Heading into 2020, the biggest lesson for Canadian tech investors comes from the dramatic rise and fall of WeWork. 

The company planned to go public this year after closing a round that valued it at US$47 billion. By mid-September, it was hoping for an IPO valuation of just US$10 billion. Then the IPO was shelved, CEO Adam Neumann resigned with a nearly US$1.7-billion payout and the company laid off 2,400 employees.

The entire saga was “a little on the frightening side,” said Boris Wertz, CEO and founder of Version One Ventures, because it marked a stark shift in how investors perceived the tech industry.

The Logic spoke to seven Canadian venture capitalists who said they expected the WeWork debacle to usher in more thoughtful investment decisions in 2020, with a renewed emphasis on firms that prioritize profitability over growth. They also predicted another year of big cheques, renewed interest in Canada from international investors and the emergence of quantum computing and real estate tech.

The WeWork hangover

The 2010s brought “an explosion” of software-as-a-service (SaaS) firms, said Sarah Marion, an associate at Montreal-based Inovia Capital. The shift to the cloud opened the door for tech-enabled businesses that transformed our connection to physical infrastructure in industries like property and logistics.

WeWork and other unicorns that had highly anticipated IPOs in 2019 like Uber, Lyft, Slack and Peloton became top industry players after raising billions from investors, but each faced “rocky transitions,” said Marion. While they grew huge user bases, none made gains in profitability.

“Investors valued these firms in a very similar way [to] software companies, and we learned very quickly that’s not the right way because they’re built differently … and needed to be approached differently. Much differently,” she said. 

“We were so used to building purely software companies with high gross margins, which were also easy to scale and capital-efficient. Then, suddenly, we had the WeWorks of the world,” said Wertz. 

Heading into the 2020s, the cautionary tale of WeWork will instill “more discipline in the market” as investors become more prudent in distinguishing between a pure software model and tech-enabled services, said Marion. “I think investors will now be forced to be a little bit more rational in giving valuations that tech companies deserve,” she said. 

Damien Steel, head of OMERS Ventures, agreed. “Private companies need to show how they can one day be profitable, even at the most early rounds.”

“The notion of subsidized growth is and will continue to face scrutiny by new investors and valuations of certain high-growth tech companies may suffer as a result.”

Plaza Ventures’ Matthew Leibowitz said he’d always been an advocate of profit versus growth “at all costs,” and that he wanted to see the market shift back to that.

“It’s time to focus on cash flow,” he said.

Thomas Park, vice-president of operations and strategy at BDC Capital, conveyed a similar perspective on the new year: “The WeWork example showed you’ve got to have a real business plan at the end of the day.” 

Bigger cheques, faster scaling

Canadian VC investment hit a six-year high in November 2019, with $2.4 billion invested in the third quarter of that year. VC deal size was up 215 per cent compared to the average over the previous five years. Twelve Canadian companies attracted more than $100 million each in private capital in 2019.

Park sees this as a positive, saying “big rounds means companies scaling faster.”

“For a long time in Canada, VCs were drip-feeding the system,” he said. “Now we’re seeing the emergence of large funds over $100 million [and] a lot more corporate involvement with innovation and investment.”

SoftBank, whose US$100-billion Vision Fund fuelled the growth of WeWork and other unicorns, normalized a trend of “writing bigger cheques,” Park said, in what he called “the weaponization of capital.” He said he expected it to continue in 2020.

“We have US$2 trillion of capital in the world. We just haven’t found a way to park it,” he said. 

Steel also believes this excess of capital will drive investment decisions this year. “I expect valuations to remain high as these pools of capital look to deploy,” he said.

As venture capital funds take larger speculative risks, “investors continue to look for alpha in non-traditional investment areas,” said Patrick Lor of Panache Ventures.

“Profitable growth remains elusive [to] all but the best companies, as Facebook and Google continue to dominate the paid acquisition space,” Lor said. “After an entire decade without a recession in the U.S., many are predicting the end of the cycle within the next few years. No matter when it comes, companies that survive recessions are ones that can grow without major amounts of investment capital.”

‘A good vibe in Canada’

The consensus among investors is that 2020 will be a banner year for investments in Canada from international growth equity investors.

In the first nine months of 2019, U.S. and other international investors contributed 61 per cent of the total funding in Canada, CPE Media Analytics found, up from 58 per cent the year previous. B.C. companies received the largest share of overall disbursements from U.S. investors. 

Steel expects this moment to grow, predicting a record year in exit opportunities for Canadian late-stage private tech companies, as well as more Canadian firms going public.

