In Canada, we love to talk the talk when it comes to supporting the New Economy and the job creation that will stem from the high-tech sector’s growth.
But when get beyond the talk, thereâ€™s a much different story happening. Without setting off the alarm bells too loud, thereâ€™s a crisis looming that will have a major impact on the New Economy.
The problem is the sharp decline in the amount of venture capital available to start-ups in Ontario, which accounts for about 40% of VC investment in Canada. While this issue hasn’t got a lot of coverage, the reality is the money available to companies that want develop products and hire lots of people is quickly evaporating. If you look at the number of deals done in Ontario so far this year, there is a huge decline compared to historical trends.
Calling a spade a spade, Wellington Financial’s Mark McQueen described the first-half venture capital statistics as â€œbrutalâ€. The numbers tell the story â€“ and it isnâ€™t pretty.
In Q2, total venture capital investment in Ontario dropped 57% to $131-million from Q1, and 35% from Q2 2006. In Quebec, $149-million was invested â€“ a modest 12% drop Q1 and a 10% year-over-year increase. In B.C., $112-milion was invested â€“ 44% higher than Q1, and only 13% less than Q2 2006. (Source: CVCA)
If you exclude Guelph, Ont.-based Geosignâ€™s $160-million financing in the first-quarter, McQueen estimates there was just $83.8-million invested in Ontario during the first six months of 2006.
â€œFor all of the time and effort that has gone into the MARS project, the technology industry is starving for capital in this province,â€ he said.
If you go further up the food chain, the funding “problem” is also evident by looking at fund raising by Canadian VCs. In Q2, VC firms raised $272-million, a 46% drop a year earlier, while fund-raising over the first half of 2007 dropped 21% to $739-million.
So whatâ€™s gone wrong?
In simple terms, there are two major issues:
1. A couple of years ago, the rules on where institutional investors could invest their capital changed. Rather than forcing them to invest 40% of their funds in Canada, institutional investors can now do whatever they want to get the best returns possible, including the vibrant U.S. private equity market. As a result, it has become more of a challenge for Canadian venture capital firms to raise money.
2. Two years ago, Ontarioâ€™s Liberal government decided to phase out the tax credits for labour-sponsored funds. While the phase-out period extends to 2011, the market has effectively dried up because investment advisors are unwilling to aggressively sell a product that has a financial cloud hanging over it.
This one-two punch has unfortunately meant thereâ€™s less and less money around for start-ups. VCs that do have capital to deploy are funneling a good chunk of their money into existing investments rather than jumping into new deals.
Another impact of the dearth of start-up financing is it could see U.S. VCs retreat form Canada. Why? U.S. VCs like to invest in â€œBâ€ rounds rather than early-stage deals. But without a vibrant early-stage market, there will be fewer â€œBâ€ round opportunities.
For anyone thinks you need to encourage innovation, the commercialization of R&D, and support the entrepreneurial community, this situation is very troubling.
So whatâ€™s the solution to jump-start the venture capital market in Ontario?
The Ontario government could do the high-tech industry a huge favour by reversing its tax policy about labour-sponsored funds. Bringing back investment tax credits would go a long way in encouraging retail investors to come back. It would also see Ontario have much the same approach again to labour-sponsored funds as Quebec and B.C. where the financing markets for start-ups are much healthier. With the Ontario election campaign about to kick into high gear, it would be a positive sign if tax credits became part of the discussion when the focus turns to job creation.
Getting institutional investors interested in Canada again is a more complex situation because they need to be confident thereâ€™s an opportunity to generate strong investment returns. One way to instill confidence is doing whatâ€™s needed to nurture vibrant venture capital and high-tech markets.
Truth be told, jump-starting Ontarioâ€™s venture capital landscape is going to take time. But if we truly believe in the New Economy, having a healthy amount of financial support for start-ups and entrepreneurs is crucial for success. If Ontario is really serious about creating this kind of environment, now is the time to make the necessary moves.
More: Who knows; maybe Google will rescue Ontario’s VC market given the cash-rich search engine giant has started to make investments of about $500,000 or less in promising startups as it hired a team of financial analysts to assess deals. GigaOm wonders whether the weak U.S. economy will “KO Web Startups”.