Canadian startups began 2022 on a fundraising high, bringing in nearly US$5 billion in the first three months of the year, the second most VC investments recorded for a single quarter.

But over the next three months, funding dropped by more than half, PitchBook data shows, with deals drying up further as the year went on, mirroring a broader market slump.

In the last three quarters of 2022, Canadian startups raised just US$5.7 billion, down from US$10.6 billion for the same period in 2021. “It’s a massive amount of context-switching, which blows people’s minds,” said Patrick Lor, managing partner of Panache Ventures. 

VC investors say uncertainty—both economic and geopolitical—was at the heart of the slowdown, with companies and investors alike waiting for some semblance of stability before resuming fundraising. “It’s a bit of a chicken game,” said HarbourVest managing director Senia Rapisarda. 

By the end of 2022, the volume and value of deals looked more like those of a typical year before the pandemic, but without question the game has changed. The past year marked the end of the “free-money era” that defined the earlier pandemic investing environment, said Megh Gupta, a partner at Wittington Ventures. Now, investors are ramping up diligence and setting new deal terms as they grasp for certainty in a volatile market. 

Here’s a look back at the sobering year in Canada’s venture capital ecosystem and what it means for the industry’s future. 

Shrinking deal sizes: Venture capital rounds worth US$25 million or more accounted for about 80 per cent of all investments in the first three months of the year, with 28 such deals closing in Q1, according to PitchBook. In Q2, the number of such deals dropped to about 64 per cent at 23 deals, before bottoming out at 11 deals in the third quarter, representing about 56 per cent of all funding. 

The last three months of 2022 saw a rebound in large deals, with 19 such rounds, making up over 71 per cent of all VC activity. B.C.-based Svante’s Series E helped drive investments in the US$25-million-plus category toward the end of the year, closing a US$318-million round in December. Three other companies—TouchBistro, Xanadu and Hopper—each closed investments worth around US$100 million in November.

Lor said the drop in large deals is in part a response to the public tech stock retrenchment. Venture capital transactions had ballooned leading up to 2022, as investors offered up cheap cash with the expectation that companies would soon go public, allowing backers to exit quickly with tidy gains. 

“Everyone started looking at public-market valuations with this belief that this little pre-seed or Series A or Series B number is just a pre-pre-pre-IPO,” said Lor. “Now you’re 10 years away from going IPO.” With no IPO rebound in sight, Lor said inflated price-to-earning ratios at startups are getting a correction, pulling deal sizes back to earth. 

Valuations hold steady—for now: Average post-money valuations topped US$265 million in 2022, up from US$233.5 million in 2021, according to PitchBook data. 

Rapisarda said the “perceived lack of decline” may be an indication that companies are avoiding down rounds. Firms at risk of raising money at much lower valuations than they previously fetched delayed fundraising in 2022 in hopes the market would turn in their favour, she said. 

“They’re not coming to market, but the runway is shortening,” said Rapisarda. “At a certain point many of these companies will have to come back to market.” When they do, she expects valuations to decline. 

Lor attributes the valuation stability in part to investors prioritizing strong companies while the markets dipped. “If you’re in the top percentile category of entrepreneurs, of idea, of execution, that’s still being funded—at the early stages,” he said. 

Rapisarda also noted that inside investment rounds—which only involve existing investors and don’t require startups to set a new price—may have buffered companies from lower valuations. “These internal rounds are usually done on companies that people believe are going to be winners, and they just want to give them enough runway to be able to command higher power or better valuations.” 

Transactions get conditional: Competition to clinch a spot on companies’ cap tables virtually ended in 2022, as VC investors took a wait-and-see approach to deal-making. 

With less competition, interested investors have more leverage to set terms that reduce the risk of losses in what could be a prolonged economic rout. Those include establishing lower valuations for a company and insisting on better liquidation preferences. “The table has turned,” said Rapisarda. “For me, in order to get comfortable, I want my money to come out first when a company gets sold. As simple as that.” 

Gupta said some investors are now asking for deals to include free warrants, giving them the right to purchase company stock at a specified price within a given timeframe. Investors are also carving out liquidation preferences that give them a higher return multiple if a company exits for a price lower than the estimated value when the investor bought in. Investors may also include earn-out clauses, said Rapisarda, which reserve additional funding that’s conditional on the company hitting certain milestones.  

“Usually when you go through a market downturn you start to see some teeth in the financing rounds,” said Gupta. 

Cleantech stands out: Investments in cleantech and climate-tech companies accounted for about 18 per cent of all funding in the last nine months of 2022, up from 11.5 per cent in all of 2021.

The sector’s relative resilience comes amid sweeping government programs—including Washington’s US$437-billion Inflation Reduction Act and Ottawa’s $15-billion Growth Fund—designed to encourage innovation to help solve the climate crisis. “There’s momentum in that space,” said Kim Furlong, CEO of the Canadian Venture Capital & Private Equity Association industry lobby group. “Some of these companies will seize on a moment where governments and companies and society are looking for these types of solutions.” 

A glimmer of light?: Venture capital deal-making rebounded slightly in the last quarter of 2022, with values back around where they were before COVID-19 sent startups on a rollercoaster. Canada-based companies raised US$1.9 billion over 187 deals in the last three months of the year, up nearly 20 per cent in value from the US$1.6 billion raised across 217 deals the quarter before, according to PitchBook data.

While deal-making was down substantially year over year—from over US$3 billion in Q4 2021—amounts surpassed what companies raised in the fourth quarters of both 2019 and 2020. 

Gupta calls the uptick in investments “negligible,” however, and cautions against interpreting it as a recovery. “Investors are still jittery, and so are public markets,” he said, adding that startups aren’t immune to the economic forces that have triggered layoffs and cash crunches at large public tech firms. 

Still, he believes more companies will return to the VC market in the latter half of 2023, and that VC firms have the funds to invest.

Lor said Panache is among the firms ready to spend its money in a slower-paced market. “While we didn’t want the market to swing this far back,” he said, “we really cherish the time that we have to sit down and get to know entrepreneurs, and really pick our partners for the next five, 10, 15 years—the life of the investment.”

Editor’s note: This story originally contained inaccurate data about the volume of cleantech and climate tech investments in this quarter. It has been corrected.