Venture Capital – Driving innovation and competitiveness

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In February, the Canadian Chamber of Commerce launched a 10-point national plan to improve Canada’s economic competitiveness. Along with our network of Chambers of Commerce and Boards of Trade across the country, we are working on ten issues that challenge the competitiveness of Canadian businesses, weaken Canada’s economy, and strengthen our rivals.

As part of our competitiveness agenda, we are calling on all key stakeholders — the federal and provincial and territorial governments, the private sector, venture capital industry associations, educational institutions, think tanks, venture capital funds, investors and entrepreneurs — to come together to develop a national strategy to build a strong and robust venture capital industry in Canada.

Why is Venture Capital So Important?

Access to capital may be particularly challenging for young technology companies with new or unproved products, and start-ups in general that lack cash-flow and tangible assets to satisfy a commercial bank’s collateral requirements. Venture capitalists help to plug the financing gap making it possible for entrepreneurs to transform breakthrough ideas and newly developed technologies into successes in the marketplace.

Venture capitalists also offer extremely valuable ancillary services such as mentoring, assisting in hiring key management, sitting on boards of directors, participating actively in company operations, formulating strategies and making connections to aid sales and marketing efforts. Their goal is to build and grow the company to a point where it can go public or be acquired by a strategic buyer.

These attributes — the patience, the hands-on guidance and the willingness to take on risk and fail — make venture capital unique as an asset class.

Canada’s Venture Capital Market

According to Thomson Reuters and Canada’s Venture Capital and Private Equity Association (CVCA), $1.5 billion in venture capital was invested in 444 Canadian start-ups in 2011. The average size of a Canadian venture capital investment was $3.4 million.

As a comparison, in the United States, $28.4 billion in venture capital was invested in 3,673 ventures. U.S. venture capital-backed firms received an average of $7.7 million U.S. 

“We can only truly move forward when innovative companies are being financed at the same levels as global competitors,” said Gregory Smith, President of the CVCA.

Fundraising continues to be the major challenge facing the Canadian venture capital industry. In 2011, the industry raised $1.0 billion, little changed from 2010. U.S. venture capital fundraising totalled $18.2 billion, up 32 per cent from 2010.

Poor long-term returns in the venture capital industry have contributed to the difficulties in raising capital. Canada’s annualized returns in the venture capital asset class have lagged U.S. returns for most of the last decade. Institutional investors (mainly pension funds) have fled the industry. The relative poor returns have also discouraged foreign investors from investing in the Canadian venture capital industry.

Public Policies Can Support A Vibrant Venture Capital Infrastructure

Budget 2010 eliminated tax reporting under section 116 of the Income Tax Act for many foreign investors, including private equity and venture capital firms.

Previously, when a foreign venture capital firm sold an investment, all the principals in the venture firm who made the investment decisions as well as the firm’s limited partners had to fill out hundreds of pages of documents. The elimination of tax reporting under Section 116, as it applies to foreign venture capital funds, reduced tax compliance and administrative costs for foreign investors and has made Canada a more attractive destination for capital.

Additionally, a general partner (GP) of a venture capital received an exemption from registration with Canadian Securities Administrators if the GP’s role is to select small private companies that they will actively manage and develop. This has resulted in a more streamlined and harmonized approach to the regulation of investment activities across Canada.

These are two examples of how the government can set a helpful policy framework for venture capital to flourish.

A Healthy Venture Capital Ecosystem Depends On A Number of Factors

Venture capital funding is only one piece of the puzzle. Several other inputs are necessary for a strong and robust venture capital industry:

A supply of quality companies and talented entrepreneurs with strong management teams and management systems.

A strong angel-investor network that provides adequate seed and bridge capital, and venture capitalists who pick the best companies while quickly cutting off under-performing companies.

Investors who are willing to invest at all stages of company growth.

Attractive initial public offering (IPO) and mergers and acquisitions markets that have confidence in venture capital-backed companies.

Strong networks that link all players domestically and to global experts, markets and businesses.

A culture that embraces entrepreneurship and risk taking, mentoring of first-time Canadian entrepreneurs and the development of commercialization skills.

A public policy framework that encourages venture capital and entrepreneurial activity, including:

-  a strong IP-rights regime;

-  minimal regulatory red tape;

-  predictability, consistency and timely delivery of Scientific Research and Experimental Development Investment Tax Credits; and

-  a strong interface between post-secondary institutions and the private, public and non-profit sectors to accelerate the pace of discovery and commercialization and turn Canadian research efforts into successes in the marketplace.

Independent research by McKinsey & Company concluded that “the Canadian venture capital industry exhibits gaps in many of these elements.”

The Way Forward

The Canadian Chamber calls on all key stakeholders to come together to develop a reinvigorated national strategy focused on building one of the strongest and most robust venture capital ecosystems in the world.

Venture capitalists have been an important source of financing to many Canadian start-up companies that have gone on to become leading global enterprises.

They have made an important contribution to the development of Canada’s information technology, clean technology and life sciences sectors, among others.

These knowledge-based industries have bolstered economic growth and spurred job creation.

Venture capital-backed technology companies, for example, employee close to 150,000 people (direct and indirect jobs), contribute roughly $15 billion annually to Canada’s GDP and are highly export oriented (source: CVCA).

Canada can capture global leadership in innovation by fostering early-stage investment in the next generation of made-in-Canada knowledge-based companies. 

Tina Kremmidas is the Chief Economist of the Canadian Chamber of Commerce

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