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Canadian Venture Capital Activity: An Analysis of Trends and Gaps (1996–2002)
Part II: 5. Sectorial Venture Capital Investment Trends
5.1 Overview of Sectoral Venture Capital Investment Trends and Analysis
Highlights
- Generally, venture capitalists will invest in firms with high-return potential. This likely explains most of the distribution of VC investment across sectors. Sectors with the highest growth and returns potential attract most of the VC.
- In most countries, including Canada and the U.S., the emergence of information technology firms has been driving VC investment since 1996. In Canada, the amount invested in information technology firms grew by 368 percent between 1996 and 2002, resulting in a 96-percent increase of their average market share, from 33 percent in 1996 to 65 percent in 2002. This represented an average of 53 percent of total VC investments from 1996 to 2002 and for the first nine months of 2003.
- Life sciences firms have also driven VC industry growth, although to a lesser extent than have information technology firms. The amount invested in life sciences firms increased by 103 percent over the past seven years, resulting in an average market share of 19 percent of total VC investment (ranging from 22 percent in 1996 to 19 percent in 2002 and 22 percent in the first three quarters of 2003). The success of these firms is largely attributed to the creation of investor groups specialized in these sectors.
- Traditional firms, on the other hand, experienced a 27-percent decline in investment and a declining share of total VC investment since 1996 — from 37 percent in 1996 to 11 percent in 2002, for an average share of 24 percent over the period (and 22 percent in the first three quarters of 2003). Venture capitalists' investment criteria and demand for high returns is probably making it difficult for traditional-sectors firms to attract VC.
- Compared to the U.S., the Canadian VC industry has demonstrated a relatively more balanced distribution across sectors.
- The U.S. VC industry has been, over the past seven years, heavily focussed on information technology, with these firms capturing an average of 74 percent of total investments (compared to 53 percent in Canada). This may explain why the U.S. VC industry has declined further since 2001.
- The relative importance of life sciences firms is similar in both countries. These firms attracted an average of 17 percent of total VC investments from 1996 to 2002, compared to 19 percent in Canada.
- U.S. venture capitalists have been less interested in traditional-sectors firms, which attracted an average of only 7 percent of total investments since 1996 (compared to 24 percent in Canada).
5.1.1 1996–2002 Overall Sectoral Venture Capital Trends
Sectoral venture capital activity trends confirm venture capital's importance to high technology firms
As demonstrated previously, high technology firms have driven the growth of the Canadian VC industry in recent years. Indeed, the data for 1996–2002 confirm that the Canadian VC industry has focussed on high technology firms (see Figure 27). Companies in the information technology, life sciences and other technology sectors have accounted for, on average, almost 80 percent of total VC investments from 1996 to 2002. Their share has increased from 87 percent ($5 billion) in 2000 to 91 percent ($3.5 billion) in 2001, but that has declined to 89 percent ($2.2 billion) in 2002 and 78 percent in the first nine months of 2003. This decline is probably due to the decline of investments in information technology firms, although the third quarter of 2003 suggests that these investments have picked up again and that the situation looked like it should be positive for the fourth quarter.
Figure 27: Average Share of Venture Capital Investments and Venture Capital Financings by Sector, 1996–2002
To confirm the importance of information technology firms, Figure 28 reveals that information technology has driven VC activity in Canada over the past seven years, attracting 33 percent of total investments in 1996 and 71 percent in 2000, or 65 percent over the entire period. See further in this section for more details. However, while information technology has received the largest proportion of investment, life sciences and other technology sectors firms have also attracted substantial amounts of VC financing in recent years.
Figure 28: Venture Capital Investments by Sector, 1996–2002
In terms of regional activities, as shown in Figure 29, this focus on high technology firms was consistent across most provinces and regions. Indeed, these firms captured an average share of 88 percent of total VC activity in B.C., 82 percent in Ontario, 61 percent in Atlantic Canada, 67 percent in Quebec, and 62 percent in Alberta. In contrast, in the Prairies, particularly in Manitoba and Saskatchewan, firms in the traditional sector attracted most of the VC activity, averaging 68 percent and 60 percent, respectively, from 1996 to 2002 (compared to 11 percent and 7 percent for information technology and 20 percent and 29 percent for life sciences). More details on the regional VC activity trends are presented in Section 6.
