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Overview of the venture capital markets in Canada and the US

Although geographically Canada and the US could not be closer, their venture capital markets are fundamentally different. Industry Canada gives an overview of the Canadian and US venture capital markets and provides analyses of the trends in the two markets and the differences in their structure and performance.

Participants in the markets

In Canada, the major participants in the venture capital market over the past few years have been the Labour Sponsored Venture Capital Corporations (LSVCCs), corporate funds associated with industrial and financial corporations and private independent funds that raise funds from institutional and individual investors. Among these different types of venture capital firms the LSVCCs have been the largest suppliers of venture capital during recent years, followed by corporate funds and the private independent funds. The dominance of the LSVCCs, along with a growing participation by government agencies, such as the BDC, shows that the Canadian venture capital market is very dependent upon government involvement and support.

In 1999, the private corporate and independent funds have a considerably smaller combined share (38 per cent) of venture capital investments under management than the government-related firms (50 per cent) do but in 2000 the private independent funds expanded their share considerably to almost equal that of the LSVCCs. The LSVCCs have also provided much of the growth in venture capital financing since their creation along with a lesser, although growing, contribution from the corporate funds and private independent funds. Over the years, private independent funds seem to have been constrained in their growth by the reluctance of Canadian institutional investors, particularly pension funds, to increase significantly their allocation of funds for venture capital financing.

In the US market, on the other hand, by far the dominant participants in venture capital financing have been the private independent firms that have no affiliation with other financial institutions. These firms generally invest through funds organised on a pooled basis as limited partnerships in which the venture capital firm serves as the general partner with the investors, largely pension funds, being limited partners in the structure. The next most important firms in the US market are venture firms associated with financial institutions, often on an affiliate or subsidiary basis. Corporate venture firms, that are subsidiaries of industrial corporations, also play a significant role, usually by making investments on behalf of their parent companies. Government participation in the US market is very limited and generally takes the form of government programs aimed at augmenting the funds available through private sector venture financing, often through private venture capital firms.

The major difference between the participants in the Canadian and US markets is the starkly different role played by governments in venture capital financing between the two markets. The Canadian market has a much greater dependence on government participation through both direct financing programs and the provision of tax incentives to investors than is the case in the US. The extent of participation by private independent funds is also very different between Canada and the US with these firms playing a very dominant role in the US but only a more limited role in the Canadian market. This, in turn, reflects an underlying difference in the participation of institutional investors in venture financing between the two countries. In the US, institutional investors provide the bulk of funding for venture capital financing, whereas in Canada venture financing is more dependent on funding from corporations and individual investors, particularly small investors through the LSVCCs, with pension funds playing a lessor role.

Supply of venture capital financing

The supply of venture capital financing has increased substantially in both Canada and the US since 1997 but growth in the US (492 per cent) has far exceeded that in Canada (250 per cent) during the 1997 to 2000 period. In 2000, the Canadian market invested funds equivalent to only 6.1 per cent of the funds invested in the US market, which is proportionately small compared to the relative size of the economies (Canada 15 per cent of the US) and on a per capita basis (approximately $0.35 per capita in the US vs. $0.20 per capita in Canada). This difference again appears to be related to the comparatively weak position of the private independent funds in Canada relative to those in the US, which draw on the huge pool of pension fund financing made available for venture financing in the US. Although the LSVCCs have been successful in raising funds in Canada they are restricted in making these funds available for venture capital financing by their dependence on small individual investors for their funding and the need to hold large reserves of non-venture investments, equal to 30 per cent of their total holdings, to protect these investors and provide liquidity for withdrawals of funds by investors. The growth of corporate venture firms is also more limited in Canada by the fewer and relatively smaller Canadian industrial and financial corporations that can effectively sponsor and fund such firms compared to the situation in the US, where many companies have the capability of doing so, particularly in the technology sector.

Venture capital investment by stage of activity

In Canada, the split between early stage and expansion stage investment on the part of venture capitalists has been very consistent throughout the 1997 to 1999 period, with approximately 35 per cent of total investment going to early stage companies and 53 per cent going to expansion stage companies each year during the period. This represented a well balanced provision of venture capital to companies in accordance with needs as individual investments in expansion stage companies would generally need to be larger than those for early stage companies, thereby resulting in a higher percentage of total investment going to those companies. However, in 2000, investment in early stage companies increased to 45 per cent of total investment and investment in expansion stage companies declined to 49 per cent, reflecting a greater focus on new companies. Of particular interest in 2000 was the substantial increase in seed investment in very early stage firms.

In the US, the pattern of investment by stage of activity appears to have been somewhat more volatile but the trend appears to be moving towards an increasing percentage going to expansion stage companies. In addition, in the US, a significant portion of total investment also goes to later stage companies that are beyond the initial expansion stage of activity; whereas, in Canada, this type of investment does not appear to have been significant. If these two stages of activity are taken together in the US the percentage of total investment going to companies operating beyond the early stage of activity substantially exceeds the percentage of total investment going to these companies in Canada. On the other hand, the percentage going to early stage companies in Canada significantly exceeds the percentage going to these companies in the US. This would appear to be one of the significant differences between the Canadian and US venture capital markets.

Sectoral distribution of venture capital investment

The sectoral distribution of total venture capital investment between the technology sector and traditional industries has been virtually the same in Canada and the US during each year over the 1997 - 1999 period but in 2000 there was further shift away from traditional industries. For example, in 1999, 80 per cent of total investment went to the technology sector while 20 per cent went to traditional industries in both countries but in 2000 the technology sector captured 97 per cent of total investment in the US and 90 per cent in Canada. Within the technology sector the most striking trend in the US was the sharp increase in investment in the internet sector. Although investment in internet companies in past years has not been broken out in the Canadian data, 2000 data also showed a significant percentage of investment in internet investment in Canada. Another significant difference between the two countries was the substantially higher percentage of investment going into biotechnology in Canada compared to that in the US. Communications, on the other hand, received a somewhat higher percentage of investment in the US than in Canada until 2000 when Canada had a higher percentage.

Regional distribution of venture capital investment

In Canada, over the 1997–2000 period, venture capital investment has been concentrated in Ontario, which in 2000, received almost half of total investment. However, Quebec and Ontario received almost equal percentages of total investment during the 1997 to 1998 period, with the two regions combined receiving approximately 70 per cent of total investment on average during the entire period. The only other region to receive a significant portion of total investment was Western Canada, which averaged approximately 20 per cent during the 1997–1999 period but declined significantly in 2000. The Atlantic region received only a minimal share of total investment throughout the period. In the US a similar regional distribution pattern occurred during this period with the Southwest region, dominated by California, receiving almost 50 per cent of total investment. The only other region to receive a substantial percentage was the Northeast, which consistently received about 20 per cent of total investment. All other regions in the US received almost equal amounts of less than ten per cent of total investment throughout the period. This evidence suggests that both countries are experiencing difficulties in achieving a balanced distribution of venture capital investment among the various regions of their countries. In both countries, this pattern also reflects the regional distribution of venture capital investment opportunities and part of the solution to this unbalanced regional activity may be greater promotion of new businesses in these regions that would be available for venture investment.

Copyright © 2002 Industry Canada

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