Canadian Venture Capital Activity: An Analysis of Trends and Gaps (1996–2002)

Part II: 6. Regional Venture Capital Investment Trends

Absolute versus relative measures

As in previous sections, when we analyze the regional distribution of VC activity in Canada, we need to take into account both absolute and relative measures. There are no precise measures of what should be the optimal or appropriate amount of VC investment for an economy (or a particular region), so most countries have instead used the U.S. as a benchmark.

But this many not necessarily be appropriate in all situations or for all regions. For example, an absolute comparison between Canada and the U.S. (e.g. total VC investments and number of deals) reveals that the Canadian VC industry is smaller and less developed. On a relative basis, however, the data reveal that Canada's VC activity from 1990 to 2002 has been similar to U.S. activity. This suggests that the current Canadian VC market situation may not be problematic, even if there are some key differences or imperfections in different segments of the two VC markets (such as in deal size and total disbursements).

Regional distribution of overall VC activity in Canada is also relative. To be meaningful and useful to policy-makers, one must compare the current regional distribution of VC with the most appropriate benchmarks. The most frequently used benchmarks are population, economic activity (GDP) and the number of KBI firms. Since VC funding is generally directed toward KBIs, it is appropriate to use the number of KBI firms by region to compare the regional distribution of VC activity across regions. However, this is not a perfect measure. This review will adapt the concentration of KBI firms and GDP across regions to make a comparative analysis of the regional distribution of VC investment in Canada.

Based on these measures — VC activity, number of KBI firms and GDP — for each of the five regions, the data reveal relative gaps in the distribution of VC activity in the Prairies and, to a lesser extent, Atlantic Canada. Other gaps may exist in some specific areas within a province or region, such as northern Ontario and eastern Quebec. Unfortunately, the current data do not permit a detailed analysis of specific areas within each province or region.

The following section reviews regional VC activity trends since 1996. While some regional elements have been discussed previously, the information is collected here to provide a more detailed analysis of the regional distribution of VC. This analysis will help us understand these gaps and will explain the relative concentration of VC activity in Ontario and Quebec. It will also review regional VC activity (e.g. total growth, average distribution of total VC activity, and shares for each region over the period) and determine whether the regional situation is improving or worsening and whether we should act to ensure the continued growth of VC activity across Canada. These issues will inform policy issues being considered in the gap analysis in Part IV.

6.1 1996–2002 Overall Regional Venture Capital Investment Trends and Analysis

There is a relatively strong relationship between regional distribution of venture capital activity, gross domestic product, and knowledge-based industry firms, except in the Prairies and Atlantic Canada

The absolute data show that VC activity in Canada since 1996 has been concentrated in Ontario, Quebec and B.C. In these provinces, market patterns seem very similar. For example, we find a dedicated focus on the information technology and life sciences sectors, particularly in clusters centred in Ottawa, Montréal and Vancouver. This tendency mirrors U.S.-style VC investment activity, which is highly focussed on high technology and is concentrated in a few states, with California (Silicon Valley) and Massachusetts (Boston) attracting the majority of VC investment.

This high concentration of VC activity in a few regions is usually associated with the structure and nature of VC investment (see Part I). In fact, because of the strong mentoring role usually played by venture capitalists, VC has historically had a strong local component. While there are some indications that venture capitalists are now more specialized and, thus, increasingly open to investing in good opportunities regardless of location, VC investment remains highly concentrated in a few regions. A good example of the fading importance of local restrictions is the increasing level of foreign investment in Canada (and the increasing levels of investment by Canadian VC funds outside the country), as well as the growing number of VC funds that invest in all regions. However, many venture capitalists continue to invest in firms located a reasonable distance from their main office. This tendency is reinforced by concentrations of high technology firms in specific clusters.

Furthermore, the types of businesses that generally attract VC funding may also contribute to this concentration. As explained in Part I, VC is only appropriate for and used by a very limited number of firms (677 in 2002). These firms must be able to offer high-growth potential and can only be financed by 35 percent to 40 percent of investors who are willing to accept high risks in exchange for high returns. Most often, such opportunities are found in the technology sectors, which tend to concentrate in specific regions, such as Ottawa (information technology), Montréal (life sciences) and Vancouver (life sciences).

To clarify the links between VC activity and high technology firms, Figure 34 illustrates the relative distribution of VC activity, KBI firms and GDP across regions. More particularly, it shows that provinces or regions with high concentrations of SMEs and KBI firms (such as Ontario and Quebec) attracted substantial amounts of VC in 2002. The Ottawa area, for example, is often cited as a "technology cluster," and it captured 56 percent of the total amount invested in Ontario-based firms in 2001 and 2002. Likewise, the Montréal area captured 69 percent and 73 percent of provincial VC investment in 2001 and 2002, respectively, while in B.C. the Vancouver area captured 93 percent and 90 percent in 2001 and 2002. A similar link is observed between the provincial or regional share of GDP and VC investment. In 2001 for example, as shown in Figure 34 and Table 14, Quebec attracted a similar proportion of total VC activity, KBI firms and GDP, with 26 percent, 20 percent and 21 percent, respectively, in 2001.

However, this relationship between VC investment and the distribution of GDP and KBI firms by region does not apply to all provinces or regions. In fact, a VC activity gap can be detected in the Prairies and Atlantic Canada, where the share of VC activity (4 percent and 1 percent, respectively, in 2001) was lower than the proportion of GDP (19 percent and 6 percent) or KBI firms (19 percent and 3 percent) in 2001. This may be due to the fact that provincial VC investment patterns are often influenced by the nature of specific provincial activities and economies. The Prairies and Atlantic Canada may not have a critical mass of high-growth technology companies, which appear to attract VC investments in similar proportions to the rest of Canada. Consequently, businesses in these regions appear to have more difficulty attracting the same proportions of VC.