Figure 29: Average Share of Venture Capital Investment by Sector and Region, 1996–2002
Links between clusters and venture capital activity in specific sectors and regions
It is unclear how the presence of industry clusters affects the level of VC activity in some sectors or regions. However, given the link between high technology firms and VC activity, it is not surprising that sectors and regions that comprise successful technology clusters have been relatively active in terms of VC investment. In fact, as described in the box below (and in Figure 4), clusters are, along with the risk-capital market, one of the key components of the innovation system. On one hand, clusters support VC activity and the economic development in some sectors or regions, and, on the other, VC activity is a key contributor to the creation and success of high technology firms, which, in turn, is essential to the formation and success of industry clusters.
What is a cluster?
- "A geographically proximate group of interconnected companies and associated institutions in a particular field linked by commonalities and complementarities." (Michael Porter)
- "A regionally based network of public and private institutions, including private sector firms, universities, other research laboratories as well as financial and other service providers whose interactions are focussed on technological development and innovation for economic growth." [National Research Council Canada (NRC)]
How do clusters develop?
Clustering is a long-term process, and several key ingredients must be in place to ensure its ultimate success:
- The cluster process must be community driven with a well-defined technology focus, active networks and committed local champions.
- A cluster develops when a critical mass of innovative knowledge-based firms acts as a magnet, attracting other firms to invest and locate in the same area. These firms gain strength when supported by strong research institutions, a concentration of capital and business expertise, and an appropriate environment in which innovation can flourish.
- Importantly, clusters need a science and technology anchor, usually a government research institution or a university that is able to work with local companies, able to transfer technology and able to spin off new enterprises.
Clusters are only one element of the innovation system, which includes:
- A solid entrepreneurial culture with a critical mass of established private firms, particularly R&D performers;
- A strong knowledge and science system that includes public and private research institutions, universities and other education and training organizations, and technology transfer agencies;
- The right government policies and programs — which would cover government labs, R&D funding, and conditions that favour business and innovation (such as policies on intellectual property, taxation and regulation);
- Networks and business organizations that aid knowledge and technology transfer; and
- A financial system with strong angel and VC investment to support technology firms.
What are the benefits of clusters?
- They improve productivity by increasing access to specialized suppliers, skills, information and training.
- They foster innovation by making it easier to perceive opportunities. Local suppliers and research institutions encourage knowledge creation and experimentation.
- They aid commercialization by making it easier to create new firms, start-ups, spin-offs and new business lines.
What are current government actions?
- The NRC's cluster-building approach allows the entrepreneurial spirit in local industry sectors to tap into the NRC's primary strengths: R&D expertise, scientific and technical information resources, and innovation assistance programs. The NRC helps Canadian companies make the most of national and international networks. With existing strengths in key sectors and growing interest from national and global investors, many Canadian communities are poised to make a powerful entrance into the global knowledge-based economy.
- The NRC has 10 regional technology centres. It is spending $110 million over three years for the Atlantic Technology Clusters initiative; $110 million over three years for the innovative clusters initiative; and $20 million for the new Medical and Related Sciences Centre. It is also funding initiatives in various cities through Regional Development Agencies.
Because innovation and high-growth firms are important to regional economic development, government initiatives help develop sectoral and regional clusters. Examples of such initiatives include Genome Canada, NRC technology centres, National Centres of Excellence, Precarn, and technology road maps. For example, NRC's cluster-building approach allows the entrepreneurial spirit in local industry sectors to tap into key components of the innovation system: R&D expertise, scientific and technical information resources, and innovation assistance programs. The NRC also helps Canadian companies make the most of its national and international networks.
The following box presents a map of sectoral clusters that shows existing NRC clusters by key sector.61 With existing strengths in key sectors, and growing interest from national and global investors, many Canadian communities are poised to make a powerful entrance into the global knowledge-based economy.
National Research Council Canada Sectoral Clusters
Information technology, life sciences, photonics — Ottawa — contributing to cluster activities in information technologies, life sciences, R&D, and training in photonics.
Information technology/e-business — Fredericton, Moncton, Saint John and Sydney — integrating regional strengths to build a competitive information technology/e-business cluster.
Aerospace, biopharmaceuticals, industrial materials — Montréal — building infrastructure to assist SMEs in Canada's largest aerospace and biopharmaceuticals clusters, as well as investigating novel materials and manufacturing techniques.
Life sciences — Halifax — building enabling technologies and integrating players in the fields of marine biosciences and brain repair.
Medical devices — Winnipeg — advancing medical technologies, precision and virtual manufacturing.
Agri-biotechnology, nutraceuticals — Saskatoon — adding new dimensions to the world's leading agro-biotechnology cluster.
Nanotechnologies — Edmonton — building Canada's R&D capacity, infrastructure and programs in this emerging field.
Ocean technologies — St. John's — creating new opportunities locally, nationally and internationally.
