Early stage Canada

Though venture capital activity is dwarfed by its neighbour to the south, Canada has taken steps toward realising its full entrepreneurial potential. By Art Janik

You'd think sharing a continent with the world's leading economic power would ignite an intense level of entrepreneurial activity and private investment. But Canada, with a population of less than 32 million people and a national GDP less than that of California, has historically not been a hotbed for venture capital activity. Local venture insiders hope to see this change.

Canada's relatively underdeveloped venture capital industry seems odd considering its geographical proximity to the US market (Canada is America's biggest trading partner), a common language and similar culture, not to mention a monetary exchange rate favouring US investors. But there has not been as much cross-pollination as one would expect.

“If you look at the strength of the Canadian marketplace, you have lower wages and a talent pool that's just as skilled in the US, that's loyal and works just as hard,” says Richard Osborn, a partner at Vancouver-based Greenstone Venture Partners. “There's all this attention being paid to Israel, India, Scandinavia, Bolivia. If you look at Canada on a dollar-to-dollar basis, it's almost as effective or on par with India. And Vancouver is only a two-hour plane ride from the San Francisco Bay area.”

Of the roughly C$1.49 billion ($1.09 billion, €901 million) VC dollars disbursed during 2003, only 17 percent, roughly C$257 million ($189 million, €155 million) came from US and foreign investors, according to statistics compiled by Toronto-based private equity research firm Macdonald & Associates. Meanwhile, Canadian venture capital firms have also had a tough time fundraising domestically, partly because of the economic downswing and partly because Canadian institutions have not been enthusiastic about the asset class compared to US counterparts.

“Venture capital as an asset class is not nearly as developed in Canada as it is in the US,” says David Ferguson, a managing general partner at Toronto-based VenGrowth. “Only the largest institutional investors have the resources and understanding to create venture capital investment committees. Canada lacks the US infrastructure in terms of returns data and even a consultant base that understands the asset class and can help investors allocate money.”

Most early stage financing in Canada comes from corporations, directly from the government and from a peculiar, indigenous type of firm called a labour-sponsored investment fund (LSIF) (see also page XXXX). Though the merits of LSIFs, or retail funds, are hotly debated, Macdonald & Associates reports that this class of investor contributed C$458 million, or a whopping 31 percent of total venture capital investments in 2003. This compares to C$218 million expended by private, independent funds during the same period.

To stimulate corporate investing, in 1986 the Canadian federal government set up the Scientific Research and Experimental Development (SR&ED) programme, which offers annual tax credits of 35 percent of up to C$2 million in R&D expenditures to small Canadian businesses.

“Whereas in the US, where new technological developments often come out of the Department of Defense and NASA projects, Canada doesn't have that same R&D strength,” says Harry Jaako, chairman and co-chief executive officer of Vancouver-based Discovery Capital. “Canada needed a way to stimulate early stage R&D work. As a result, companies get cash back from government tax credits, so that shareholders can get more expenditure in R&D financed than otherwise.”

However, many industry observers worry that ongoing government monetary aid may prohibit the venture capital markets from expanding further under non-subsidised market conditions. Indeed, even with one of the highest rates of post-secondary education in the world and a chummy relationship with the US, Canada has a ways to go before it taps the full reservoir of the country's underexploited financial and entrepreneurial resources.

“I think Canada failed to advance opportunistic conditions to take advantage of the talent here,” says Andrew Waitman, a managing partner at Canada- and UK-based Celtic House. “The success of commercialising a technology from its embryonic stages to a $100 million company takes a fairly aggressive competitive nature. While it's improving, we are not at the level or intensity of competition you'd find in the US.”