Figure 34: Regional Distribution of Venture Capital Investment, Knowledge-Based Industry Firms and Gross Domestic Product in Canada, 2001

Table 14 shows that, in terms of the growth of VC investment from 1996 to 2002, both the Prairies (93 percent) and Atlantic Canada (33 percent) have remained below the national average (139 percent). As a result, the gap appears to be growing over time. In an absolute sense, the problem is worse in the Prairies, but, in terms of lagging growth, the discrepancy is more pronounced in Atlantic Canada. On a positive note, the number of active funds in the Prairies and Atlantic Canada has grown faster than the national average over the period (growth of 154 percent and 120 percent, respectively, compared to 117 percent for Canada).

This regional disparity of VC activity touches on an important debate about the direction of causality. Does strong VC activity lead to the creation of high-growth firms, or does the presence of a critical mass of high-growth-potential KBI firms result in the creation of more VC funds and the expansion of investments? How do clusters affect the creation of the critical mass required to attract VC investment and support high technology and innovative firms? To better understand these relationships, and to further suggest explanations and potential solutions to some of the regional economic development issues, we now look in more detail at regional VC investment trends, and we review existing clusters in each region, province or city.

Table 14: Summary of Venture Capital Activity Growth in Canada

	Growth in VC Investments (percent)	Growth in # of VC Funds (percent)	Average Share of Total VC Investments (percent)	Average Share of Total VC Funds (percent)
Source: Macdonald & Associates Limited, 2003
Ontario	165 ($487M–$1.3B)	126 (50–113)	49	40
Quebec	123 ($323M–$722M)	88 (41–77)	31	30
British Columbia	134 ($107M–$251M)	126 (19–43)	11	15
Prairies	93 ($82M–$159M)	100 (15–30)	7	11
Atlantic	33 ($33M–$44M)	120 (5–11)	2	4
Total	150 ($1B–$2.5B)	117 (130–282)	100	100

Absolute growth of venture capital activity was observed in all regions from 1996 to 2002

Despite the concentration of VC activity in Ontario, Quebec and B.C., and despite the impact that this may have on the economic development of the other regions, these numbers should be placed into perspective. First, few firms receive VC investments in any given year. Just 677 did in 2002. In provinces or regions that have had a small base of VC investments, a very small change in the number of investments can dramatically shift the regional distribution figures from one year to another. Areas with less VC industry are more susceptible to these fluctuations, so we should review regional investment trends over longer periods.

Table 15 and Figure 35 show that the overall pool of VC has been rising in all regions, despite the 2002 downturn. Even if a particular region's share of total investment does not change much relative to other regions, the data may still reflect a substantial increase in actual dollars invested, and may suggest an improved industry structure and the potential for future investment.

Figure 35: Trends in Regional Distribution of Venture Capital Activity, 1996–2002

In addition to the growth of VC investment across all regions since 1996, Table 15 shows that the last seven years have seen significant growth in the number of active VC firms and funds in all regions of Canada. However, the most active VC investors in Canada are concentrated in Quebec and Ontario. This suggests that many of the new VC firms outside central Canada tend to be smaller, and, as result, it is difficult to determine their impact on provincial investment trends. On the other hand, large VC firms in central Canada (e.g. bank-owned VC firms and some LSVCCs that raise capital across the country) are becoming more active nationally through branch operations in other regions. It would be informative to collect and review the data on the provincial activities of these firms.

Table 15: Summary of Regional Venture Capital Investment Trends, 1996–2002

	Total Growth 1996–2002 (percent)		Average Share of Total VC (percent)		Average Deal Size	VC Funds		KBI (2001)	GDP (2001)
	$M	# of Financings	$M	# of Financings	$M	# of Funds 2002	Increase 1996–2002 (percent)	Percent	Percent
Sources: Macdonald & Associates Limited, 1996–2002; Statistics Canada, 2002
Ontario	165	17	49	30	4.6	113	126	45	41
Quebec	123	50	31	48	1.7	77	88	20	21
British Columbia	134	57	11	9	3.3	43	126	13	13
Prairies	93	60	7	10	1.8	38	100	19	19
- Alta.	138	56	4	4	2.7	19	280	–	–
- Sask.	183	32	1	2	1.6	12	71	–	–
- Man.	-10	94	2	4	1.5	7	133	–	–
Atlantic	33	-13	2	3	1.7	11	120	3	6
Canada	139	39	100	100	2.7	283	117	100	100

In 2002, the most active Canadian investors in terms of number of Canadian companies financed were mostly in Quebec: the FTQ, the BDC, CDP Capital, Desjardins Venture Capital, Innovatech Montréal, Innovatech Québec et Chaudière-Appalaches, Fonds régional de solidarité FTQ, GrowthWorks, FondAction, CDP Capital — Technology Ventures, and VenGrowth Capital Partners. Key foreign investors (mostly located in California and Massachusetts) included VIMAC, Kodiak Venture Partners, Morgenthaler Ventures, Technology Crossover Ventures, Flagship Ventures, Pilgrim Baxter, Norwest Venture Partners, Prism Venture Partners, Menlo Ventures, and Kinetic Capital Partners.

6.2 Provincial and Regional Trends

As there is not enough data for some subregions to provide a significant comparative analysis, the following analysis focusses on trends by province or in such key areas as Ottawa, Montréal, Vancouver and Calgary. As a result, the Prairies and Atlantic Canada are being analyzed in aggregate, although we offer a short analysis of Alberta, Saskatchewan and Manitoba.