Aluminium technologies — Ville Saguenay — building value-added manufacturing in a region housing 95 percent of Canada's aluminium players.
Fuel cells — Vancouver — supporting the development of fuel cell and alternative energy technologies.
Astronomy — Victoria, Penticton — creating new opportunities in structural engineering, radio engineering and precision instrumentation.
However, while the presence of successful clusters may have contributed to the strengths of some sectors, as well as to VC activity in these sectors and regions, there are fundamental policy issues and questions related to establishing clusters. Among these is the role of government in cluster development. According to Michael Porter, governments can improve economic performance by working actively with cluster participants to understand their needs and to invest in cluster-specific training, research institutions and infrastructure.
However, it may not be appropriate for government to be directly involved in creating clusters, even though it is already involved in such clusters as the NRC's. Does government need to do more? Clusters should be considered as one element that can help financial markets operate efficiently and that can help them create and commercialize innovation. These ideas are considered in the gap analysis (Part IV).
5.1.2 Information Technology
1996–2002 overall trends: information technology is the clear driver of venture capital activity
Overall sectoral trends favouring information technology have generally been consistent with the nature of VC and the investment criteria of venture capitalists (as explained in Part I). Venture capitalists' (particularly foreign venture capitalists') recent increased interest in information technology investments has meant that this sector has experienced the strongest growth of VC investment since 1996, increasing by 368 percent (from $340 million in 1996 to $1.6 billion in 2002). This growth was underpinned by strong performances in communications and networking (a 567-percent increase, from $101 million in 1996 to $673 million in 2002); software (a 129-percent increase, from $157 million in 1996 to $358 million in 2002); semiconductors (a 2178-percent growth, from $11 million to $247 million in 2002); and Internet industries (a 943-percent growth, from $14 million to $154 million).
This increased activity has propelled the information technology sector to the forefront of VC activity in Canada since 1996, capturing 53 percent of total VC investments and 42 percent of VC deals (see Figure 30). In Canada, the predominance of the information technology sector was even more evident in 2001 and 2002, when these firms attracted 70 percent and 65 percent of VC investments and 53 percent and 44 percent of VC deals, respectively.
Figure 30: Information Technology Venture Capital Activity Trends, 1996–2002
Moreover, the average information technology VC deal was 179 percent bigger in 2002 than it was in 1996. The average size of these deals was also significantly larger than the national average VC deal size during this period: $3.5 million for information technology investments (with a peak at $6.2 million in 2000) compared to $2.7 million for the national average.
Recent situation — despite a steep decline of venture capital activity, information technology continues to dominate venture capital activity in 2002 and 2003
Despite the burst of the technology bubble, information technology still drives VC investment in Canada (and in most countries, including the U.S.). Renewed activity in communications and networking, software, and other information technology sectors has accounted for much of the recent rise in capital invested in Canada.
In 2002, information technology firms attracted 65 percent of total VC investment (worth $1.6 billion) and 44 percent of financings (in 358 deals). This represented a decline from 2001, when $2.7 billion, or 70 percent of total investments, was invested in 511 deals (representing 53 percent of transactions). Within the information technology sector, communications (42 percent), software (22 percent), Internet industries (11 percent) and semiconductors (15 percent) attracted most of the VC investment in 2002. However, with the exception of semiconductors, the capital invested in all information technology subsectors declined between 2001 and 2002. Capital invested in semiconductors increased by 17 percent in 2002, from $211 million in 2001 to $247 million in 2002.
In 2002, the main Canadian investors in information technology companies included the BDC; Innovatech Montréal; GrowthWorks; Desjardins Venture Capital; VenGrowth Capital Partners; Innovatech Québec et Chaudière-Appalaches; Caisse de dépôt et placement du Québec (CDP) Capital; Fonds de solidarité des travailleurs du Québec (FTQ); Covington Capital Corporation; and CDP Capital — Technology Ventures. In terms of foreign investors (mostly located in California and Massachusetts), the most active ones were Venture Investment Management Company LLC (VIMAC); Kodiak Venture Partners; Morgenthaler Ventures; Technology Crossover Ventures; Flagship Ventures; Pilgrim Baxter; Norwest Venture Partners; Prism Venture Partners; Menlo Ventures; and Newbury Ventures.
In the first nine months of 2003, the decline of VC investment in information technology firms continued. In fact, while information technology still dominated VC investment in Canada, with 53 percent of total investment and 42 percent of deals in 2003, this sector's share of total VC has been declining since 2000. However, these early data represent only nine months of the year, and it remains to be seen whether this tendency is an aberration or a long-term trend.
