U.S. participation in Canadian venture capital deals this year has dropped by nearly a third on an average monthly basis. 

As of October 29, U.S.-based investors participated in 281 venture capital deals in Canadian companies, compared to 462 deals for all of 2019, according to PitchBook data. 

The drop is part of a longer-term trend showing U.S. firms are participating in a smaller share of Canadian VC deals relative to local investors.

The dollar amount of Canadian deal flow involving U.S. investors also fell this year. American investors participated in deals worth a combined US$1.74 billion for the first three quarters of 2020, down from US$2.59 billion for the same period the year before. 

The drop comes even as the Canadian Venture Capital & Private Equity Association (CVCA) reported record-high venture capital activity in the second quarter of 2020, despite concerns the COVID-19 pandemic would thwart fundraising efforts. 

“There’s definitely that extra hurdle for outside investment to come into Canada,” PitchBook VC analyst Kyle Stanford told The Logic. “If you’re an investor and you haven’t previously invested outside your local area, it’s much more difficult and probably something not many investors are going to go searching to do.” 

According to Stanford, American participation in Canadian VC by number of deals this year roughly tracks with other foreign markets. Within the U.S., local VC investors are likewise participating in fewer deals—from about 985.5 monthly in 2019 to 756.5 in 2020 so far. However, the amount of U.S. venture capital in the domestic market is outpacing last year’s deal flow, with about US$111.55 billion raised this year to date compared to US$114.35 billion for all of 2019. 

“The U.S. market is completely different,” said Stanford. “There’s such a density of investors and capital that we haven’t seen much of a drop in deal activity, which is really surprising.”

The data shows that investors are doubling down on larger but fewer deals, which Stanford said speaks to the uncertainty in global economies. It could also partly explain why U.S. investors are focusing on promising local firms rather than risking their funding on unfamiliar, and often smaller, Canadian companies. 

“Where there’s economic uncertainty and headwinds, there’s going to be a flight to quality,” said Stanford. “If you’re a company and you have a really strong revenue track record or getting strong traction due to the pandemic, investors are going to see those deals and will flock to them.” Already this year, there’s been close to 250 deals of US$100 million or more in U.S. firms, he said, which is already more than all of 2019. 

While U.S. participation in Canadian deals fell from 68.8 per cent in 2019 to just 61.2 per cent so far this year, the longer-term trend shows U.S.-based investors are participating in fewer but larger deals in Canada, too. In 2010, U.S. investors were involved in nearly 67 per cent of all VC deals in Canadian firms, compared to just over 55 per cent so far this year. Over the same period, however, deals in which U.S. investors participated grew from about 42 per cent to 61 per cent based on dollar amount.

Canada saw a spike in large venture capital raises in the latter half of last year, including $515 million for financial-crime-management firm Verifin, $393 million for banking-services firm Clearbanc and $330 million for legal-tech firm Clio—all of which attracted U.S. funding. 

“So much of the market now is driven by really large deals, said Stanford. “For an ecosystem such as Canada—which is growing but doesn’t have the capital or late-stage companies that the U.S. does—those outsized deals are really going to influence that overall figure quite a bit.”

Kim Furlong, CEO of the CVCA, suggested that, barring lower interest from U.S. investors relative to last year, government relief programs and local investors gave Canadian firms a boost in the first half of the year. “When I think about 2020, we had a good quarter in Q1 and a better quarter in Q2, based on matching programs from EDC and BDC, and VCs doubling down and giving runway of about 18 to 24 months to stars in their portfolios,” she said. “Plus [investors] had fundraised [before the pandemic].” 

Furlong noted that among CVCA’s few U.S. members, the average size of early-stage investments in which they participated increased to about $17.8 million in the first half of the year, up from about $10 million in 2018. 

Despite the record-high year-on-year venture funding in the first half of the year, Furlong said she expects numbers for the rest of the year to dip, as investors return to a more normal pace after having shored up funding for their portfolio firms. Ultimately, she said VC activity for 2020 may end up looking closer to 2018, a more typical year for the market relative to 2019’s anomalous showing. 

Stanford likewise predicts U.S. investors will return to a more standard pace, which could mean more money flowing to Canada. “We’ve seen in the U.S. that as investors got more comfortable sourcing deals and making investments in companies that they haven’t been able to meet in person, investment trends have kind of pushed back to where we were in 2019 before the pandemic,” he said. “I would expect those types of similar trends to play out in markets around the world.”