Venture capital funding in Canadian companies shrunk to less than half its value in the latest quarter from the same period a year earlier, as the economic slowdown brought the deal-making frenzy to a halt.

Canada-based companies raised US$1.9 billion during the three months ended June 30, down from US$4.9 billion during the same quarter last year, according to PitchBook data provided to The Logic.

Tony Barkett, managing director at RBCx, said the stark reversal from last year’s “phenomenal activity” is striking. “I don’t think we looked at it like we were at the tipping point yet,” he said. “We thought it probably may come down, but not where it’s coming down today.”

The drop in fundraising for private startups and scale-ups echoes the public-market downturn. The S&P 500, Nasdaq and the S&P/TSX Composite indices lost about 21 per cent, 30 per cent and 12 per cent, respectively, in the first two quarters of the year, as rising inflation and interest rates, coupled with Russia’s war in Ukraine, weighed on the economy.

“We’re entering a new chapter, and everyone’s trying to get their bearings,” said Andre Charoo, founder and general partner at Maple VC in San Francisco and venture partner at Montreal-based Inovia Capital. “FOMO has gone out of the market. Competitive deals aren’t necessarily there anymore. The option to wait is greater than making any moves at this moment in time.”

The funding rout follows an unprecedented year for venture capital in Canada. Companies raised over US$14 billion, according to PitchBook data, nearly as much as the previous three years combined.

While VC activity peaked in mid-2021, the chill on deal-making didn’t set in until this past quarter. PitchBook’s data shows Canadian firms raised US$3.5 billion in the first three months of 2022—considerably more than any other quarter between Q1 of 2018 and Q1 of 2021—even as the stock-market sell-off was well underway.

Charoo said there’s typically a delay before public-market swings ripple to the private market. “For valuations in the public market to make its way down to early stage takes longer than you would expect,” he said.

While private, venture-backed firms may have just started feeling the downturn’s effects in Q2 of this year, Charoo noted that VC investment activity recorded for the quarter may not fully capture the extent to which deal-making has slowed. “Oftentimes deals that get recorded in that quarter actually happen in the prior quarter,” he said, predicting that there will be a starker drop in venture capital activity in the next quarter’s data.

Barkett said the substantial dry powder still in the market—Canadian venture capital firms raised a record amount of funding to invest last year—will keep deal-making going. “Deals are still going to get done,” he said. “The challenge is [VCs] are not going to just invest in everything.”

Investissement Québec topped the list of most active Canadian venture capital investors over the past three months, participating in eight deals at home and another eight abroad, PitchBook’s data shows. Kitchener, Ont.-based Garage Capital was the second most active VC with six deals in Canada and nine abroad. Inovia Capital, Panache Ventures and N49P Ventures rounded out the list of five most active investors specifically in the Canadian market, while NBA Top Shot creator Dapper Labs, Portage Ventures and Dragonfly Capital were among the most active Canadian VCs globally.

There were 198 venture deals in Canadian firms in Q2, down from 277 the previous quarter and 318 a year earlier. Montreal-based cleantech firm Enerkem’s $255-million late-stage round was the largest in the most recent quarter.

So-called “tourist investors”—those dabbling in venture capital, but not strictly dedicated to the asset class—have scaled back their funding for Canadian firms, according to PitchBook. Corporations, for example, spent about a quarter of what they did on VC in Q2 compared to the same period last year.

Despite the year-over-year drop in venture investing, the median deal size actually increased, from about US$3 million to US$4 million. At the same time, the share of large funding rounds worth at least US$25 million declined from about 81 per cent of all deals in Q2 of 2021 to about 70 per cent in the most recent quarter, with more deal-making in the US$1-million to US$10-million range.

Charoo said the larger median deals may in part reflect a lag in valuation drops. But he added that it could also be because investors are being more selective, placing more money in fewer companies with strong fundamentals. “We’re not paid to deploy capital; we’re paid to make a return on that capital,” he said. “For those companies [that get funded], we might actually see deals stay the same in terms of the round sizes, but we will see fewer of those companies raise a $4-million seed round than we have seen in the past.”

Kim Furlong, CEO of the Canadian Venture Capital and Private Equity Association, said preliminary results from CVCA’s Q2 survey of its members show that investment by Canadian venture capital firms has retracted at a similar rate as Canadian startups’ fundraising. “We’re inching towards $1.4 billion, which is quite different from last year where we had a $5-billion quarter,” she said.

And although Furlong said members are now openly planning for a correction—“it used to just be whispers,” she said—deal-making activity is still relatively strong. “While we see a delta to [2022 from] 2021, the quarter so far is in line with 2019 and 2020,” said Furlong. “It will be interesting to see where the numbers land.”

Charoo takes the position that settling into a recession will be better for deal-making than the current period of uncertainty. “The market has dropped quite a bit in such a short period of time … it’s like a shock to the system,” he said, comparing the current slowdown to the early-pandemic freeze in March 2020.

“That uncertainty is lasting a little bit longer because there’s no stimulus this time,” he said.

“Once you digest the shock and figure out what the aftermath looks like, then it’s like, ‘I can get on with my business. Here’s the new game being played on the field, and here’s how I’ve got to go play that game.’”