6.2.1 Ontario

1996–2002 overall venture capital activity trends and analysis: Ontario leads venture capital activity in Canada

Given the strong concentration of KBI firms in Ontario, and the affinity of venture capitalists' (particularly foreign investors) for technology firms, it is not surprising that VC investment in Ontario has experienced the strongest growth since 1996. Investment in Ontario grew 165 percent, from $487 million in 1996 to $1.3 billion in 2002 (with a peak at $3.4 billion in 2000). Ontario has been the leading province in terms of VC disbursements from 1996 to 2002, with a 49-percent average share of total VC. This proportion has been roughly consistent with Ontario's 45-percent share of KBI firms in 2001 and its 41-percent share of GDP in 2001 (Figure 32).

However, Ontario has not been the leader in the number of VC transactions in Canada. In fact, Ontario-based firms only captured an average of 30 percent of total VC financings from 1996 to 2002. This is also reflected in the more modest growth of total VC transactions in Ontario, which increased by 17 percent between 1996 and 2002, from 189 to 222 deals (peaking at 427 in 2000). A higher share of total VC investments and fewer VC financings meant that the average VC deal size in Ontario from 1996 to 2002 ($4.6 million) was the highest of all provinces and regions, and was well above the national average VC deal size ($2.7 million).

Ontario ranked first in the growth in the number of active VC funds (see Table 16), growing from 50 VC funds in 1996 to 113 in 2002 (a 56-percent increase). By 2002, 40 percent of Canadian VC funds were in Ontario, slightly below the 49-percent average share of total VC investments from 1996 to 2002.

Figure 36: Ontario Venture Capital Activity Trends, 1996–2002

Ottawa-based firms lead venture capital activity in Ontario and in Canada

Within Ontario (and within Canada), Ottawa-based firms have played a major role in the development of the VC industry since 1996. Between 1996 and 2002, investment in the Ottawa region represented 38 percent of the total amount of VC invested in Ontario-based firms, and this investment has been the engine behind Ontario's strong VC performance over the past several years. Over the same period, VC investment in Ottawa increased 1063 percent (from $63 million to $735 million), and the number of deals grew by 71 percent (from 38 to 65). The average deal size in Ottawa increased by 565 percent (from $1.7 million to $11.3 million) to reach an average of $6.9 million for the seven-year period. This was largely responsible for the growth of the average deal size in Canada, which increased by 72 percent over the period (from only $1.7 million in 1996 to $3.2 million in 2002), for an average of $2.7 million for the period.

Recent situation: Ontario (particularly Ottawa) continues to lead venture capital activity in Canada

Although VC activity declined significantly after peaking in 2000, Ontario (particularly Ottawa) continued to perform well and to lead the other Canadian provinces and regions in 2002 and the first nine months of 2003.

In 2002, Ontario captured 52 percent of total VC investments, worth $1.3 billion (compared to 55 percent and $2.1 billion in 2001). In 2002, Ottawa continued to drive most of Ontario's VC activity, with 57 percent ($735 million) of the province's investments taking place there. Ottawa's dominant position is rooted in the region's strong focus on information technology, which attracted most of the foreign VC over the past few years.

The most active Canadian and foreign investors, in terms of number of companies financed in Ontario in 2002, included such Canadian investors as VenGrowth Capital Partners, Covington Capital Corporation, the BDC, Skylon Capital Corp., RoyNat Capital Inc., Genesys Capital Partners, Lawrence & Company, Ventures West Management Inc., Royal Bank Capital Partners, and Best Investment counsel. It also included foreign investors: VIMAC, Kodiak Venture Partners, Technology Crossover Ventures, Flagship Ventures, Menlo Ventures, Newbury Ventures, Morgenthaler Ventures, JK&B Capital, Synopsys, and Glynn Capital Management.

For the first nine months of 2003, Ontario lost its lead in total investment to Quebec. Indeed, Ontario-based firms attracted 39 percent of total investments (or $362 million). Most of these investments were concentrated in Ottawa and Toronto, which attracted 43 percent and 42 percent of total VC (or $156 million and $153 million), respectively. While the first three quarters of 2003 suggested a significant decline in investment in Ottawa, the third quarter regained activity and saw foreign investors return, sending positive signals for the fourth quarter of 2003.

Sectoral focus — information technology industries are driving Ontario's venture capital activity

Despite a precipitous decline in overall VC investment in Canada and the U.S. (particularly in the information technology sector), in recent years an increasing proportion of Ontario's VC investment capital has been generated by the information technology sector, the exception being the first six months of 2003. To confirm this, the following are some trends related to sectoral investments in Ontario.

• Information technology — Information technology firms attracted a 77-percent average share of total Ontario VC investments from 1996 to 2002; this trend increased to 87 percent in 2001 and 81 percent in 2002. The rising share of information technology reflects both the growth in foreign VC investments in Ontario's information technology sector and the decline in life sciences investment, discussed below. Within Ontario, information technology industries capture most of the province's VC investments. Nationally, Ontario also attracts most of Canada's information technology investments. In fact, Ontario attracted an average of 66 percent of all information technology VC investments from 1996 to 2002; this increased to 68 percent ($1.8 billion) in 2001 and fell to 66 percent ($1 billion) in 2002.
• Life sciences — Life sciences' importance in Ontario has faded in recent years. In fact, between 1996 and 2002, life sciences' average share of Ontario's VC has consistently fallen below the average share of several provinces, and has been falling significantly in recent years, even as the amounts invested rose through to 2000. The value of life sciences VC investments in Ontario has fallen from $248 million in 2000 to $158 million in 2001 and $134 million in 2002. This decline has significantly affected the position of the life sciences sector within Ontario. From 1996 to 2002, the average share of Ontario's VC investments in life sciences was 10 percent. This share has fluctuated in recent years, from 11 percent in 1999 to 7 percent in 2000, 8 percent in 2001, and 10 percent in 2002, but has remained far below the 1996–2002 national average for the life sciences sector, which was 19 percent of total VC investments.

