Venture capital investing took a holiday this summer, as ongoing economic instability drove down deals to half their value compared to the same period the year before.
Companies headquartered in Canada raised US$1.4 billion for the third quarter of 2022, down 44 per cent from US$2.5 billion a year earlier, according to PitchBook data provided to The Logic. The year-to-date decline is even more dramatic, as VC dollars fell about 69 per cent from the US$4.5 billion raised in the first quarter of 2022.
Talking Point
Venture capital funding for Canadian firms continued to drop in the third quarter, after plummeting in the first half of the year. Founders and investors are locked in a standoff of sorts, with venture capitalists waiting for the market to bottom out and entrepreneurs avoiding fundraising at decreased valuations.
“The macroeconomic climate and uncertainty has led to both investors and startups waiting on the sidelines,” said Megh Gupta, a partner at Wittington Ventures.
The drop in deal-making follows a drastic decline from this year’s first to second quarter, as high-profile investors, including Silicon Valley firms Sequoia Capital and Andreesen Horowitz, began sounding alarms over the toll that turbulent markets, higher inflation and geopolitical instability would have on venture capital.
Canada’s rout reflects a global slowdown in venture investing, from nearly US$190 billion in the third quarter of 2021 to around US$90 billion in the quarter that just ended.
Senia Rapisarda, Toronto-based managing director at VC firm HarbourVest, said investors are now taking longer to close deals and being more selective about where they put their money. “Before, investors were given two days to decide on an investment,” she said. “Now there is time to do a deeper due diligence. We’re back to normal where you would evaluate [a deal] in three or four weeks.”
That’s given investors a chance to distinguish between companies fuelled by hype versus ones with real potential. “There’s clearly attention to, rather than just growth at any cost, to growth and being profitable,” said Rapisarda.
Rapisarda said companies operating in “mission critical” sectors—artificial intelligence and fintech, for example—are better positioned to attract investors during a downturn.
Meanwhile, funding has slowed dramatically for several sectors that garnered a sudden spike in investment during the pandemic. The pharmaceutical and biotech sector is among those that have taken a hit relative to the same period last year. Funding dropped from US$447 million in the third quarter of 2021 to US$74 million for the same period this year, after falling to just US$4.7 million in the second quarter.
Cleantech and climate tech investing for the quarter increased, from about 14.7 per cent of all investments a year ago to about 26.8 per cent in Q3.
Venture funding in the cryptocurrency and blockchain space also bucked the trend, attracting a flood of investments, despite a battering from public markets in recent quarters. The sector jumped from about 1.7 per cent to over 14 per cent of all investments, an overall increase of about US$154 million. Gupta noted that a dip in valuations may have spurred investment in crypto and Web3 startups.
Many venture investors predicted earlier this year that funding would dry up most for companies seeking later-stage financing. That call has borne out, with investment rounds worth more than US$25 million down about 10 per cent as an overall share of deals globally and down 11 per cent in Canada.
Gupta and Rapisarda both think the funding environment will remain slow at least for the rest of the year, with investors and entrepreneurs holding their ground in a standoff of sorts: while VCs wait for valuations to bottom out, entrepreneurs are conserving cash to avoid down rounds—fundraising at a lower value than their previous investment.
Meanwhile, investors are still waiting on a large chunk of government money meant to seed dwindling venture capital funds, which may also be tempering deal-making, said Rapisarda. Ottawa began accepting applications for the second cycle of its $450-million Venture Capital Catalyst Initiative (VCCI) in May. Most of that budget is reserved for funds-of-funds—venture capital firms that invest in other funds, and ultimately invest in companies—which have to raise $3 from other private investors for every government dollar they receive.
Rapisarda expects VCCI dollars to begin flowing sometime after the first quarter of 2023. That, coupled with lower startup valuations, could be a boon to VCs next year. “Some of the best vintages have been built in recessions,” she said.
By then, Gupta hopes investors will be in the right headspace for deal-making. “A lot of this is psychological,” he said. “Once the central banks stop raising rates, it will generate a bit of euphoria in the public markets… which will start to permeate throughout the [private] market,” he said. “I do think things will start to change in 2023. Whether that’s Q1 of 2023 or Q3 of 2023, frankly, I don’t know.”
Correction: The chart titled “The shift in Canadian VC deals” has been updated to correct the labelling of the quarters.
Editor’s note: This story originally contained inaccurate data about the volume of crypto, blockchain, cleantech and climate tech investments in this quarter. It has been corrected.
