Published by the Canadian Venture Capital Association in Private Capital
Retail venture capital in Canada, where tax credit eligible money is raised from individual investors, has been a controversial topic over the years. Since the launch of the first Labour Sponsored Venture Capital Corporation (LSVCC) in the early 1980’s, retail funds appeared across the country, providing investors with access to federal and provincial tax credits and investing capital into young companies seeking to drive Canada’s innovation economy forward.
With the announcement of the “Sunset Clause” in Ontario in 2005, eliminating the provincial tax credit for retail funds over a five year period and the significant decline of fundraising levels in the aftermath, many were left wondering what the future might hold. The Venture Capital Action Plan (VCAP) initially arrived on the scene as part of the 2012 federal budget, allocating $400 million in new capital over a 7 to 10 year period, with the objective of attracting an additional $800 million from the private sector. The 2013 federal budget announced the progressive elimination of the LSVCC tax credit program over 2015 to 2017, leaving an asset class that once raised billions with an uncertain future.
With limited venture capital dollars being raised in recent years and a lack of specific details around how and when the bulk of VCAP dollars will flow, there is a climate of uncertainty around what the impact might be on VC funds and, ultimately, the companies in which they invest. Reflecting on an asset class that has been a part of Canada’s venture capital landscape for 30 years, opportunities for involvement in the future may become apparent, as further details around VCAP come to light.
Canadian retail venture capital has made a significant contribution to the financing of Canada’s early stage companies, including:
- In terms of investment, from 1996 to 2012:
- Retail venture capital funds invested $7.8 billion into 2,419 Canadian companies, representing 53% of all VC-backed companies in Canada at the time (1)
- In technology sectors alone, retail funds invested $5.5 billion in 1,190 companies, or 45% of all Canadian VC-backed companies at the time (1)
- In terms of exits, from 1999 to 2013: (i) of the 29 companies that exited by sale with a purchase price in excess of $200 million, 19 were backed by retail funds; and (ii) of the 37 companies that undertook an IPO in excess of $30 million, 22 were backed by retail funds (1)
Over this timeframe, it stands to reason that the level of fund manager expertise was increasing, as part of the typical growth and development of a young industry. This is reflected in the trend of shifting the investment strategy to focus on later stage co-investment and investing indirectly in specialized private sector venture capital funds, thereby becoming a supplier of capital to the broader VC industry. As an example, Quebec retail funds have committed $830 million to 59 private independent funds, of which 29 are based in Quebec, 10 in the remainder of Canada, and 20 in international locations. (3)
Retail venture capital funds have played a key role in generating investment in areas that are typically undeserved. As an example, retail funds in Saskatchewan have invested an average of $80 million per year over the last three years and $600 million in 193 companies since inception, while leveraging significant co-investment from outside of the province. Saskatchewan’s residents and economy have benefitted, in terms of companies being able to remain in the province and the employment that has been generated as a result. (2)
Although varying themes may exist, criticism of retail venture capital funds includes poor performance levels, inappropriate structures and governance models, fund managers lacking the necessary expertise, and funds being too small to provide a sufficient amount of capital to support the developmental needs of early stage companies.
Research into these areas, among others, indicates that although there is room for improvement, a number of the typical criticisms may not be entirely valid (and, at a minimum, are outdated). Consider the following:
- Although the performance of Canada’s retail funds has been poor, it has been comparable to the rest of the Canadian venture capital industry. The net 10 year return as of June 30, 2005(4) for retail funds was -1.4%, compared to private independent funds at -3.9%, other captive funds at -3.6%, and an overall industry return of -3.0%. The issue of poor performance is not due to the retail sector alone, but rather, is driven by broader factors, including timing, fund size, and a lack of experienced fund managers during the period. (5)
- Given that the Canadian venture capital industry is significantly younger than that of the US and Europe, it is not entirely surprising that the level of experience and expertise among fund managers would require additional development. This issue, however, is not unique to the retail segment, as other venture capital funds in Canada were arguably facing the same challenges, especially back in the 1980’s and 90’s.
- The structure and governance model of some retail funds may have been less than ideal, in terms of areas such as fee arrangements and independence. Although this criticism should not be generalized to all retail funds, even a limited incidence of this type of weakness can reflect poorly on a broader group.
- Although some retail funds have been challenged by a lack of size and ability to provide the degree of capital that early stage companies often require in order to fully develop, research has indicated some improvements in this area. In addition, considerable consolidation occurred in the industry several years ago, reducing the number of small funds.
Despite the foregoing, the retail venture capital industry has been challenged by an overall decline in appeal from the channels in which capital is raised, a situation that has been difficult to overcome. The reality of this type of circumstance is that it can be difficult to find a way forward, regardless of positive achievements and the presence of change.
It’s no secret that Canada is significantly underserved in terms of venture capital, lagging behind that of key global markets. Early stage companies that seek to drive the innovation that Canada requires in order to be globally competitive have a critical need for financial support, particularly in terms of venture capital. Under the circumstances, Canada needs more venture capital, not less, so it’s important that new initiatives such as VCAP truly represent an incremental source of capital, particularly given the phase out of retail tax credits.
Retail venture capital funds have demonstrated the ability to support private (non-retail) funds, invest in and play a key role in developing early stage companies, and effectively benefit regions that are typically underserved. The opportunity to work in concert with VCAP in some manner seems worthy of consideration, to preserve and continue to grow these important strengths. Funds that have had some success and continue to have the opportunity to reinforce their achievements through good performance may be well positioned for collaboration going forward.
Change and evolution are often two-fold, where the increase in ability that is gained through experience raises the opportunity to develop and implement strategies that better serve the future. This occurs in many industries and is a necessary part of growth. Blending the best of both worlds into the future may be an important step in moving Canada’s venture capital industry forward as a whole.
(1) Thomson Reuters
(2) Thomson Reuters and Saskatchewan retail funds
(3) Retail Funds and Teralys
(4) Represents the only hard data that compares retail venture capital with the rest of the Canadian venture capital industry undertaken by Thomson Reuters in 2006 for the CVCA.
(5) Review of Main Criticisms Concerning VC Investment by Canadian Retail Funds (G. Durufle, 2013)