Higher interest rates could dim valuations for VC backed startups in Canada: experts

toronto financial district
toronto financial district

Venture capital experts say higher interest rates could trim sky-high valuations Canadian startups have grown accustomed to over the last couple of years, but not right away.

On Wednesday, the Bank of Canada raised its benchmark interest rate to 0.50 per cent from 0.25 per cent, with more hikes expected this year.

“This initial increase shouldn’t hinder venture capital (VC) deployment or hurt startups looking to raise as venture funds are flush with cash right now and want to use it,” says Laura Lenz, who leads investment activity in Canada at OMERS Ventures.

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However, she says there could be less money going into venture funds as rates continue to rise, resulting in capital deployment moving at a slower pace and funding rounds being smaller in size.

Consequently, Lenz sees venture capital firms taking a slightly more measured approach when deciding which companies to back.

“I think that VCs will take more time in their diligence, which is a good thing, because it will provide founders with time to assess partner-founder fit, which is critical in building a long-term successful business,” she said in an interview.

In addition, if exuberant deal valuations, especially from U.S. funds, are tempered, Canadian VC firms may be in a better position to compete with their U.S. counterparts that have been dishing out very large amounts of cash to companies in Canada, according to Nick Quain, vice president of venture development at Invest Ottawa.

“Many Canadian VC firms have been outbid and not willing to match the size and valuation of rounds U.S. funds have offered Canadian companies in the last few years,” he said.

Money has been flowing across the border from investment firms like New York’s Tiger Global Management, which has led multiple large investments in Canada during the pandemic period. U.S. VCs are the most active foreign investment groups in Canada.

A VC market cooldown will likely have more of an impact on mature companies in the startup ecosystem and late-stage funding known as Series C+ financing, but some early growth stage companies looking to raise money in the near future are beginning to consider the ripple effects and implications for first significant rounds of VC financing.

Kitchener-Waterloo cleantech company EnPowered is one example as it prepares to have conversations about Series A first round financing at the end of the year, said founder and CEO Tomas van Stee.

“We are adding an extra six months to our runway calculations, essentially reducing our spend in order to give us another six months of runway before running out of capital just in case the VC market does cool down at the Series A stage,” he said.

At the same time, he sees large growth funds focusing more attention on earlier funding levels (Series A and B) because of competition at the Series C+ level, which could drive up valuations there and potentially benefit his company’s raise.

Last year was a record for venture capital investment in Canada with $14.2 billion distributed across 751 deals, 71 of them being megadeals, according to the Canadian Venture Capital and Private Equity Association.

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