Although investment in information technology has cooled in recent years, it is still a viable and healthy market. Since technology companies are now more carefully watching their costs and profit margins, the future may still be positive. Other public or private initiatives may also spur information technology investment. For example, the Silicon Valley VC firm Draper Fisher Jurvetson (DFJ) has joined forced with Primaxis Technology Ventures Inc. to raise a US$100-million fund to target investment opportunities in Canada.62 This type of partnership (along with trends such as the steep increase in foreign VC investment) signals a growing recognition of the viability of Canadian information technology investment opportunities.
Regional focus — Ontario is the clear leader in information technology investment
While the information technology sector has dominated VC investment in most regions since 1996 (see Figure 29), this tendency has been more evident in Ontario, Atlantic Canada, B.C. and Quebec, where information technology firms have captured, respectively, average VC investment shares of 67 percent, 48 percent, 42 percent and 39 percent over the 1996–2002 period. See Section 6 for more details for each region.
5.1.3 Life Sciences
1996–2002 overall trends: constant share of total venture capital activity despite the remarkable growth of amounts invested
While life sciences investments have not led VC activity in Canada since 1996, this sector has experienced solid growth in VC investment. Its relative importance has remained relatively stable over the past seven years, with a slight increase in 2002 and the first nine months of 2003. Compared to the information technology sector, life sciences did not face as steep a decline. Canadian life sciences VC activity has been driven by successful fundraising among investor groups that specialized in this sector. When an important new innovative sector emerges in the VC industry, we usually see more well-capitalized specialized funds featuring investment professionals with the relevant technology expertise. In recent years, strong Canadian fundraising activity has helped national and regional life sciences specialty funds, such as the Canadian Medical Discoveries Fund Inc., T2C2 Capital, and Genesys Capital Partners Inc. These funds have, in turn, been able to invest more in this sector.
The data from 1996 to 2002 show that this sector benefited from a 103-percent surge in VC investment, from $228 million to $463 million, and an 80-percent increase in VC deals, from 95 to 171 (see Figure 31). Mirroring trends in overall VC investment, the bulk of this increase came in 2000 and 2001, when life sciences investments reached $826 million (253 deals) and $651 million (184 deals), respectively.
Figure 31: Life Sciences Venture Capital Activity Trends, 1996–2002
Within the life sciences sector, biotechnology firms have typically accounted for the largest amount of VC capital invested in life sciences. However, in terms of the growth of VC investments within this sector, investment in medical devices and equipment increased by 192 percent, from $44 million in 1996 to $127 million in 2002; followed by 163 percent for medical and biotechnology software, from $13 million to $35 million; 76 percent for biopharmaceutical investment, from $163 million to $286 million; and 65 percent for VC investment in health care, from $8 million to $14 million.
As a result of this increased activity level, life sciences firms attracted 19 percent of total VC activity and 18 percent of VC financings between 1996 and 2002. Similarly, life sciences' share of total VC investment for 2001 and 2002 — 17 percent and 19 percent, respectively — was generally consistent with the overall trend since 1996. Other forms of financing (e.g. IPOs and secondary financing) in life sciences have experienced similar growth over the same period, but the virtual closing of the IPO market since 2001 has meant that VC financing has accounted for a larger portion of overall financing.
Life sciences investments need a lot of capital to move from the research stage to the developmental or precommercialization stages. Accordingly, 65 percent of life sciences financings in 2001 were large deals, driving the average deal size up to $3.5 million in 2001, but down to $2.7 million in 2002 because of the general decline of activity. From 1996 to 2002, the average life sciences VC deal was $2.7 million, which was similar to the national average deal size.
However, considering the high capital requirements of these firms, this average deal size raises a number of financing and policy issues for life sciences firms, particularly considering that the average U.S. life sciences deal is much larger. The current economic climate has severely strained cash flow and the smaller average size of financings in Canada, compared to the U.S., which exacerbates these difficulties. For example, the average biotechnology VC deal size in Canada was C$2.7 million in 2002 versus C$16 million in the U.S. The same is true in the later financing stages in the public markets, where the average biotechnology IPO is C$6.4 million in Canada, compared to C$83 million in the U.S.63
Biotechnology Firms
The latest Statistics Canada data on biotechnology companies in Canada in 2001 indicate that there were 375 companies with revenues of $3.7 billion that spend $1.3 billion on R&D.64 The majority of these firms were SMEs (71 percent small, 17 percent medium-sized, and 12 percent large). This $1.3 billion in private sector R&D, along with more than $400 million in federal government R&D, represents a significant combined effort in biotechnology.
