Canada’s VCs anticipate a drop in early-stage startup funding

Small Business Minister Mary Ng responds to a reporter’s question following a ceremony in Ottawa in November 2019. The Canadian Press/Adrian Wyld

Canada’s venture capital community is anticipating a plunge in new deals as investors focus on minimizing the damage to their portfolio companies amid the COVID-19 pandemic. 

In a letter sent Thursday night to Small Business Minister Mary Ng, the Canadian Venture Capital and Private Equity Association (CVCA) warned of “prolonged fundraising timelines and the inability to start deploying capital into the market, resulting in a severely constrained flow of capital into the Canadian innovation ecosystem.” 

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Talking Point

Investors from several of Canada’s most active venture capital firms told The Logic they’re anticipating a slowdown in early-stage funding, as they stop taking meetings with prospective portfolio companies and focus on worst-case-scenario planning for their current investments. In a letter to the federal government, the Canadian Venture Capital and Private Equity Association warned of “severely constrained flow of capital into the Canadian innovation ecosystem,” and urged the Business Development Bank of Canada to launch a VC fund-matching program to stimulate deal activity.

Among its recommendations for how to backstop Canada’s startups, the CVCA, which represents over 290 member organizations, asked the Business Development Bank of Canada (BDC) to help close funding rounds that are currently open and to match VC funding for venture-backed startups with up to $2 million in convertible loan notes.

“The first thing investors have done in this time of crisis is turn to their CEOs and portfolio companies and look to make the investments necessary to keep as much staff as possible and plan for when a recovery comes,” CVCA CEO Kim Furlong told The Logic. “But we need to ensure more dollars flow to these high-growth companies to keep them alive so when we hit recovery, they can continue to grow, create employment and create value for the Canadian economy.

“The matching program will make every dollar a VC has go further,” she said. “The need for liquidity of Canadian startups rose significantly in the last couple weeks.”

VCs from several of Canada’s most active firms told The Logic they’ve spent the past few weeks poring over their portfolios, scenario-planning for each firm in which their funds are invested. “We are talking to our companies about three months minimum, six months likely and potentially up to 12 months to make sure we have plans in place across that continuum,” said Peter van der Velden, managing general partner at Lumira Ventures. Other investors are even more conservative: Standup Ventures and Relay Ventures—which is an investor in The Logic—said they are setting contingency plans for up to 24 months out.

“We’re planning for the worst-case scenario, and drive at the most conservative top-line case,” said Kevin Talbot, Relay co-founder and managing partner. “Once we know what that is and we know how much cash we have, then we know what we’ve got to take out of the business. In priority, we’re cutting [capital expenditures], we’re cutting third-party expenses, we’re cutting consultants, we’re working with landlords on abatements or discounts on rents and talking to service providers about the same thing. And last is reductions in headcount,” he said. “We’re trying to avoid cutting to that level—our teams are the most important asset we have—but at the end of the day, we have to make it out of this thing.” 

Many investors expect early-stage funding to be hit the hardest. With their priorities set on keeping active portfolio companies afloat, investors say they aren’t in a position physically or financially to fund new startups that aren’t already in their pipelines. “We’re not at a point where we’re willing to make an investment in a company [for which] we haven’t physically met management yet,” said Jim Orlando, a managing partner at Wittington Ventures. “Making a venture investment is a long-term proposition, so as of right now, any company we haven’t had an opportunity to meet with, we’ll do some of the background work, but that’s more preparing for the future.” 

“I think new financings are going to be the challenging part of the ecosystem,” said van der Velden. “I imagine second-quarter numbers will be down very meaningfully.”

Global seed-stage funding has already dropped 22 per cent since January, according to a report from CB Insights. CVCA, which tracks investment activity in Canada, told The Logic it’s too early to glean statistical data on how COVID-19 has affected venture capital funding in the country; however, its letter to the federal government suggests it anticipates deal activity will generally slow down. “Anybody who’s raising right now is finding investors are more hesitant—that’s what our companies are seeing for those raising rounds now,” said Andrew Ray, vice-president of investment at Innovacorp. “For those planning rounds for the next few months, they’re rethinking those plans.” 

Ray, whose firm is backed by the Nova Scotia government, said Innovacorp is in a better position than some privately backed funds whose investors may be taking a more cautious approach. “The province is much more supportive of us putting money into companies now,” he said. “If we do nothing and just try to ride it out and don’t make investments, we’re going to lose half of our good companies.” However, he said a lack of co-investors could compromise those deals. “I’ve had these conversations about potential co-investors, and they’re worried about asking their LPs for lots of money when their portfolio might be down 40 per cent.”

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Van der Velden echoed Ray’s concerns about finding other investors to close deals with. Lumira, which focuses on healthtech companies, is likewise scouting buying opportunities. “We’re looking back on our pipeline over the last 24 months at companies where maybe we didn’t do the deal because of valuation or because of some other characteristics, but that might make sense today,” he said. “But I think putting together syndicates on companies we know well and want to invest in might be the new challenge.” 

Ray noted that a federal VC-matching program like what CVCA suggested “will go a long way to addressing some of the significant concerns” around startup funding. “It’s a lot better than giving companies half the money they need and then sending them out into a difficult market to find the rest.”