Venture capital invested in Canadian startups declined again this summer to the lowest level since the early days of the COVID-19 pandemic, as companies attempted to stretch their cash with quiet inside rounds mostly from existing investors.

After a slight rebound in activity this spring, the third quarter’s relatively low deal volume reflects covert investments made to avoid disclosing reduced valuations since the economy took a turn last year, investors told The Logic. “The founders are keeping their mouths shut,” said John Ruffolo, founder and managing partner of Maverix Private Equity. “They don’t want to go to the market and say, ‘Your business might be doing terribly.’”

Companies raised approximately US$900 million across 138 deals from July through September, PitchBook data shows. It’s the first time that quarterly venture investing fell below US$1 billion since the third quarter of 2020, as high interest rates weighed on startups and their ability to raise money on friendly terms. 

The funding is roughly half the amount companies raised the previous quarter. Investments had ticked up this spring after dropping from their 2021 record highs. Interest in artificial intelligence and green technology helped boost activity during that second quarter. 

With initial investor excitement wearing off for generative AI and government cleantech stimulus, overall VC activity slowed back down. 

Investments in artificial intelligence companies fell to about US$367 million, compared to US$517 million the previous quarter. Cleantech and climate-tech companies, meanwhile, raised about US$154 million, down more than 60 per cent from US$414 million a quarter earlier. 

Investors who spoke to The Logic noted that while funding has certainly slowed, the VC activity reflected in public announcements—on which PitchBook bases its data—doesn’t capture the large share of deals that are happening behind closed doors. 

Many startups and scale-ups fetched uncommonly high valuations in 2021. But challenging economic conditions—including rising interest rates, supply-chain uncertainty and inflation—have strained startups’ operations and their value. 

To avoid disclosing plummeting valuations, investors have been quietly backstopping portfolio companies that are short on cash, said Ruffolo. 

The quiet deals—called inside rounds or bridge rounds—can buy companies time to grow into the high valuation set a couple years ago when markets were friendlier to startups and help investors avoid write-downs. “There’s a bunch of those that are going on,” said Ruffolo, who said he’s been pitched on such deals. 

Now a year and a half into the slowdown, companies may have run the clock on inside rounds, said Mark Blackwell, a Calgary-based general partner at California firm Builders VC. Many of those deals haven’t bridged the gap in companies’ valuations. “We’ve done everything we can,” he said, “and we’re now starting to see the cohort of companies having to go back to reprice [their valuations].”

The need for more capital regardless of market conditions may stimulate deal flow in the coming quarters, said Blackwell.

At the same time, however, he said liquidity is becoming more of a concern for limited partners (LPs), the people and institutions that invest money into venture capital funds. High interest rates and the increasing cost of doing business is making it harder for companies to return capital to LPs, he said. Those investors, in turn, have less money to put into new VC funds. 

“If there’s no liquidity in the next couple of quarters, funds that are at Year 4 or 5 are going to be sitting on their hands because they can’t raise new vehicles,” said Blackwell. 

Janet Bannister, founder and managing partner of Staircase Ventures, said startups at the earliest stages remain attractive. That’s not just because they don’t have inflated valuations to live up to, but because it takes a special kind of founder to start a company in this market. 

“In tough times, it’s really the more resilient, experienced founders who have the confidence to say, ‘I’m going to start a business even though the climate, in a lot of ways, makes it more difficult,’” she said. Those characteristics make them more likely to succeed, she said. 

Another advantage for early-stage startups, Bannister said, is they likely don’t need as much venture capital to operate as their recent predecessors. “We’re seeing much more well thought-out business plans, much more solid business finance fundamentals from Day 1,” she said. “And a lot of businesses that frankly don’t need as much money to break even.” 

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Methodology

The numbers in this article are based on data provided by PitchBook, a research and analytics platform. PitchBook gathers information on the public and private markets from publicly available sources, including news reports, regulatory filings and press releases. Its research team conducts manual reviews to vet the data.

While the quarterly VC data is current as of publication, PitchBook may update it retroactively as more information on past deals becomes public later.