According to Statistics Canada, most of the financing for biotechnology firms over the years has come from VC. For example, in 2001 VC financing accounted for 43 percent of financing (only about a seventh of which was U.S.) followed by 23 percent from public offerings and private placements, 15 percent from angel investors, 13 percent from governments, and 7 percent from banks. Canadian VC provided the largest share of funds to SMEs, 37 percent and 46 percent, respectively. Large firms received 54 percent of their funding from conventional and government sources and 14 percent from VC.
In 2001, Canadian biotechnology firms raised $980 million in financing capital for biotechnology activities, which included $517 million (53 percent) for small firms, $374 million (38 percent) for medium-sized firms and $89 million (9 percent) for large companies. The health sector accounted for $858 million of the $980 million raised. Quebec attracted the most financing, with $467 million, followed by $216 million for Ontario, $139 million for Alberta, and $127 million for B.C. Within the companies' internal operations, small firms raised proportionately more for biotechnology activities than did large firms, which tend to have more diversified operations.
Only 50 percent of small biotechnology firms were able to reach their financing targets, compared to 80 percent of medium-sized firms and 66 percent of large companies. The limited success of these firms in raising capital was due to three main reasons: the capital was unavailable because of market conditions (78 cases), lenders needed further product development or proof of concept (43 cases); or the biotechnology products or processes were deemed not sufficiently developed to warrant financing (42 cases). Insufficient management expertise and limited product lines were cited in 13 and 12 cases, respectively.
Life sciences firms that use biotechnology progress from the VC stage to the IPO stage faster than do other high technology companies. This is because life sciences firms require substantially larger amounts of funding, and the product development period is significantly longer.65 Most life sciences firms go public during the development stage, whereas other high technology firms go public once products have been produced and sales are being generated. This has had an impact not only on Canadian firms' ability to become internationally competitive but also on their ability to benefit from current government R&D programs and policies in the same way that other R&D firms do. For example, in 1999 the average unused Scientific Research and Experimental Development Program tax credit accumulated by biotechnology companies was double that of nonbiotechnology firms, accounting for $500 million or 10 percent of all unused tax credits of Canadian R&D firms.66
The most definitive study conducted to date on the financial needs of Canadian biotechnology therapeutics firms (which represent 80 percent of total capital demand in biotechnology) indicates that the capital demand between 2001 and 2006, based on products currently in the development pipeline, will be $4.8 billion annually, and that the capital supply will likely average $4.2 billion, suggesting a $600-million annual shortfall.67 This conservative estimate does not include indirect cost considerations, nor does it address those discoveries that will be seeking financing in order to move to the development stage. According to the study, these additional requirements would mean an annual shortfall of at least $3.3 billion.
The challenge for biotechnology firms is to attract significant amounts of new capital. We have identified the unique financing challenges associated with biotechnology companies, using the Innovation Strategy engagement process, Statistics Canada surveys, national and regional reports, statements by leaders in the Canadian health research community, provincial government initiatives (such as the Quebec and Ontario budgetary initiatives), and direct engagement with the biotechnology community.
The overwhelming majority of Canada's 375 biotechnology companies are SMEs with limited managerial resources and significant challenges in accessing capital. Compared to other enterprises, biotechnology R&D is too expensive and takes too long to commercialize. These companies depend on limited and short-timeline venture capital support and other nontraditional sources (e.g. Technology Partnerships Canada and the Industrial Research Assistance Program). The biotechnology community believes that no more than half of these firms are viable. The majority of these firms are very early-stage university spin-off companies that have not developed a strong enough business case for their research.
Many Canadian biotechnology companies are increasingly developing their research, some are commercializing it, and many newer entrants continue to focus on research and predevelopment. Government programs need to reflect this shift to biotechnology development and commercialization. Will government policies and programs keep up with the pace of biotechnology innovation? Can government work with the private sector to help develop and commercialize biotechnology in Canada?
Recent situation — despite a decline in venture capital activity in 2003, the life sciences sector captured an increasing share of total activity
Life sciences VC activity increased in 2001 and 2002, a tendency that may have been related to increasingly cautious information technology investment strategies. Life sciences activity remained strong throughout 2001, 2002 and 2003, despite the decrease in total VC invested compared to 2000. In 2002, life sciences firms captured 19 percent of total VC for $463 million and 171 transactions (21 percent of deals). Within the life sciences sector, biopharmaceutical companies received 62 percent of life sciences VC investment in 2002.
