the G7”.

But if Canada’s VC market has shown great growth as a whole, regional disparities remain. According to WD, western Canada – the provinces of Alberta, British Columbia, Manitoba and Saskatchewan – has for decades been lagging behind Ontario and Quebec, where most activity is concentrated.

Over the past two years in particular, due to an economic slump caused by low oil prices, the west’s share of the market fell to its lowest point since 2003, the department added. In 2016, western Canada attracted $609m of VC investment, $420m of which was concentrated in British Columbia. Ontario and Quebec, meanwhile, raised a respective $1.4bn and $1.1bn that year.

The key cities in the Canadian VC landscape seem to be Montreal, Vancouver, Ottawa, the Toronto-Waterloo Corridor – often likened to the San Francisco Bay area and nicknamed “the Silicon Valley of the north” – and, more recently, Edmonton.

Reflecting on the country’s progress, Telus Ventures’ Osborn said: “The Canadian VC market is currently experiencing incredible growth. Venture deals have grown in a similar fashion to the US, with more activity in series A and B and more megadeals – defined here as rounds over $50m – with 15 of these in 2017 compared with only five five years ago. We also have an increasing number of narwhals [Canadian unicorns – companies worth at least $1bn] and several startups poised to get there soon.”

Canada has been home to a number of startups that subsequently developed into global companies. One is Slack, founded in 2009 in Vancouver, and whose $250m SoftBank-led round last year brought its total raised funds to $841m and gave it a valuation of $5.1bn. Another Vancouver-born company, Hootsuite, reached an estimated valuation of $1bn after raising a $60m round that brought its total funding to around $250m in 2014.

Photography sharing platform 500px, based in Toronto and founded in 2009, is another success, receiving a total of $23m in funding and acquired by Visual China Group for a rumoured $17m last month. Finally, Shopify, an Ontario cloud-based e-commerce platform that received over $250m in funding, launched its IPO in 2015 with an initial market capitalisation of close to $1.3bn.

Sectors

According to GCV Analytics, IT has been consistently strong over the past three years, with eight deals recorded in both 2015 and 2016, and seven in 2017. Healthcare stands out as another important investment area, having been successively the first and third strongest investment area in 2015 and 2016, with nine and seven deals respectively.

In addition, services and financial services led the pack in 2016 and 2017 respectively, with 10 services deals in 2016 and nine financial services deals in 2017. The consumer sector was also strong last year, raking second with eight deals.

An area of activity booming in Canada now is artificial intelligence (AI). A determining event was notably the raising of $102m by the Montreal-based startup Element AI last year, through a series A round led by Data Collective and joined by Development Bank of Canada, Fidelity Investments Canada, Hanwha Investment, Intel Capital, Microsoft Ventures, National Bank of Canada, Nvidia, Real Ventures and global wealth funds. The group, which was only eight months old at the time, had previously raised money from Tencent, Microsoft and Hanwha.

Telus Ventures’ Osborn said: “From our point of view, AI, healthcare, cybersecurity and the internet of things (IoT) are the most compelling segments, not only because they drive business performance for our parent company, but also because the strength of opportunities in the market is incredible.

“We have been committed to these sectors for a while, and have already completed two exits – one in IoT with the sale of Otono Networks to the private equity-backed group Idemia in late 2017, and the other in security with the acquisition of Zenedge by Oracle earlier this year.”

The Toronto-Waterloo corridor, Montreal and Edmonton were recently identified as three strong AI superclusters towards which funding, business and people are gravitating. To help these locations grow further, the government launched a $125m Pan-Canadian Artificial Intelligence Strategy, administered by the Canadian Institute for Advanced Research and working in partnership with three new AI institutes – the Alberta Machine Intelligence Institute in Edmonton, the Vector Institute in Toronto and the Montreal Institute for Learning Algorithms.

A number of international corporations have already understood the growing importance of these innovation hotbeds in the VC landscape, and have been quick to make a move in the region. In September last year, Facebook followed in the footsteps of Google and Microsoft by opening its own AI research laboratory, Fair Montreal. The previous year, IBM had already set foot in Hamilton, Ontario, having launched a collaborative research initiative with the Hamilton Health Sciences medical group.

Hill said: “AI, IoT and genomics are three very interesting areas currently attracting a lot of capital to Canada, with foreign investors looking to take advantage of the quality and talent in innovation that exists here. We are seeing investments in university labs, incubators, and in some cases in venture funds. And as success brings success, those places have become centres of gravity attracting more capital, more talent and more resources.”

Growing interest from abroad

Telus Ventures’ Osborn said: “There is absolutely no doubt that Canada and Canadian entrepreneurs are on the radar for global players – both for investments and acquisitions – in a way they have not been before. There is a lot of dry powder [uncommitted investment capital] as we all know, which combined with currency, R&D tax incentives and low interest rates makes for a very attractive set of conditions in Canada. While they are creeping elsewhere, domestic valuations are generally 20% to 40% lower for comparable-stage companies.”

