Net Benefit: For Canadian Startups, Not All Exits Are Created Equal

Originally produced for the Innovation Economy Council (IEC). The IEC is now the The Conference Board of Canada’s Canadian Centre for the Innovation Economy (CCIE).

Read the detailed report here.

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The abrupt demise of Element AI is often cited as evidence that Canada’s innovation ecosystem is badly broken. 

The Montreal-based artificial-intelligence startup seemed destined for greatness. Co-founded by world-renowned deep learning expert Yoshua Bengio, the company enjoyed fawning media coverage and generous early financial backing from governments and private investors. 

Unfortunately, Element AI lacked a viable path to commercial success. In 2020, it was swallowed by Silicon-Valley software company ServiceNow, which stripped the company of its patent portfolio and a clutch of top researchers. 

The acquisition of tech startups by foreign buyers is on par with other countries. 

Element AI’s experience does not reflect the vast range of outcomes — and exits — that predominate in Canada’s thriving technology sector, according to research by the Innovation Economy Council. 

More money is flowing into Canada’s tech sector than is leaving via mergers and takeovers. For every Element AI, there are examples of successful companies bringing in new rounds of financing, doing initial public offerings and expanding aggressively via acquisition and internal growth. 

The ideal outcome is for companies to evolve from startup to commercial success, all the while remaining Canadian owned, controlled, and headquartered. These anchor companies are the gold standard because they become magnets for suppliers, partners, talent and investors. And they spread those benefits broadly throughout the economy. 

But that doesn’t mean that everything short of the gold standard is a net loss to the Canadian ecosystem. 

To be sure, there is a loss of control and profit when a company is sold to foreign interests. There may also be other losses, depending on the nature of the takeover, including the migration of IP and talent. 

But companies sold to foreign buyers don’t typically leave behind an economic void. Buyers often run acquired companies as stand-alone businesses, providing them with fresh infusions of capital to invest, create jobs and do research and development here in Canada. Even in a worst-case scenario, where a company is effectively dismantled, the talent, experience and capital can be recycled to help seed a new generation of Canadian startups. 

Indeed, more venture capital is flowing into the ecosystem than is being cashed out. V.C. financing is booming in Canada, particularly for technology companies. More than 400 companies raised a record $10.9 billion in venture capital deals in the first nine months of 2021. That’s more than in any full year to date, including 2000, the height of the dot-com boom. The vast majority of the money is going to technology, life sciences and cleantech companies. 

And the deals are getting larger. There have been 34 deals worth more than $100-million so far this year, triple the previous full-year high set in 2019. This year, more than 10 Canadian tech companies achieved the milestone “unicorn” status — private companies with valuations of at least U.S.$1 billion. 

There was $8.3 billion in V.C. investment in the first half of 2021, versus $5.9 billion in exits. And more than half of that tally of exits came in one transaction: U.S.-based NASDAQ’s $3.5 billion buyout of Newfoundland-based fintech company Verafin Inc. 

Nor do exits necessarily imply a loss for the Canadian economy. Included in those exits are three major IPOs: Montreal-based Dialogue Health Technologies Inc. (online healthcare) and Nuvei Corp. (payment software), along with Vancouver’s Thinkific Labs Inc. (online training). 

The uptick in larger exits isn’t a bad omen, but an indication of Canada’s “maturing” technology ecosystem, argues Kim Furlong, chief executive of the Canadian Venture Capital & Private Equity Association. In turn, she says, that is attracting more investors for Canadian V.C. funds and deals. 

It’s also been a banner year for taking companies public. Canadian technology companies raised more than $8 billion in IPOs on the TSX and TSX Venture Exchange in the first half of 2021. That’s more than in all of 2020. There have been 14 tech IPOs on the TSX in the past 12 months, or more than in the previous decade. Another $9 billion worth of private equity deals was also completed in the first half, according to the CVCA. 

More of the money being invested in Canadian tech companies is homegrown. That’s a good thing, because Canadian ownership can make a difference as tech companies scale up and mature. Startups with a majority of Canadian investors are more likely to stay Canadian-owned when they exit, according to an analysis of M&As by the Innovation Economy Council, based on data from Pitchbook. Of nearly 400 V.C.-backed companies involved in M&As between January 2019, and February 2021, more than half were acquired by foreign investors, with the vast majority based in the U.S. Of those that remained in Canadian hands after being taken over, 71 percent had a majority of original Canadian investors. The findings suggest that a greater share of domestic owners is a good predictor that a company’s post-takeover owners will also be Canadian.