The Business Development Bank of Canada (BDC), the country’s largest early-stage tech investor and most active venture capital investor, says it is concerned about an apparent decline in the number of new startups founded in the country.
Data from Hockeystick, a Toronto-based research and software provider, lists 349 companies in its database of Canadian startups as being founded in 2016, the last full year for which data is available. The total is down 26 per cent from 472 companies founded in 2015, and is the lowest in the dataset since 2011.
Peter Misek, a partner at BDC’s IT Venture Fund—which manages more than $300 million in VC investments in the tech space—said data in the fund’s own larger proprietary database mirrors Hockeystick’s “very, very closely.”
The emphasis on scaling up Canadian tech companies may be leaving a void in the funding of early stage startups, according to the Business Development Bank of Canada. But some tech execs question whether company creation is the right success metric.
“When we saw it, we were perplexed,” said Misek, who noted that preliminary data for 2017 shows a continuing decline.
“We agree with Peter’s concern that a downward trend is negative news for the Canadian innovation ecosystem,” said a spokesperson for BDC, adding that it is monitoring the data.
Startup activity is an important barometer on the health of the overall innovation ecosystem. Only half of new Canadian firms are estimated to survive their first five years, making early creation a numbers game.
“While everybody seems focused on scaling up—and that is a good and important focus—we should be mindful to ask, ‘Did we forget something?’” said Misek. “Did we make a mistake by not continuing to have a sustained drive for company creation?
“You need to help and double down on the scaling-up side, but you also need to make sure that you continue to have a funnel of company creation because otherwise, in the next few years, the number of companies that are going to attempt scaling up is going to decline dramatically, and so you potentially hurt your scaling-up exercises down the road.”
BDC added that its own analysis, based on Statistics Canada data, also suggests the rate of business creation in the Canadian tech sector showed a declining trend from 2001 to 2015, the year with the most recent available data.
Business creation during the 14-year period analyzed by the bank reached its high point in 2005, at just under 17 per cent, and its lowest in 2015, at 12.6 per cent. (Business sector growth has also slowed down more in other sectors.)
As the number of companies being created may be slowing, the amount of money flowing into Canadian startups has been on a yearly record-breaking streak. The latest annual report on VC funding in Canada by PwC and CB Insights showed US$2.7 billion was deployed to venture-backed companies in Canada, up seven per cent from 2016’s then-record haul of US$2.5 billion.
“Capital has shifted to be more interested in scale-ups,” said Jay Shah, director of University of Waterloo incubator Velocity. “And that’s a Canadian phenomenon, though I also think a North American phenomenon. Even looking at U.S. VCs, you’re seeing larger funds being established—$100- or $200-million funds—and the economics just don’t work for them to be writing early-stage cheques. They need to be writing larger cheques; they need to be getting in on bigger deals and that’s pushing them upstream.”
In a sign of a maturing tech space where bigger late-stage deals are more common, the number of total deals in 2017 fell to 333, with the average deal size growing 31 per cent year-over-year from US$8.3 million to US$10.9 million.
While the amount of funding for early-stage companies may be shrinking, there is still a large pool of hungry entrepreneurs pitching their ideas, according to some prominent tech executives.
“Based on our experience, we don’t see a drop in deal flow,” said Eva Lau, co-founder and managing director of Two Small Fish Ventures, which invests in early-stage Canadian internet companies. “In fact, the number of companies, especially the high-quality ones, went up in the past few years. The drop in the total number of early-stage companies getting funded might be due to the fact that investors are becoming more selective.”
BDC also flagged that data from Seattle-based firm Pitchbook showed “only a slight trend downward over the past five years” in terms of company creation, suggesting a healthier outlook for firm creation.
For its part, Hockeystick considers there to be a “steady increase in the number of funded startups in Ontario and Canada in general.” And Waterloo-based Shah added that Velocity has seen an “intense appetite” in applications from entrepreneurs to the program, which comprises early entrepreneurial activity that isn’t necessarily detected in startup founding numbers. Velocity’s early-stage pitch competitions increased 11 per cent last year, and applications are up by nearly a third for their next round.
“The magnitude of the phenomenon is yet to be determined,” said Misek. “While everybody says that there’s a scaling problem, I’m telling people there might be a company creation problem, as well.”