This relative decline in Ontario progressed as life sciences investment revived in 2001 and 2002 across North America (see Section 5) and as Ontario saw significant increases in public and private investment in life sciences, health care and research. A detailed review of regional factors for this discrepancy may be warranted.

Foreign investment: Ontario is attracting the majority

Another distinctive recent regional trend is Ontario's disproportionate share of foreign capital. For example, in 2002, Ontario captured 84 percent of total foreign VC investment, compared to 8 percent in Quebec, 6 percent in B.C. and 2 percent in Alberta.^{Footnote 76} Furthermore, with VC investments declining in 2001 and 2002, foreign investors' share of Ontario's total investments rose to 38 percent and 42 percent, respectively, compared to national levels of 29 percent and 26 percent.

The increase in disbursement dollars and market share were not limited to Ontario. In fact, foreign investors have increased from being 3 percent of Canadian VC investment in 1996 to 26 percent in 2002. While the flow of foreign VC has slowed in 2002, a pattern mirrored by other investor types, Canada (particularly Ontario) seems to have enjoyed a comparative advantage in attracting foreign VC investors in this period of stock market weakness and investment reductions. More details on trends in investor type are presented in Section 7.

While foreign investment in the Canadian VC market is undoubtedly a positive signal, we need to better understand the impact of this trend on Ontario's investment climate. For example, who are the investors and what they are investing in; why are they increasingly interested in Canada; and how are they contributing to business growth, innovation and economic development? Of particular interest is whether such investments are more likely to result in foreign acquisition and offshore product development and marketing. These issues are currently being reviewed and analyzed by Industry Canada, PricewaterhouseCoopers and Macdonald & Associates Limited. This analysis should produce useful results in the winter of 2004.

6.2.2 Quebec

1996–2002 overall trends and analysis: Quebec venture capital investments are characterized by more smaller venture capital transactions, a strong focus on biotechnology, and relatively little foreign investment

VC investment in Quebec increased 123 percent from 1996 to 2002 (from $323 million to $722 million). This performance was comparable to the growth in Ontario (a 165-percent increase, from $487 million to $1.3 billion) and B.C. (a 134-percent increase from $107 million to $251 million). As a result, from 1996 to 2002 Quebec was second, with a 31-percent average share of total VC investments (26 percent in 2001 and 29 percent in 2002), which is slightly higher than Quebec's share of KBI firms (20 percent) and GDP (21 percent) in 2001.

As well, Quebec dominated all regions by averaging 48 percent of total VC financings since 1996 (compared to 30 percent in Ontario and 9 percent in B.C.). This increased market share may be explained by Quebec having a 50-percent growth in VC deals between 1996 and 2002, from 269 transactions in 1996 to 404 in 2002, which is the nation's highest such increase.

Figure 37: Quebec Venture Capital Activity Trends, 1996–2002

However, with more financings and a lower share of total VC investment, Quebec's average deal size over 1996–2002 was $1.7 million. This was lower than the national average of $2.7 million, and well below the averages of $4.6 million in Ontario, $3.3 million in B.C., and $2.7 million in Alberta.

In terms of the number of VC funds, Quebec's 77 funds ranked second behind Ontario's 113 funds, and represented 27 percent of funds in Canada in 2002 (consistent with its 31-percent average share of VC investments from 1996 to 2002). In fact, the number of active VC funds increased significantly in Quebec, from 41 in 1996 to 77 in 2002, which was a 53-percent increase.

Montréal drove Quebec venture capital activity between 1996 and 2002

Quebec's VC activity has been highly concentrated in the Montréal area, which captured an average of 70 percent of Quebec's investments from 1996 to 2002. Just as Ottawa's information technology cluster drove Ontario's VC performance, life sciences in Montréal played a critical role in the recent strength of Quebec VC activity. Investments in Montréal increased by 124 percent from 1996 to 2002, from $236 million to $530 million (and peaked at $1.1 billion in 2000). The average deal size in Montréal over the period was $2 million, slightly higher than that in Quebec overall ($1.6 million) but lower than the national average of $2.7 million. This seems to support biotechnology firms' concerns over the shortage of large amounts of capital.

Recent situation: Quebec remains very strong in 2002 and the first nine months of 2003

Quebec's overall VC activity declined in both 2001 and 2002. In total, 404 financings, for $722 million were negotiated in 2002 (compared to the 434 financings worth $984 million concluded in 2001). While Quebec has generated less VC investment than Ontario, the number of transactions — primarily small and mid-sized deals — has remained consistently higher. Furthermore, in the first nine months of 2003, Quebec took the lead in both investment and number of companies financed, with $411 million invested in 262 companies (compared to $362 million in 121 firms in Ontario).

However, the average deal size in Quebec continued to decline in 2002 and 2003, from $2.3 million in 2001 to $1.8 million in 2002 and only $1.4 million in the first three quarters of 2003. This is well below the national averages of $3.9 million in 2001, $3 million in 2002, and $1.8 million in the first nine months of 2003.

In 2002, the most active Canadian investors in terms of the number of companies financed in Quebec, were Quebec-based funds: the FTQ, CDP Capital, Desjardins Venture Capital, Innovatech Montréal, Innovatech Québec et Chaudière-Appalaches, FondAction, CDP Capital — Technology Ventures, Fonds régional de solidarité FTQ, the BDC, and Innovatech sud du Québec. Foreign investors active in Quebec in 2002 were Vertex Management, Seaflower Ventures, Advent International Corporation, Schneider Electric Ventures, The Artemis Group, ProQuest Investments, IDEC Pharmaceuticals Corporation, Shire Pharmaceuticals Group, BioFund of Finland, and BayTech Venture Capital.