The key Canadian investors in terms of amount invested in 2002 were FTQ; the BDC; Desjardins Venture Capital; Innovatech Montréal and Innovatech Québec et Chaudière-Appalaches; Canadian Medical Discoveries Fund Inc.; Genesys Capital Partners; CDP Capital — Technology Ventures; T2C2 Capital; and CDP Capital. The most active foreign investors were Kinetic Capital Partners; Seaflower Ventures; Sanderling; Softbank Venture Capital (Mobius Venture Capital); Qwest Emerging Biotech Fund Ltd.; ProQuest Investments; IDEC Pharmaceuticals Corporation; Hearthstone Investments Ltd.; Shire Pharmaceuticals Group; and BioFund of Finland. While most of these are located in California and Massachusetts, a few are from the U.K., Finland, and other U.S. states.
In the first nine months of 2003, while the life sciences sector experienced a decline of VC investments, its overall performance remained strong compared to firms in other sectors. In fact, life sciences firms attracted an increasing share of total investment, with 22 percent of total investments ($200 million in 83 companies) and 19 percent of financings (or 97 deals).
Regional focus — Quebec and British Columbia leading life sciences venture capital activity in Canada
Between 1996 and 2002, the life sciences sector in B.C. captured a 42-percent average share of provincial VC investments (compared to 24 percent in Quebec, 20 percent in Atlantic Canada and 22 percent in the Prairies). Since investment in Ontario has tended to favour information technology firms, the life sciences sector in that province has traditionally accounted for a lower share of provincial disbursements, averaging 12 percent from 1996 to 2002.
This is generally consistent with the Statistics Canada 2001 biotechnology survey, which indicated that biotechnology VC activity was most prevalent in Manitoba, Quebec and B.C., but represented a smaller proportion of overall financing in Ontario. On the other hand, the survey revealed that Alberta and Saskatchewan received the highest proportion of financing from angel investors. See Section 6 for more details for each region.
5.1.4 Other Technology
1996–2002 overall trends: this sector represents a small but constant portion of venture capital activity
As shown in Figure 32, capital invested in the other technology sectors (composed mostly of energy and environmental technologies) has experienced a moderate 56-percent growth over the past seven years — from $86 million to $134 million. However, in relative terms, this sector's share of total VC investments fell 35 percent between 1996 and 2002, for an averaged 4 percent of total VC investment from 1996 to 2002 (and in the first nine months of 2003).68 The number of deals in this sector increased by 118 percent — the highest growth of any sector — from 28 in 1996 to 61 in 2002; and from 5 percent of deals in 1996 to 7 percent of deals in 2002, an increase of 57 percent. As a result, the average deal size fell 28 percent, from $3 million in 1996 to $2.2 million in 2002, for an average deal size over the period of $2 million. This average deal size was lower than the national average deal size of $2.7 million.
In terms of Canadian investors, the most active in the other technology sectors in 2002 were Innovatech Québec et Chaudiere-Appalaches; FTQ; CDP Capital; The Quantum Leap Company Limited; GrowthWorks; Skylon Capital Corp.; Fullarton Capital Corporation; Innovatech sud du Québec; Hydro-Québec CapiTech; and the BDC. The main foreign investors investing in other technologies firms included Shell Hydrogen BV (Netherlands); BTG Ventures (Pennsylvania and the U.K.); Royal Dutch/Shell Group (Netherlands); Aretê Corporation (New Hampshire); and JohnsonDiversey (Wisconsin).
Figure 32: Other Technology Venture Capital Activity Trends, 1996–2002
Despite this relative decline of VC investment, and despite this sector's declining importance relative to the information technology and life sciences sectors, the future may offer interesting investment opportunities for VC investors. New environmental technologies and other related technologies may gain some importance with the implementation of the Kyoto agreement.
Energy and environmental technologies firms have also benefited, as have life sciences firms, from the recent growth in sector-focussed VC funds with in-house expertise (e.g. ARC Financial | ARC Energy Venture Funds, Chrysalix Energy Management, OPG Ventures Inc.). This expertise allows the funds to invest more in these sectors. Indeed, the energy and environmental sector is the only technology field in which VC activity has remained fairly steady during the market slowdown. This indicates something of its potential growth capacity in Canada, particularly in certain areas such as fuel cells.
5.1.5 Traditional Sectors
1996–2002 overall trends: declining importance of traditional venture capital activity
Confirming that venture capitalists generally invest in high-return-potential firms, VC investment in traditional sectors (which includes consumer and business services, consumer products, manufacturing, miscellaneous, and retailers) declined 27 percent, from $379 million in 1996 to $278 million in 2002. The traditional sector's share of total VC investment fell from 37 percent in 1996 to 11 percent in 2002 (see Figure 33). However, this sector had the second-highest average share of total VC investment, with 24 percent, ahead of life sciences (19 percent) and other technologies (4 percent), but behind information technologies (53 percent). In terms of the number of financings, this sector's share also declined, from 43 percent (251 deals) in 1996 to 28 percent (224 deals) in 2002.