“I think it’s just become a good vibe in Canada,” said Leibowitz, citing investments made over the past decade in industries that are now maturing; the growth of entrepreneur studies at Canadian universities; a burgeoning startup industry; and a “favourable” government that has created programs and grants like the Venture Capital Action Plan and Venture Capital Catalyst Initiative to spur investment. 

“This is the natural byproduct of the investment cycle,” Leibowitz said. “A few years ago, a lot of new VCs raised money, and now we are seeing a lot of fruits of that labour. Great companies are starting to scale now.”

Marion said venture capitalists were helping break the “historical bias against Canadians that go out and say, ‘I want to build a business that only serves the Canadian market.’” 

“People equate that statement with a lack of ambition,” she said. “But the Canadian market is enormous.

“I would expect to see a little bit more nuance in investor thinking in 2020 for Canadian-first or Canadian-only companies that are tackling this market.”

Lauren Robinson, general partner and COO at Highline Beta, also foresees more partnerships with U.S. investors to build new ventures in Canada. She said she’s heard from Canadian entrepreneurs in San Francisco who say, “It’s time to come back to Canada.”

Some of this will be on the government’s shoulders, Lor said. Despite the creation of venture capital-focused initiatives, in the new year, he said the government will have to address criticism that said these policies “failed to produce a significant amount of new opportunities for entrepreneurs to access.”

And as markets like China, India and Africa grow, investors and companies alike “should no longer rely only on G7 audiences for product development feedback,” he added.

And while Canadian investment trends are positive, the 2020 U.S. election presents “broad uncertainty” for the global financial market, Wertz said.

Real estate tech, quantum computing and ESG

Leibowitz believes real estate tech will define the years ahead. 

“Urban technologies is very much a nascent stage. It’s akin to what fintech was maybe seven, eight years ago,” said Leibowitz, whose Plaza Ventures is partnering with Sidewalk Labs in a venture fund focused on smart-city technology. 

“Just like New York is known for consumer technology and Boston’s known for medical technology, Israel for cyber technology and London for fintech, we want Toronto to be the global urban tech hub,” he said.

Park foresees “greater sophistication” in investment patterns this year, which he said will prioritize “good management and technical expertise” in artificial intelligence companies, but also in the oil and gas and manufacturing sectors, which are facing pressure to change their business models. 

“As commodity prices are low, [Canada’s energy companies] are looking for greater efficiencies, which is a good thing for sustainability,” he said. “Lower commodity prices force them to be innovative.”

Park also sees quantum technology as being “the next AI” for venture capitalists. Canada has invested over $1 billion in quantum science over the last decade. McKinsey & Company ranked Canada fifth globally by total annual quantum-science spend, and first among the G7 in per-capita quantum-research spending. 

But there will be geopolitical tensions, similar to those currently faced by 5G technology.

Quantum computing “is a key technology from a national security perspective, and we have an opportunity to learn from our experience with AI. A lot of our AI talent was lost to global firms, for example. That hasn’t happened with quantum yet,” Park said.

As the financial industry girds itself against a possible downturn in the economy, Park also predicted a big spike in seed investments, which are furthest removed from the market and allow companies to preserve capital. He cited the examples of Airbnb and Uber, which emerged around the financial crisis. “If you need capital, now’s the time to get it,” he said.

Robinson hopes diversity will become a bigger topic in venture capital this year. In March, The Logic found that some 90 per cent of Canadian investment deals since 2014 had gone to companies founded exclusively by men. But while Robinson identified a need to “ensure we have decision-makers that represent the populations we have,” she said Canadian VCs should also ensure they’re making investments in underserved sectors—which means looking across the country outside of the major cores.

Some of that has already started. In April, Toronto-based Bridging Finance launched a new Indigenous-focused fund, projecting eight per cent returns. And in June, Vancouver-based Raven Indigenous Capital Partners also raised a $1.75-million fund for Indigenous entrepreneurs. According to the Canadian Venture Capital and Private Equity Association (CVCA), investments in Saskatchewan’s startup ecosystem with venture-capital financing rose from $4 million in the third quarter of 2018 to $98 million the same period in 2019. 

Lor said 2020 investments will favour companies that are conscious of environmental, social and governance issues, and those that focus on reducing labour costs, expanding the gig economy and promoting entrepreneurship above all.

Robinson predicted more socially conscious investments, as the culture of venture capitalism changes to include more input from corporate executives who want to co-innovate with investors. 

“We need a lot more diligent focus around investment,” she said. “Where it’s going and what it’s benefitting, which inherently will affect more process than specific valuation.”