VC Quarterly is The Logic’s recurring series on the state of venture capital in Canada, including the latest financing trends and deals that are shaping the startup landscape. 

A handful of massive venture capital deals in the last quarter catapulted investing to the highest levels since before the market tumbled in early 2022, PitchBook data shows. Behind the big numbers, however, challenges persist in the fundraising landscape, investors told The Logic.

Companies raised US$2.8 billion in the third quarter, which ended Sept. 30. That’s up from US$1.2 billion the previous quarter and about US$900 million in the first quarter of 2024. 

About half of the venture capital invested in this past quarter was concentrated in two growth-stage deals, both announced in July: Toronto-based AI darling Cohere’s US$500-million Series D led by PSP Investments, and B.C. legal-tech scaleup Clio’s US$900-million Series F led by San Francisco-based New Enterprise Associates. 

While the total dollars invested increased, the number of deals announced last quarter, however, declined considerably. Just 165 companies raised venture capital in Q3, down from 235 in Q2. Excluding the Cohere and Clio deals, that put the average round size at about US$8.6 million, compared to about US$5.1 million last quarter and US$5.2 million a year earlier. 

The numbers reflect a complicated investing landscape that’s still stabilizing after a turbulent boom-and-bust cycle. 

On the one hand, it shows that investors are being more selective about the companies they back, said Emil Savov, managing director at MaRS Investment Accelerator Fund, an early-stage investment firm funded by the Ontario government. “It’s an indication that the quality is better and [companies] are raising more capital,” he said. “That’s what we’re seeing in general.”

Companies had to adapt over the last two years to a more cautious investment environment. High interest rates and general economic uncertainty prompted many VCs to conserve their cash for existing portfolio firms or different asset classes altogether. The conditions prompted startups and scaleups to make due with what they had—stretching money by slowing hiring or laying off employees, or adopting technology to operate more efficiently. With spending now under control, investors are reinvigorated to cut cheques. 

“Companies in general are growing more profitably,” said Hugues Lalancette, a partner at Montreal-based venture firm Inovia Capital, where he focuses on the firm’s growth funds. “That’s great for investors because it’s less dilution and just more sustainable.” 

That doesn’t mean investors are being frivolous with how they’re deploying capital. For venture capital firms trying to raise their next funds, the market is still difficult. Toronto-based Information Venture Partners announced last week that its 2019 fund will be its last, citing downturn-induced pressure to deliver quick returns—an approach, it said, that’s incompatible with supporting entrepreneurs. 

The challenging fundraising environment is in part a reaction to the slow exit market over the past two years, in which relatively few venture-backed companies have been acquired or gone public. That means money from those would-be exits hasn’t cycled back to the limited partners who would normally reinvest it in new venture capital funds. 

A recent PitchBook report shows that returns to U.S. limited partners have been in the single digits for eight consecutive quarters, and are nearly as low as they were in the Great Recession. The lack of returns is straining investing in the U.S. especially, where Q3 deals declined 32 per cent by dollar value and 34 per cent by volume from the previous quarter. 

While the liquidity crisis hasn’t hit Canadian deal-making as hard, many venture-backed companies are certainly struggling. Savov said the market remains challenging for firms trying to graduate from seed-stage rounds. Startups that raised large investments on merely a good idea in the 2021 low-interest-rate era are now expected to have real customer traction and a path to profitability. “It’s the moment of truth,” said Savov. “The hype is gone. Show me the money.” 

Matt Cohen, founder and managing partner at Toronto-based seed-stage firm Ripple Ventures, said startups doing well in this market are those whose services help other companies cut their own spending. “The cost-benefit analysis for enterprises to replace a lot of manual labour tasks with higher efficiency, lower-cost solutions is real,” he said. “You’re seeing this in a lot of companies.” 

Cohen said he’s also seeing more founders building companies that require less capital from the start, which, ironically, makes them more appealing to investors. “We have a [portfolio] company that has two employees and over half a million in recurring revenue,” he said, declining to name which one. 

Many of those firms have been catalyzed by the AI boom. PitchBook data show that AI and machine-learning companies captured more than a third of all venture capital in the third quarter, after excluding outlier deals Cohere and Clio. These companies may be shielded from the risk-aversion investors adopted when the market began slowing in early 2022, said Lalancette. “AI is attracting a lot of capital,” he said. “It feels like there has been no reset in that market.” 

While Inovia was an early investor in Cohere and participated in its latest round, Lalancette said there are dwindling opportunities to invest in that sort of “pick and shovel” company building the infrastructure for AI. 

All three investors who spoke to The Logic for this article said they’re instead focusing on applied AI—for example, AI-enabled apps that solve a specific problem for their customers. 

Savov said that overall, the VC market feels like it’s stabilizing. The drop in interest rates—with more expected in the coming months—is one factor instilling optimism, he said. “If the trend continues,” he said, “that will bode well for the economy, including for investments going forward.” 

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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.