In general, VC investment in traditional sectors tends to be less capital-intensive than investment in most high technology firms, which tend to need more capital. As such, the average traditional-sector investment of $1.6 million did not approach the $3.5-million average deal size in the information technology sector, or the overall average deal size for 1996–2002 ($2.7 million).
Figure 33: Traditional Venture Capital Activity Trends, 1996–2002
Recent situation: declining importance of traditional sectors in 2002
Consistent with the trends from 1996 to 2002, traditional-sector firms continued to lose market share in 2002, capturing $278 million for 11 percent of total VC investment. However, the number of financings remained stable, with 223 in 2001 and 224 in 2002. After declining to 27 percent in 2000 and to 23 percent in 2001, the traditional sector's share of financings recovered to 28 percent in 2002.
This consistency may suggest that, while VC investors do not focus on traditional-sector firms, some of these firms may be viable investment opportunities, particularly for smaller deals. In fact, in the first nine months of 2003, traditional investments attracted 21 percent of total investment, which represented a significant increase from previous years. However, this increase may be due not to increased investment but to the strong decline of investment in the information technology and other sectors.
In 2002, the key Canadian investors in the traditional sector were FTQ, CDP Capital, Fondaction, Desjardins Venture Capital, Fonds régional de solidarité FTQ, Crocus Investment Fund, Crown Capital Partners Inc., Innovatech Montréal, Crown Investments Corporation of Saskatchewan, and the BDC. There were also three foreign investors (from California and Texas) who invested in six traditional sector companies in 2002: Prospect Venture Partners, VentureLink Holdings, and Claridge/Andell Group.
Regional focus: traditional sector still leads venture capital investments in Manitoba and Saskatchewan
Between 1996 and 2002, investments in Manitoba and Saskatchewan were highly focussed on traditional sectors. This sector averaged 68 percent and 60 percent of VC investments in those provinces, respectively, compared to 11 percent and 7 percent for information technology, and 20 percent and 29 percent for life sciences. By contrast, an average of 33 percent of VC investment in Quebec and Atlantic Canada went to traditional sectors from 1996 to 2002. However, venture capitalists increasingly focus on high technology firms, so VC investment in the traditional sector has been decreasing consistently in most regions from 1996 to 2002. Only Saskatchewan continued to see heavy VC investment in traditional sectors in 2002, with 54 percent of provincial VC going to that sector. See Section 6 for more details for each region.
5.2 International Comparison
5.2.1 Comparison: Canada–United States
1996–2002 overall venture capital trends: the United States' venture capital activity is slightly more focussed on information technology
Despite some discrepancies in the sectoral definitions and breakdowns between the two countries, which may affect the accuracy of the comparisons presented here, the sectoral distribution of VC activity in Canada and the U.S. from 1996 to 2002 confirms that in both countries VC investments have been heavily focussed on information technology (particularly in the U.S.) and life sciences. See Table 15 for a summary of the amounts invested in each sector for the two countries in 1996 and 2002.
- Information technology69 attracted an average of 74 percent of total U.S. VC investment from 1996 to 2002, and 60 percent of it in 2002 (or C$18.3 billion). This is significantly higher than the average of 53 percent of total Canadian VC investments between 1996 and 2002, but lower than the 65 percent observed in 2002 (with C$463 million). This greater concentration on the information technology sector in the U.S. over the past seven years may be because U.S. investment in that sector has been concentrated on software and Internet products, which grew tremendously between 1999 and 2001, but which have declined sharply since. Canadian information technology investment has been more diversified across a broader range of technologies, which has insulated the Canadian VC industry since 1998 from the rampant fluctuations of boom and bust.
- Life sciences70 attracted an average of 17 percent of total U.S. VC investments from 1996 to 2002, and 22 percent in 2002 (or C$7.1 billion). This compares relatively well with the average of 19 percent of Canadian VC investment allocated to life sciences firms, both from 1996 to 2002, and in 2002, when C$431 million was invested. However, as explained above, VC investments made in Canadian and U.S. life sciences firms are very different in average size. See Section 9 for more information on the policy issues related to this issue.
- Other technology71 captured a 4-percent share of total VC activity in the U.S. and Canada from 1996 to 2002. However, VC investments in other Canadian technologies increased by 56 percent between 1996 and 2002, compared to 15 percent in the U.S.
