The federal government recently announced that it would be injecting $400 million into the venture capital sector in Canada in 2013. To Canada's private equity and venture capital community, this comes as welcome news and serves as a call to action for an industry that has certainly gone through some dark days in recent years. Yet, based on the activity in the last 24 months in the private equity and venture capital markets, there may yet be room for optimism.
Private Equity
Almost $4.5 billion in private equity deals were done in Canada in 2012, representing more than 110 transactions – a 25% increase over Canada's best year in 2008. In part, the number of transactions, particularly in Quebec, reflects a generational transfer of ownership among the baby boomers. As well, these numbers are reflective of a large number of going-private transactions, where many companies (that had no business going public anyway) are simply giving up on the market or find they can't live with the required level of compliance and regulation.
Venture Capital
Another telling statistic is that venture capital funds raised almost $1 billion in 2011 and $1.8 billion in 2012, and more than $400 million was actually disbursed (70% more in 2012 than the previous year). As for the $2.8 billion raised in 2011 and 2012, these are venture capital funds that will have to be invested, mostly in Quebec, over the next five years. Of the total funds raised across Canada last year, Quebec funds captured a 52% share, or $924 million. Bottom line – venture capital fundraising is at its highest level in a decade.
The Federal Government's Venture Capital Action Plan
Lastly, in January 2013, the federal government of Canada, in a studied and planned effort to provide support to Canada's underexploited knowledge-based economy, announced that it would deploy $400 million over the next seven to ten years to bolster the presence in Canada of a strong and mature venture capital private sector. This is more good news for Canadian start-ups and Canadian venture capital funds and national funds of funds, as well as foreign funds seeking to enter the Canadian market as co-investors. These funds will not be managed by the feds; instead, this program will be pushed down through the existing funds of funds network in Quebec.
The government's plan is in response to historically less-than-stellar returns for venture capital investors in Canada resulting from a lack of investor confidence, the unwillingness of large institutional investors to take a chance on early-stage companies, and a lack of venture capital funds and experienced fund managers in Canada who are able to lead successful venture capital funds. The government hopes to overcome this systemic problem with a long-term view of improving Canada's economic competitiveness by increasing private sector investment and decision-making in emerging Canadian companies with high-growth potential. Based on the experience of growing knowledge economies, such as Boston, New York and Silicon Valley, this program underscores the importance of a sustainable private sector venture capital sector, as well as recognizing other factors, such as technology transfer offices, linkages to foreign investment pools and the availability of mentors for inexperienced venture capital firms to build local expertise.
In order to do this, the government has committed this $400 million to support the creation or growth of private sector, large-scale venture capital funds in Canada. The $400 million will be allocated three ways: (i) $250 million to establish new, large private sector-led funds of funds in partnership with institutional and corporate strategic investors, as well as interested provinces; (ii) up to $100 million to recapitalize existing large private sector-led funds of funds; and, (iii) up to $50 million to be invested in a handful of existing high-performing venture capital funds in Canada.
The fact that the lion's share of the funds will go to both new funds of funds (which should be up and running within the year) or existing funds of funds represents a big opportunity for foreign institutional investors seeking to enter the Canadian market and invest in Canadian high-growth companies in a significant way. With a minimum investment requirement of $10 million, potential investors for the new and existing national funds of funds are large foreign or domestic institutional investors, such as banks, pension funds, corporations, SWFs, insurance companies and interested provinces (the participating provincial governments will contribute capital on the same terms as the capital from the government of Canada).
Each of the national funds of funds must be managed by an experienced private sector general partner with a substantial presence in Canada. Eligibility for the underlying venture capital fund managers also depends on a substantial presence in Canada and a commitment to invest one-third of their total capital in Canadian-domiciled firms. The incentive structure for private sector investors will be the same in both the new and existing funds of funds. In each case, the government will privilege funds of funds capitalized between $200 million and $300 million, and making market-based private sector investments focused on maximizing returns.
Interested investors will have the opportunity to examine a draft term sheet from the government outlining: (i) the key parameters of the funds of funds; (ii) the funds' investment orientation; and, (iii) the selection of private sector general partners.
Somewhat surprisingly, this program has not yet received significant media attention. The reason may be due in part to the fact that, at this point, the exact size and sectorial focus, if any, of these national funds of funds are undetermined. The decisions the government makes will depend on discussions with private sector investors and which investment strategies and conditions maximize participation from institutional and corporate strategic investors.
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