| || ||Daniel Munro |
Principal Research Associate
The story of Canada’s lagging innovation performance is well known. Canada earns a “D” grade and has consistently ranked near the bottom of 16 countries in The Conference Board of Canada’s How Canada Performs Report Card on Innovation. Canada has an exceptional system of higher education that produces high-quality research and graduates with advanced skills and knowledge. But we are especially weak in terms of business inputs to innovation—such as business spending on research and development and ICT investment—and a range of innovation outputs—such as patents, trademarks, high technology manufacturing, and export market shares of key industries. Too often, Canada fails to use its research and advanced skills as sources of advantage for innovation and commercialization.
In one key area, however, there are signs of improvement. Venture capital (VC) investment in Canada has more than doubled in recent years—from nearly $1 billion (0.07 per cent of GDP) in 2009 to $1.98 billion (0.11 per cent of GDP) in 2013 (see charts 1 and 2), and to over $2.3 billion (0.12 per cent of GDP) in 2014. Meanwhile, nearly all of Canada’s global peers have experienced massive declines in VC investment as a percentage of GDP.1 Recognizing that there is some volatility in global VC rankings, Canada has nevertheless climbed from third-worst to second-best in VC investment relative to 15 peer countries. These improvements in Canada’s VC situation could have positive effects on innovation performance overall.
Why Is Venture Capital Important to Innovation?
VC plays an important role in a country’s innovation ecosystem by providing young firms with early-stage financing (such as pre-seed, seed, start-up, and other early-stage funding) or later-stage financing (funding provided after commercial manufacturing, but before an initial public offering). This risk capital provides firms with the financial resources they need to invest in further research and development, manufacturing, and marketing before they are able to generate solid revenue streams to do so on their own.
VC is also an important source of managerial experience—a key ingredient in successful innovation. Along with financing, venture capitalists bring entrepreneurial experience, industry knowledge, and networks of customers, suppliers, and other funders, which many young entrepreneurs lack.2 In this light, it is worth noting that the number of Canadian firms receiving VC—and thus management expertise and networks—climbed from 376 in 2009 to 522 in 2014.3 Whether these specific companies succeed or fail, the increase in entrepreneurs receiving real-world management guidance bodes well for Canada’s innovation performance in the future.
What Explains Canada’s Venture Capital Renaissance?
As part of its How Canada Performs Report Card on Innovation, the Conference Board is examining a variety of explanations for improvements in Canada’s VC investment. While results are not expected until fall 2015, a few candidate explanations are emerging:
- VC investment tends to follow the business cycle and has grown along with gradual improvement in Canada’s economy since the recession. While VC investment in Canada grew from just under $1 billion to more than $2.3 billion between 2009 and 2014, it only now matches the pre-recession level of $2.3 billion recorded in 2007.4
- In 2013, the federal government’s Venture Capital Action Plan (VCAP) committed $400 million to VC funds and sought to raise another $800 million from outside investors.5 Although VC has not grown by that ambitious $1.2‑billion target over the past 18 months, some funds from VCAP have contributed to growth.
- Historically, roughly 30 per cent of VC investment in Canada has been funded by foreign, primarily U.S.-based, sources.6 By 2014, however, U.S. sources alone accounted for over 37 per cent of the $1.9 billion VC investment in Canada whose sources are known. In fact, as U.S. venture capitalists look for new opportunities, U.S.-based VC investment in Canada jumped by nearly $400 million in 2013, accounting for over 90 per cent of VC growth in Canada that year. In other years, both Canadian and non-U.S. sources have contributed substantially to growth.7
Seizing Canada’s Venture Capital Opportunity
Even as Canada has vaulted into the top tier of VC investment destinations, firms in the United States continue to attract VC at higher rates and see deals that are twice the size of average deals for Canadian firms. Given that these firms compete in the same North American and global markets, Canadian firms are at a significant disadvantage in this regard.
More troubling is a pattern of investment that favours late-stage, rather than early-stage, VC investment. Early-stage VC declined from $438 million to $376 million between 2009 and 2013, before jumping to $602 million in 2014. Even with the recent spike, Canada’s early-stage VC as a percentage of GDP (0.03 per cent) is no better in 2014 than it was in 2009. Most growth has been in late-stage capital. Firms receiving later-stage VC certainly benefit from additional funding, management expertise, and wider networks. But investors’ apparent lack of enthusiasm for start-up innovators—especially in sectors outside ICT, life sciences, and clean tech—could impair the development of longer-term innovation capacity.
Still, that Canada’s VC investment overall has returned to pre-recession levels while many global competitors continue to struggle is a positive sign. It creates conditions for many Canadian firms to improve their innovation performance. The open question is whether Canadian investors and innovators can build an even stronger foundation for better innovation performance in the future.