- Traditional72 (or non-technology) sectors in the U.S. attracted an average of 7 percent of total VC investments from 1996 to 2002, and 5 percent of it in 2002 (or C$1.9 billion). This belies this sector's importance in Canada. Traditional-sector investment amounted to an average of 24 percent of total VC investments from 1996 to 2002, and 11 percent in 2002 (or C$134 million).
Recent situation: life sciences sector was the bright spot in 2002
In the U.S., each of the sectors declined in 2002, most by nearly 50 percent. While activity in the life sciences sector also fell, this sector was the bright spot in 2002. VC investments totalled C$7.1 billion (US$4.7 billion), accounting for 22 percent of all VC investing (up from 13 percent in 2001), which was the highest proportion of total VC in seven years.
Separately, the biotechnology industry offered strong performance and the highest average investment per company (C$17.3 million), as well as investments totalling C$4.2 billion (US$2.8 billion) in 2002. As a result, the proportion of total VC invested in the biotechnology sector rose from 3.5 percent in 2000 to 8 percent in 2001 and 13 percent in 2002. The medical devices industry also performed well, attracting C$2.9 billion (US$1.9 billion) in 2002.
According to the NVCA, the strong growth of the biotechnology and medical devices subsectors can probably be attributed to investment by corporate players and increased speed in the drug approval process. As well, according to a study from the Canadian Consulate General, New York, this recent growth may also be attributed to the broad range of opportunities created by the integration of technology in the drug development process, and to continuing advances in the genomics and proteomics fields.73
Despite the burst of the technology bubble, the U.S. software sector remained strong throughout 2001 and 2002, while networking and telecommunications remained relatively stable.74 Software, perennially the leading industry category, maintained its lead in 2002 with 20 percent of total VC (799 deals, worth $4.3 billion). Telecommunications followed with 14 percent of the annual total (335 deals, worth $2.9 billion). Investment in the networking industry fell by 61 percent in 2002 to $2.2 billion in 209 companies, or 11 percent of the total. Other information technology sectors experienced sharp declines in 2002. Investment in media and entertainment fell 70 percent, while investment in information technology services dropped 60 percent.
For the first nine months of 2003, most of the leading industries experienced declines. Software remained the leading sector, with $790 million invested in 166 firms (down 13 percent from the previous quarter). Biotechnology investing was stable but moved into second place, with $490 million in 49 firms, and investment in medical devices fell 48 percent ($255 million) from the last quarter of 2002.
5.2.2 Comparison: Canada Organisation for Economic Co-operation and Development Countries
While there are differences in specific distributions within each sector, information technology dominates VC activity across the OECD countries. The life sciences sector generally attracts less VC investment, but has recently gained importance in several countries, particularly the U.S. and Canada. This, as explained previously, may be attributed to the higher return potential, which has resulted in more VC funds specializing in raising capital for these firms.
This international trend towards investment in information technology and life sciences illustrates how, in western economies, there is a symbiotic relationship among VC, innovation and high technology.
61 This list only includes the sectoral clusters established through the NRC, and may not include all clusters in Canada. Given that clusters are generally regional, information on clusters is also presented in Section 6, which discusses regional VC investment trends.
62 Primaxis Technology Ventures Inc. has been an active player in the Canadian VC industry for the past five years, and will manage the fund out of its Toronto office. DFJ expects to leverage its investment process in Silicon Valley to provide valuable U.S. business contacts for Canadian start-ups.
63 Ernst & Young data converted to Canadian dollars (C$).
64 Statistics Canada, Biotechnology Use and Development Survey (2001).
65 Houlihan Valuation Advisors/VentureOne, 1998.
66 Conference Board of Canada, 2000.
67 Université du Québec à Montréal, Demand and supply of capital for Canadian biotechnology therapeutics companies (2002).
68 Given that this sector represents only a small share of total VC investments, only the general trends are presented.
69 For comparative purposes, the following categories have been included in the U.S. information technology category: communications, computer software, semiconductors and electronics, and computer hardware and services.
70 For comparative purposes, biotechnology and technologies related to health care have been included in the U.S. life sciences category.
71 For comparative purposes, the industrial and energy sectors have been included in the U.S. "other technology" sector.
72 For comparative purposes, the following categories have been included in the U.S. traditional sector category: retail, media and business/financial.
73 Canadian Consulate General, New York, Tri-State Area Venture Capital Report (2002).
74 PricewaterhouseCoopers/Venture Economics/National Venture Capital Association MoneyTree Survey.
