The $600-million fund the federal Liberals created to invest in startups that use technology to fight climate change is losing money, and having difficulty finding companies in which to invest.
The fund, administered by the Business Development Bank of Canada (BDC), has invested in some firms that are failing to meet performance targets and that are at risk of defaulting, according to a year and a half of BDC’s financial documents and letters sent to cabinet ministers obtained by The Logic.
The internal documents include repeated references to BDC “stretching” to invest in firms earlier than it normally would, providing more money and offering more flexible terms than is standard. A July report suggests BDC push for “more realistic” sales models from startups in which it’s investing, and flags its overall cleantech investment as having a degree of risk “near or outside operating plan thresholds.”
In January 2018, Innovation Minister Navdeep Bains announced $600 million in funding for BDC to create a cleantech portfolio that invests in startups so they can “hire new staff, develop products, support sales, and scale up and compete globally.”
The internal documents show those goals are not being met.
“[Cleantech] portfolio firms are falling short of their own forecasts and, in many cases, BDC’s base case forecasts,” reads a July report BDC sent to Small Business Minister Mary Ng. The report also suggests BDC push for “more realistic” sales models from startups in which it’s investing, and flags investment activity as a risk measure “near or outside operating plan thresholds.”
BDC says the losses it’s taking are standard for early-stage investments in the cleantech sector and the riskier investments it’s making are fulfilling the mandate the government gave it.
The documents include repeated references to BDC “stretching” to invest in firms earlier than it normally would, providing more money and offering more flexible terms than is typical. The resulting portfolio is well below BDC’s average investment quality. About 60 per cent of its cleantech portfolio is made up of investments with a B- risk rating, according to a January report. BDC overall, by contrast, has over 60 per cent of its investments in BB or higher.
Bains declined to answer The Logic’s questions. The office of Small Business Minister Mary Ng, who oversees BDC, did not directly answer questions regarding BDC’s losses or internal concerns around performance targets and defaulting.
Alessia Avola, special assistant for communications in Ng’s office, said the government asked BDC to generate new risk criteria that reflected the cleantech sector’s increased risks. “We trust the bank to make independent investment decisions as a crown corporation of the Government of Canada,” she said.
Susan Rohac, a BDC vice-president who runs the firm’s cleantech practice, said the bank is doing what government has asked it to do, is on track to meet its goals and isn’t planning to make any changes to its approach.
“We’ve got a strong pipeline of deals that we’re going to be executing on in the next while, and we feel that we’re delivering on the mandate that was given to us,” said Rohac.
Rohac also emphasized that the losses BDC has taken on its cleantech portfolio are standard for early-stage investments that are not expected to pay off for years. In fiscal year 2018, BDC lost $571,000. BDC projected it would lose $17.7 million in fiscal 2019; it lost $6.6 million instead.
“We’re doing better than what we anticipated in fiscal ‘18 and ‘19. And so far in ‘20, as well.”
Rohac said it’s a “bit surprising” no firms have defaulted so far, given how risky these investments are. “It’s still early days to see defaults and arrears, and hence, we don’t see any yet,” she said.
A BDC analysis conducted in February rated the cleantech investments as near the upper limit of the bank’s tolerance for risk. “Both sub-debt / direct equity have weighted average risk rating of 4.8, approaching BDC’s highest risk rating for productive accounts (5.0),” reads the analysis.
In a June 2018 BDC report, the potential for “some reputational risk” is flagged as a top-of-mind issue, partially because most of the cleantech companies BDC might invest in were unattractive opportunities that lacked technological or commercial validation. (Shawn Salewski, BDC assistant vice-president for communications, told The Logic reputational risk is no longer a concern.)
The June report also flagged concerns around a lack of more mature firms in which to invest. That issue is highlighted repeatedly in BDC reports over the next 13 months, including in the July 2019 report presented to Ng.
Part of the problem for BDC is a lack of private-sector investment. Multiple internal reports raise concerns about a dearth of interest from the venture capital firms to which the federal government gave $400 million as part of the Venture Capital Action Plan (VCAP). VCAP fund-of-fund managers and “other institutional LPs [limited partners] have shied away from pure cleantech because of unattractive risk / return profile,” reads one July 2018 report. Four of the five fund-of-fund managers that received money from VCAP also got funding under the $400-million Venture Capital Catalyst Initiative (VCCI).
BDC also predicted that other Canadian cleantech funds would have difficulty raising money, and that some would fail to do so.
Canadian cleantech venture capital funds’ “financial performance has historically been poor to bad,” reads the July 2018 report.
The participation of other investors in BDC’s cleantech deals has improved in recent months. As of May, other investors had put in 1.1 times the amount of money BDC did. That ratio is now up to 1.6.
BDC is trying to further increase the amount of outside investment. In September, Toronto-based ArcTern Ventures announced a $165-million fund to invest in cleantech companies. Earlier this week, Vancouver-based Renewal Funds closed a $145-million cleantech fund. BDC invested in both.
The bank is also getting help from overseas investors. In the July 2019 report, BDC identified New York-based Azimuth Ventures and the Oil and Gas Climate Initiative—which includes some of the largest energy companies in the world—as “good partners.”
However, internal concerns with BDC’s portfolio companies remain front of mind for the bank. The July report states that BDC needs to “push back” on client forecasts, and that time to market is “significantly underestimated” by cleantech entrepreneurs.
In January, BDC board chair Mike Pedersen wrote to Ng to request additional money ahead of the original schedule.
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“I am now requesting on behalf of the Board a second capital injection of $277 million, which would allow BDC to continue uninterrupted until September 2020. This date was chosen taking into account typical capital injection approval timelines after the election and, as applicable, transition briefing of new Ministers.” BDC has received that $277 million, on top of a $125-million tranche it already got.
Asked if BDC requested the additional funds early in case of the election of a government that wants to cancel the cleantech practice, Salewski said that was not a consideration, but that “if the government changes, that’s a decision that they’ll own and BDC as a Crown corporation is here to ensure that we implement the decision of our shareholder.”
With files from Murad Hemmadi and Iain Sherriff-Scott