Sectoral focus: despite a strong life sciences sector, information technology leads venture capital investments in Quebec

Quebec's life sciences companies, especially its biopharmaceutical sector, show interesting strength. This sector accounted for 74 percent of Quebec's life sciences activity in 2001 and 62 percent in 2002. Quebec captured an average of 40 percent of total Canadian life sciences investments between 1996 and 2002. Quebec's traditional firms also captured an average of 44 percent of Canada's traditional sector investments, while information technology firms came third, with 21 percent of Canadian information technology investments over the same period.

Even though Quebec leads life sciences VC investment in Canada, and is attracting much of Canada's traditional-sector investments, within the province the information technology sector leads Quebec's VC investments, averaging 39 percent of provincial disbursements from 1996 to 2002 (compared to 33 percent for the traditional sector, 24 percent for the life sciences sector, and 4 percent for the "other technology" sector).

Foreign investments: Quebec firms attract less venture capital investment from foreign sources

While Quebec has performed relatively well in total VC activity since 1996, with an average of 31 percent of total VC investments in Canada, it has not been able to attract many foreign VC investors. In fact, Quebec captured only 7.5 percent of the total amount invested by foreigners in Canada in 2002 (and 8.5 percent in 2001). This is significantly lower than its average share of total VC activity in Canada (31 percent).

Moreover, in recent years, foreign investment has slowed in Quebec more drastically than in the rest of Canada. Amounts invested in Quebec fell 47 percent, from $93 million in 2001 to $49 million in 2002, while, in Canada overall, foreign investment fell by 40 percent. This lower foreign VC investment in Quebec is significant, since foreign investment has been an increasing source of capital in Canada and will likely continue to be important to the future development of the Canadian VC industry.

A number of structural factors may explain why foreign VC investors have shown less interest in Quebec firms.

• Foreign investors tend to focus on information technology, particularly communication and networking sectors, which tend to be concentrated in the Ottawa Valley. According to Macdonald & Associates Limited, information technology investments represented more than 86 percent of total foreign VC investment in Canada in 2002. In fact, of the $438 million disbursed by foreign investors in information technology in 2002, communications and networking accounted for 60 percent, 18 percent was directed towards semiconductors, software accounted for 14 percent, computer hardware attracted 6 percent, and Internet sectors received 3 percent. This strong focus on information technology may be one explanation for Quebec's lower share of foreign VC investments, and Quebec's strong focus on life sciences may obscure the province's information technology companies.
• Quebec's VC market tends to conclude more VC transactions, and these deals tend to be smaller. Given the size of U.S. VC funds and the average deal size in the U.S., Quebec may interest foreign investors. However, foreign investors are relatively new to the Canadian VC market. According to Macdonald & Associates Limited, new and growing firms in Quebec, particularly those in biotechnology, should eventually attract foreign VC.
• The Quebec government is more involved in the VC market, creating Innovatechs, the CDP and the Société générale de financement du Québec (SGF). This may discourage foreign investors. Hubert Manseau (President, Innovatech Montréal) has argued that Innovatech may have replaced private VC players and made private foreign investors less willing to invest in Quebec. As well, Quebec's public institutional players may take a more active role in the seed and start-ups phases, replacing or crowding out private sector VC players. As a result, Quebec's public institutions tend to avoid early and expansion financings, where the capital costs involved may be prohibitive. Furthermore, players such as the Fonds de solidarité des travailleurs du Québec have social missions that may limit their capacity to syndicate with U.S. private players, particularly at the expansion financing stage. However, the new provincial Liberal government's comprehensive review of existing programs and institutions may affect the government's participation in the VC market.

Evidently, more information on foreign VC investors' characteristics and investment criteria would help explain the lower level of foreign investment in Quebec. The growing importance of foreign investors (and private investors) as a potential source of funding makes this a significant issue for Quebec, one that Quebec's Réseau Capital has recognized as a key priority for the growth of Quebec's VC market.

6.2.3 British Columbia

1996–2002 overall trends and analysis: modest growth of venture capital activity

Firms based in B.C. experienced modest but constantly growing VC investment over the past seven years, with B.C.'s VC investment increasing 134 percent, from $107 million in 1996 to $251 million in 2002. This growth is comparable to the overall Canadian growth of 139 percent, resulting in a relatively constant average market share of 11 percent of total VC investment from 1996 to 2002 (ranging from 10 percent in 1996 to 14 percent in 2001 and back to 10 percent in 2002). This was just slightly lower than B.C.'s 13-percent share of KBI firms and 13 percent of GDP in 2001.

A strong focus on information technology (which had a 42-percent average share of B.C.'s investments from 1996 to 2002) a nd life sciences (35 percent) pushed the average deal size in B.C. to $3.3 million, which was higher than the national average of $2.7 million. This higher average deal size is rooted in B.C.'s strong focus on large deals, which have captured a growing share of total investments, from 50 percent in 1996 to 74 percent in 2002. The number of B.C. VC funds grew considerably between 1996 and 2002, from 19 in 1996 to 43 in 2002, for a 126-percent increase. By 2002, B.C. was housing 15 percent of Canada's VC funds.

Figure 38: British Columbia Venture Capital Activity Trends, 1996–2002

Vancouver has been responsible for 94 percent of venture capital activity since 1996

VC activity in B.C. increased by 134 percent between 1996 and 2002, from $97 million to $226 million. This activity was mostly concentrated in Vancouver, which attracted an average annual share of 94 percent of investments over the period (and 90 percent, or $266 million, in 2002). Investment in Vancouver was strongly focussed on information technology and life sciences, which averaged 45 percent and 35 percent of provincial VC, respectively, between 1996 and 2002.

