Ventures West - April 02, 2004 - The Great White North May Be Green

The Great White North May Be Green

By Alex Stockham, Editor

When one thinks of traditional emerging markets, English isn't typically one of the official languages.

But Canada, while very much a developed country, is still relatively undiscovered by private equity and venture capital firms. The country's geographic proximity to the United States, its lower costs of doing business and its growing entrepreneurial acumen are contributing to a growing interest among U.S. private equity and venture capital firms, however.

It is true that Canada has a home-grown venture capital market, but it is much smaller than the U.S. market. According to Venture Economics and Macdonald & Associates, approximately $15 billion was raised for U.S. venture capital funds in 2003, compared to less than $2 billion for Canadian funds. Robin Louis, president of Canadian venture capital firm Ventures West Management, says while the Canadian market may be smaller than the U.S. market, it is much more stable.

"The boom and bust in venture investment in Canada was less than in the U.S.," Louis says.

But that doesn't mean there isn't an attraction in Canada. Louis says the potential for profitable investments in Canadian companies is growing. Not only have start-ups matured in the country, but the government is getting in on the act to help generate interest. The Canadian government provides a cash rebate of 30% - up to CAN$700,000 ($534,400) per year - for qualifying research and development expenses, including salaries, materials and equipment. This makes the country a great place to start a business - or for a U.S. business to put research and development facilities. Louis adds that Electronic Arts, the video game publisher, has a development facility 20 minutes from Vancouver.

Just because Canada has a smaller venture capital community than the U.S., that doesn't mean that U.S. venture firms aren't interested in the country. Some firms see the potential that Louis describes. One such firm is San Francisco-based Draper Fisher Jurveston, which last year teamed with Toronto-based Primaxis Technology Ventures to launch a $100 million Canada fund. The fund will invest in early stage companies with the potential to become global giants, according to a press statement at the time.

Another U.S. firm with interest in Canada is Waltham, Mass.-based Kodiak Venture Partners. The firm, which closed its third fund last August on $316 million, has invested approximately 20% of its capital over the last four or five years in Canada, according to Dave Furneax, a managing general partner with the firm. The firm has 15 investments in the country, including Ottawa-based BTI Photonics Systems, Ottawa-based Tropic Networks and Ottawa-based Potentia Semiconductor. Furneax compares Canada to any U.S. city that is emerging on venture capital firms' radar.

"Like any emerging market, such as Austin, Texas when it got started, you have great technology but not the history of success on the business side," Furneax says. "Over the last few years, there's been more business talent in the region."

Louis says while Canadian companies received quite a bit of attention from U.S. venture capital firms in the late 1990s and around the turn of the century, most of that money was focused on Ottawa-based telecommunication deals. Much like their U.S. counterparts, a lot of these Ottawa telecom companies struggled, leaving a bad taste in the mouths of venture capitalists. But in 2003, a much broader variety of companies in Canada received funding from U.S. firms. Suddenly, cities outside of Ottawa began getting attention.

Furneax says Canada is really a small market trapped in a large geographic area. There are only really four cities for venture capitalists to look at - Toronto, Montreal, Ottawa and Vancouver. Despite this limitation, Canada is still the fourth largest venture market in the world and amount of venture capital disbursed as a rate of GDP is larger than that of the U.K., Germany or France. According to various sources including Venture Economics, Canadian technology companies receive a similar amount of venture funding as U.S. companies, minus those located in Silicon Valley and Boston.

"For the size of those cities and the size of the country, there's a respectable amount of activity," Furneax says. "There are some terrific companies growing in those regions."

Canada's attractiveness as a destination for VC money relates not only to the cheaper cost of doing business in the Great White North. Louis says the environment is less competitive than the U.S. and he thinks pricing may be more attractive as well.

Canada also has a high level of education, leading to a great number of companies coming out of world-class universities, but a large amount of people with the necessary training to become entrepreneurs. Approximately 47% of Canada has received a tertiary (post-college) education. Not only is the population educated, but the entrepreneurs are now experienced enough and successful enough to have moved on to a second venture.

"The technology communities are maturing so that there are repeat entrepreneurs," Louis says. "There are also active venture capital groups, angel investors and the like."

Unlike other emerging markets, Canada is also very convenient for U.S. venture capital firms. The country doesn't necessarily require personnel based there in order to get to know the lay of the land. The country has similar laws, culture and business practices. Flights are also convenient - short and in the same zones.

But an investment can only be as attractive as its potential profit. If an exit market doesn't exist, other factors don't matter much. That isn't as much a concern for Canadian companies, though, because of their proximity to the U.S.

"Canadian companies have access to U.S. sources of liquidity, such as Nasdaq and strategic purchases, that provide upside," Louis says. "Fully 75% of the liquidity in Ventures West's past four funds came from the U.S."

Furneaux says his firm saw Canada as an attractive market in the mid-1990s because there was a lack of firms investing in the country, but a large amount of talent.

"We saw a void in the market," Furneaux says. "That's been filled as some firms are up there, but they haven't committed to the region. We made a commitment to the region. If anything we've strengthened that commitment over time. When you have a good thing going, you want to keep it going."