A new report says Canada’s venture capitalists are being more cautious with their investments after a historically frothy year in 2021 – but activity at Ottawa-based VCs should remain fairly steady thanks to their focus on seed and early-stage deals, an expert says.
The Business Development Bank of Canada (BDC) said Wednesday that venture capital lending, which tends to focus on early-stage companies with significant growth potential, dropped in 2022 and is expected to remain slow as companies grapple with higher interest rates, a wave of tech layoffs and fallout from the collapse of Silicon Valley Bank.
The research found the number of venture capital deals done in 2022 shrank by 12 per cent from the year before to 706, while the total amount invested declined 34 per cent to $10 billion. The average deal size pulled back 24 per cent to $14.2 million over the same period.
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“We’ve entered into a more challenging time,” said Jerome Nycz, executive vice-president at BDC Capital.
“We’ve gone a long way in the last 10 years in creating a more mature, resilient, diversified and a bit more sophisticated VC class, and now we’re at risk of losing a lot of that momentum because of the economic environment.”
He noted that geopolitical uncertainty and the failure of Silicon Valley Bank, which was used by a slew of tech startups, have “notably shaken” investor confidence.
BDC is predicting that total VC lending in Canada could fall to between $6 billion and $8 billion in 2023, “and Ottawa will not be spared of that reality,” Nycz said in an interview with OBJ on Wednesday afternoon.
But he also noted that the city has some advantages that could keep it from experiencing a significant downturn.
Ottawa is home to a “good pool of angel investors”, as well as VCs such as Mistral Venture Partners and Celtic House Venture Partners, that channel their capital into seed and early-stage investments, Nycz noted.
That should bode well for the city’s VC community, he said, because seed-stage investment activity has remained fairly consistent over the past 18 months.
The total amount of funding for seed deals in Canada fell just one per cent in 2022 compared with the previous year, BDC’s report said, while the total number of deals declined eight per cent.
By contrast, the total amount invested in late-stage deals shrank 12 per cent and the deal tally declined 21 per cent. The drop was even more dramatic for growth-equity investments – in which the total amount of capital invested plummeted 73 per cent and deal volumes dropped 33 per cent.
“The significant reduction in later-stage (investment) will affect your market to a lesser extent,” Nycz explained. “The fact that you’ve got more early-stage investment, you’re seeing less of a contraction.”
Between 2014 and 2022, venture capitalists invested about $2.7 billion in Ottawa-based companies, he said. Nearly $1 billion of that funding occurred in 2021, but investment totals “came back down rapidly” last year to around the 10-year average of between $270 million and $300 million, Nycz said.
While that was a major drop, he said local investors continue to see “a steady (stream) of opportunities” to deploy capital to young companies.
“We’re seeing a good activity level (in Ottawa), despite the challenges that we’re describing in the report,” Nycz said. “I think angel investors, working with accelerators, working with early stage investors, will make a tremendous difference in the Ottawa market.”
The new outlook comes after a bull market produced more than 100 Canadian unicorns – startups with $1-billion valuations – in the past 25 years.
However, companies big and small are now eschewing the “growth-at-all-cost” mentality they were once known for and instead focusing on cost reduction.
Meta, the parent company of Facebook, Instagram and WhatsApp, even went so far as to name 2023 the “year of efficiency” when it embarked on a 10,000-person layoff earlier this year.
Ottawa-based tech darling Shopify cut 20 per cent of its workforce in May, following a 2022 cut that saw 10 per cent of staff depart.
Google, Netflix, Oracle, Wealthsimple and Twitter have all made staffing reductions, too.
Nycz believes the pressure to be prudent with cash and efficient with operations will continue as management teams weigh the cost and benefit of growth against the need to preserve capital should the downturn become more severe.
Half of Canadian companies and up to 70 per cent of American businesses will need to raise capital over the next year, BDC anticipates. Several companies across its portfolio have less than 12 months of runway.
Wrangling further investments will prove trickier than during the pandemic, when interest rates were low and investors were keen to put money behind ventures that were soaring amid remote work.
“People realize that we don’t need money for the next six months,” said Nycz. “They need money for the next 24 months or 36 months because people expect the market not to get back very rapidly.”
Canadian VCs hold an estimated $13.2 billion in cash, but BDC expects it to be handed out more slowly, leaving capital deployment figures below those of last year.
Those that do offer money will seek lower valuations or more investor-friendly terms, BDC said.
– With additional reporting from OBJ staff