Recent situation: stronger decline

In 2002, B.C.'s VC activity declined by 51 percent (compared to a decline of 35 percent in Canada) from $514 million in 2001 to $251 million. As a result, B.C.'s share of total VC investment declined to10 percent in 2002. This was lower than the 14 percent in 2001 and slightly lower than its average share of 11 percent between 1996 and 2002.

However, when we compared the VC activity level to B.C.'s share of KBI firms and GDP, the proportion was similar. In 2001, B.C. captured 14 percent of total VC activity, 13 percent of KBI firms and 13 percent of GDP. There was a similar decline in VC transactions. B.C.'s share of total deals reached 10 percent (80 deals) in 2002 and 11 percent (110 deals) in 2001, for an average of 9 percent between 1996 and 2002.

In 2002, the most active Canadian investors in B.C. were GrowthWorks, the BDC, Ventures West Management Inc., Discovery Capital Corporation, FutureFund Capital (VCC) Corp., Canadian Medical Discovery Corporation, Management Buyout, Smart Seed Equity Inc., Greenstone Venture Partners, and RoyNat Capital Inc. In terms of foreign investors, the most active ones were Kinetic Capital Partners, Pictet & Cie, Encompass Ventures, The Photonics Fund, Intel Capital, Trian Investments, Sylvan Ventures, West STEAG Partners, The Claridge/Andell Group, and BTexact Technologies.

In the first nine months of 2003, B.C.'s VC activity kept declining to only 7 percent of total VC investments and 7 percent of deals in Canada. This lower VC activity level had some impact on the average deal size in B.C., which declined from $4.7 million in 2001 to $3.1 million in 2002 and $1.7 million in the first nine months of 2003, which was well in line with the $3 million average deal size in Canada in 2002 (which was $1.8 million in the first nine months of 2003).

Sectoral focus: relatively balanced sectoral distribution

The average distribution of VC investment in B.C. from 1996 to 2002 was balanced between information technology (with an average of 42 percent of the province's investments) and life sciences (with an average of 35 percent of total life science investments). However, when compared to the sectoral distribution of VC investment in Canada, B.C. more strongly emphasized life sciences (19 percent nationally compared to 35 percent in B.C.).

However, despite the importance of life sciences in overall B.C. investment activity, the overall Canadian distribution of life sciences VC investment between 1996 and 2002 reveals that B.C. has not attracted the majority of life sciences investment in Canada. B.C. ranked third, with an average of 22 percent of Canada's life sciences investments, behind Quebec (40 percent) and Ontario (30 percent). From 1996 to 2002, investment in B.C.'s traditional sector represented a smaller proportion of provincial VC than was the case in any other province or region. Traditional-sector firms only attracted an average of 13 percent of the province's VC investment, compared to 24 percent of Canada's VC investments.

6.2.4 Prairies

1996–2002 overall trends: significant growth of venture capital activity, but still behind compared to its share of total gross domestic product and knowledge-based industry firms

Between 1996 and 2002, VC investment in the Prairies grew by 93 percent, from $82 million to $159 million. However, the Prairies' share of total VC declined by 19 percent. Less VC investment has meant that the Prairies' average share of total VC activity (7 percent from 1996 to 2002, and 6 percent in 2002) has been much lower than its share of KBI firms (19 percent) and GDP (19 percent) in 2001. From 1996 to 2002, the average deal size of $578 000 in the Prairies was considerably lower than the national average of $2.7 million.

The Prairies' strong focus on traditional sectors (particularly in Manitoba and Saskatchewan) may account for the region's lower VC investment, but a recent study concluded that it is not true that technology clusters can only flourish where ample risk capital is available. Ottawa's developing technology cluster, for example, showed remarkable early growth without VC.^{Footnote 77}

On the other hand, there are many more VC funds in all three provinces now than in 1996. Alberta has 19 VC funds, compared to 5 in 1996 (an increase of 263 percent); Manitoba has 7 now, compared to 3 in 1996 (an increase of 43 percent); and Saskatchewan has 12 funds, compared to 7 in 1996 (an increase of 58 percent). Overall, 38 VC funds are in the Prairies, which is 13 percent of the Canadian total of 282 VC funds.

Figure 39: Prairies Venture Capital Activity Trends, 1996–2002

Recent situation: relatively smaller decline of activity in 2002 and 2003

After peaking at $309 million in 2000, VC investments in the Prairies fell to $146 million in 2001, but recovered to $159 million in 2002 (roughly equivalent to investment levels in 1999) and to $55 million in the first nine months of 2003. The Prairies' share of total VC invested in Canada increased from 4 percent in 2001 to 6 percent in 2002 (and 6 percent in the first three quarters of 2003). However, the number of deals declined 13 percent, from 101 in 2001 to 88 in 2002 (and 61 in 2003).

In 2002, VC investors in the Prairies preferred larger deals and concluded fewer transactions than had been the case in previous years. This is reflected in the 29-percent increase in average deal size, from $1.4 million in 2001 to $1.8 million in 2002 (except for the first nine months of 2003, which saw a significant decline in deal size to $0.9 million).

Sectoral focus: strong focus on the traditional sector

A key sectoral trend in the Prairies has been the importance of the traditional sector, which averaged 46 percent of the region's VC investments from 1996 to 2002. In Canada, traditional sectors averaged 24 percent of total investment between 1996 and 2002. This strong focus on the traditional sector was most acute in Saskatchewan and Manitoba, where agriculture has traditionally accounted for significant amounts of regional economic activity.