And as the government continues to operate its charm offensive with initiatives such as the startup visa, or with facilitated entrance requirements and immigration processes for highly-skilled workers, foreign investors are taking the bait. According to data collected by Canada’s private capital news and intelligence provider CPE Media, close to 55% of Canada’s VC capital came from foreign investors in the first half of last year, with the US alone accounting for around 40%.

According to GCV Analytics, between 2011 and 2017, eight of the country’s top 15 corporate investors were US-based – Intel, which closed eight deals over that period, General Electric with seven, Motorola Solutions with six, Fidelity and Salesforce with five each, and Merck & Co, Cisco and Waste Management with four each. Five investors were Canadian – Telus Ventures, which was number one with 19 deals, RBC with 13 deals, Power Financial Corporation with five deals and OpenText and Rogers with four each.

RBC’s Laver said: “There is a recognition that there are more and more quality management teams and opportunities in Canada, while the community of experienced local VC investors is also growing. This is very positive for foreign investors coming into the market and willing to establish local partnerships, as a larger base of credible ventures funds with good track records opens up more possibilities for collaboration.”

The central role of universities

The Canadian venture ecosystem probably would not be what it is without the central role played by its universities, in terms of both talent and innovation.

According to the most recent data provided by the Organisation of Economic Cooperation and Development (OECD), Canada had the largest proportion of educated population in 2016 at 56.3%, ahead of Israel (49.9%) and Japan (50.5%). The OECD’s indicator defined this as the highest level of education completed by 25 to 64-year-olds. Canada was also second that year in terms of people with tertiary education – 46.2% of 55 to 64-year-olds and 60.6% of 25 to 34-year-olds, right behind Korea.

This should come as no surprise, since the country is home to some of the world’s most prestigious higher education institutions – University of Toronto, University of British Columbia, McGill University in Quebec, McMaster University in Ontario and University of Montreal. Ontario’s University of Waterloo, meanwhile, is often referred to as Canada’s Massachusetts Institute of Technology, and has earned itself the reputation of being Silicon Valley’s number-two choice for graduate recruitment, right behind University of California Berkeley.

Many of these institutions have contributed directly to the ecosystem’s development. To name a few initiatives, the Simon Fraser University, in Vancouver, offers the SFU Innovates program, supporting innovation and entrepreneurship across the university. TEC Edmonton, a joint University of Alberta and City of Edmonton initiative, was recently ranked one the world’s top business accelerators linked to a university. And a few years ago, Toronto’s Ryerson University launched Digital Media Zone, one of Canada’s largest business incubators for emerging technology startups, which has helped incubate or accelerate more than 317 businesses to date.

Hill said: “First and foremost, one of Canada’s biggest strengths is its employee base. Talent is in high demand these days, and the country provides an extremely well-educated population, and at a lower cost than elsewhere.”

Conclusion

In many ways, Canada is already on the right track for building one of the world’s greatest venture ecosystems. But there is room for improvement, and local market players have identified areas that could use a boost.

For Paul Sestili, the priority for big corporations in Canada is to embrace venture and see it as a critical part of innovation strategy. He said: “The rest of the pieces are in place in terms of the critical infrastructures required to have a successful entrepreneurial and venture ecosystem, so the corporates just have to make a decision to be more actively focused on direct investing.”

This observation was confirmed by BDC’s Hill, who said: “Only around 15 corporations in Canada have a designated venture arm at present, which as a percentage of all the venture entities worldwide is not reflective of what our economy represents on a global scale.”

Over the past four years, only three CVC units have been launched in Canada, according to GCV Analytics.

“To me, that means Canadian corporates have tended to be more conservative in terms of technology-driven innovation, and have invested less, both inside their own walls and abroad,” added Hill, who last year organised the Canadian Corporate Innovation Summit in partnership with Global Corporate Venturing to attract foreign corporations to the country and provide open innovation and venture insights to locals. “That is a source of capital that we would like to see more present in the market.”

RBC’s Laver, meanwhile, insisted on the importance of having a growing number of successful exits. According to GCV Analytics, 18 exits have been recorded in Canada since early 2012 – two IPOs and 16 acquisitions.

Laver said: “I do not think there is one silver bullet that will accelerate growth – it is a gradual process. As you continue to see a greater breadth and depth of venture funds, more exits, more investments and as a consequence – more entrepreneurs able to redeploy their efforts in capital back into new startups, that will over time attract more capital into the market, and the sector will continue to grow. It is a sort of circle, where one things feeds into another.”

Another element that is improving but could still progress, he added, is the access to a larger pool of late-stage investors, with people “who can write $15m, $20m or $25 cheques in support of growing companies at series C stages and above.”

Similarly, Telus Ventures’ Osborn expressed his wish to see the average deal size go up in value in Canada, where according to him it “has not increased as rapidly as in other countries”. He said: “All things equal, our companies are getting less money than competitors in other countries, and that needs to change.”

Finally, he added, the country could benefit from having a higher number of serial entrepreneurs. “It is improving, but you do not see the multiple-success teams as often as you do in the US and other regions,” he said. “Sometimes successful entrepreneurs are happy to be one and done, or they get into the venture business but not enough get back into the startup game.”