Compared to other provinces and regions, the Prairies have had a low share of information technology and life sciences VC investments since 1996, capturing only 3 percent and 6 percent of total VC investments in each, respectively. Within the Prairies, information technology and life sciences attracted an average share of provincial VC of 20 percent and 22 percent, respectively, between 1996 and 2002.

The sectoral distribution of VC activity in the Prairies may explain this region's historical difficulty in attracting VC, since investors have recently focussed on information technology. However, new technology centres are slowly being established in some regions, such as nanotechnology in Edmonton and agri-biotechnology in Saskatoon. Promoting these nascent centres may raise awareness of them among venture capitalists and may, in turn, attract more VC investment.

Other possible explanations include the absence of tax credits for LSVCCs in Alberta, the strong mezzanine market in Saskatchewan, the lack of a critical mass of potential VC opportunities, and information asymmetry between entrepreneurs and VC investors. Further investigation would help determine why the Prairies' share of VC activity is disproportionately low compared to its share of KBI firms and GDP. The detailed analysis of government programs in these regions presented in Part III may also help to identify other potential reasons for the Prairies' perennially low levels of VC investment.

Provincial overview

Following is a short summary of VC activity in Alberta, Saskatchewan and Manitoba between 1996 and 2002. As explained previously, broad fluctuations of percentages are rooted in the relatively small base of VC activity.

Alberta

• Overall trends — Alberta has driven the region's VC investments, averaging 70 percent of the Prairies' VC investments over the past three years. As well, the average deal size in Alberta ($2.7 million) is higher than the average deal size across the Prairies ($1.8  million).
• Sectoral focus — Investment patterns in Alberta mirrored national growth trends from 1996 to 2002. VC activity increased by 138 percent overall, the number of transactions grew 60 percent (from 55 in 1996 to 88 in 2002), and all sectors showed solid growth.
  
  
  • Life sciences attracted 18 percent ($6.5 million) of the VC invested in Alberta in 1996. While this share declined to 13 percent in 2002, the total VC invested in life sciences in Alberta increased to $18 million, for a growth of 176 percent.
  • Traditional sectors followed a similar trend between 1996 and 2002. While the share of provincial allotments decreased from 65  percent to 41 percent, the amount invested increased by 110 percent, from $24 million to $49 million.
  • Information technology investment's drastic growth can be credited for much of the province's increase in VC activity. In 1996, Alberta's information technology sectors captured $3  million, or 8.3 percent of provincial VC. In 2002 the information technology sector attracted 40 percent of provincial disbursements, totalling $48  million, an increase of 1513 percent. While all sectors in the Prairies showed strong growth from 1996 to 2002, information technology investment clearly drove the region's VC activity.

• Regional focus &mdas h; Within Alberta, the bulk of VC activity was centred on clusters in Calgary and Edmonton. In 1996, Calgary ($15 million) and Edmonton ($18 million) attracted comparable amounts of VC financing. Between 1996 and 2002, investment in Calgary and Edmonton increased by 262 percent and 63 percent, respectively. In 1996, 19 percent ($1 million) of the province's life sciences investment was directed towards Calgary, while 81 percent ($5 million) went to Edmonton. Calgary attracted 67 percent ($2 million) of the province's information technology investments, while 33 percent ($980 000) was invested in Edmonton, in 1996. Between 1996 and 2002, the number of deals in Calgary grew by 129 percent, while the number of financings in Edmonton fell 10 percent.
  
  In 2002, Calgary attracted $55 million and Edmonton captured $29 million in VC. By 2002, Calgary's share of provincial investments in life sciences, other technology and information technology investments had increased to 53 percent ($6 million), 47 percent ($1 million) and 86 percent ($39 million), respectively. Over the same period, traditional-sector investment declined in Calgary, from $12 million to $8 million, and gradually shifted to Edmonton.
  
  The information technology sector drove Alberta's growth over this period and, by 2002, 86 percent of the province's information technology investment was invested in Calgary. The increase in VC activity in Alberta was powered by an infusion of information technology financing in Calgary. Between 1996 and 2002, information technology investment in Calgary grew from $2 million to $39 million, a steep increase of 1839 percent. Life sciences investments also showed strong VC activity from 1996 to 2002, increasing by 389 percent ($1 million to $6 million).
• Investor profile — The most active Canadian investors in Alberta in 2002 included AVAC Ltd., Ontario Municipal Employees Retirement System, Almasa Capital Inc., RoyNat Capital, BMO Capital Corporation, the BDC, Jefferson Partners, Pangaea Ventures Ltd., FCC Ventures, and MM Venture Partners.

Manitoba

• Overall trends — Manitoba attracted just 2 percent of total VC activity from 1996 to 2002. Moreover, the recent market downturn seems to have badly hurt VCC deal size in Manitoba. From 1996 to 2002, VC investments in Manitoba declined 10 percent, from $30 million to $27 million, while the number of financings increased 40 percent, from 18 to 35. These two trends resulted in a 54-percent drop in the average deal size, which settled at $1.4 million.
• Sectoral focus — Given the small amount of VC investment in this province, a few large deals in one sector can change the overall distribution of investment, so it is hard to isolate which factors contribute to growth or decline. However, Manitoba's increasing difficulty in attracting VC investments may be rooted in its strong reliance on traditional industries, as 89 percent of total VC investment in 2002 went to high technology sectors. In fact, 68 percent of Manitoba's VC investments were directed toward traditional sectors from 1996 to 2002, which may explain the decline in the amount invested in Manitoba over the past few years. However, in recent years, Manitoba has been seeing VC investments in the traditional sector drop from 37 percent (or $16 million) in 2001 to 21 percent (or $6 million) in 2002. There is also a trend toward investment in the life sciences sectors, which attracted 41 percent ($18 million) of the province's investments in 2001 but 54 percent ($15 million) in 2002. As a result, between 1996 and 2002, this sector averaged 20 percent of provincial disbursals.

• Investor profile — The most active Canadian investors in Manitoba in 2002 included Crocus Investment Fund, ENSIS Management Inc., Lombard Life Sciences, Manitoba Capital Fund, the BDC, Lawrence & Company, TD Capital, Manitoba Science and Technology Fund, Richardson Ventures Inc., and ATS Automation Tooling Systems.

Saskatchewan

• Overall trends — Saskatchewan averaged 2 percent of total VC investment between 1996 and 2002, so it is not a major player in the Canadian VC industry. Nonetheless, VC investment in Saskatchewan increased 183 percent, from $17 million in 1996 to $47 million in 2002, while the number of financings increased 32 percent, from 19 to 25, so the average deal size increased by 115 percent, averaging $1.6 million between 1996 and 2002.
• Sectoral focus — As in Manitoba, the small base of VC investment makes it difficult to know which factors contribute to the growth or decline of VC activity or to fluctuations in sectoral activity in any given year. However, from 1996 to 2002, Saskatchewan's traditional sector captured an average share of 60 percent of total VC investments, and captured 54 percent ($25 million) in 2002. The life sciences sector is important in Saskatchewan, attracting, on average, 29 percent of provincial VC since 1996. Information technology has not historically attracted much investment, averaging 7 percent of it in Saskatchewan between 1996 and 2002. VC investments in other technology firms (e.g. energy and environment) captured 29 percent (or $5 million) of investments in 2002, suggesting interesting developments for the future.

• Investor profile — The top Canadian investors, in terms of amounts invested in 2002, were Crown Capital Partners Inc., Crown Investments Corporation of Saskatchewan, Prairie Financial Management, Westcap Management, GrowthWorks, Management Buyout, the BDC, Crocus Investment Fund, and Foragen Technologies Management Inc.

6.2.5 Atlantic Canada

1996–2002 overall trends and analysis: modest growth of venture capital activity, but relatively lower share of total venture capital investments

From 1996 to 2002, Atlantic Canada attracted a 2-percent average share of total VC investment in Canada. This proportion was considerably lower than the region's share of GDP (6 percent in 2001) and is slightly lower than the region's 3-percent share of KBI firms in 2001, so we should see what kinds of firms are currently in Atlantic Canada, particularly in its information technology and life sciences sectors. This could show whether this lower share is related either to the region's sectoral activity or to location or (most likely) to both. This being said, there are more positive observations.

• VC investments have grown 33 percent from 1996 to 2002, from $33 million to $44 million.
• The number of VC deals fell by 13 percent, from 23 in 1996 to 20 in 2002.
• The average deal was smaller than the national average, but has increased by 52 percent, from $1.4 million to $2.2 million between 1996 and 2002, with an average deal size of $1.7 million.
• The number of VC funds has more than doubled, from 5 in 1996 to 11 in 2002.

Figure 40: Atlantic Venture Capital Activity Trends, 1996–2002

Recent situation: a relatively smaller decline of venture capital activity level in 2002 and 2003

Atlantic Canada, on average, attracted just 2 percent of total investment in 2002. However, the region did not experience as steep a decline in VC investments as did the rest of the country, just 10 percent in Atlantic Canada (from $49 million in 2001 to $44 million in 2002), compared to 35 percent nationally. This trend, combined with the decrease in deals (from 28 to 20) between 2001 and 2002, drove the average deal size to $2.2 million in 2002. For the first nine months of 2003, the region saw just 3 percent of total investment (or $31 million in 10 companies).

The most active Canadian investors in Atlantic Canada in 2002 were Workers Investment Fund Inc., ACF Equity Atlantic Incorporated, the BDC, InNOVAcorp, Nova Scotia Business Inc., Fullarton Capital Corporation, Export Development Canada, Management Buyout, Skypoint Capital, and MedInnova Partners Inc. There were no foreign investors in 2002.

Sectoral focus: strong focus on information technology and traditional sectors

Just as Atlantic Canada captured little national VC investment from 1996 to 2002, it also captured a small share of Canada's information technology and traditional sector, just an average of 3 percent of total VC investment and 2 percent of total life sciences investment. These trends confirm that Atlantic Canada has little VC activity and suggest a relative imbalance compared to the regional sectoral VC activity trends.

While the traditional sectors continue to attract a significant 28-percent share of Atlantic Canada VC activity, information technology firms attracted the most, averaging 51 percent of total Atlantic VC investments between 1996 and 2002. Life sciences-sector firms came in third, with 21 percent of the region's VC investments. To better understand this low level of activity and the challenges faced by information technology and life sciences firms in this region, we should most closely compare VC activity trends to the regional sectoral activity and types of firms. Doing so will help us find ways to further encourage VC investment in the region.

6.3 International Comparison

6.3.1 Comparison: Canada–United States

Regional concentration of venture capital activity also observed in the United States

VC investment may be concentrated in a few regions in Canada, but regional concentration is more pronounced in the United States, particularly in California, New York, Massachusetts and the Southeast. These regions attracted 72 percent of total VC investments in 2002, a much higher percentage than their 39-percent share of GDP in 2002. Other regions, such as the Midwest and Northeast U.S., have a higher share of GDP, but attract little VC activity. As a result, when compared to Canada (see Figure 41), more U.S. regions get little attention from VC investors.

Figure 41: Regional Distribution of Venture Capital Investment and Gross Domestic Product in the United States, 2002

6.3.2 Comparison: Canada–Organisation for Economic Co-operation and Development Countries

Like Canada, OECD countries are marked by regional concentrations that have persisted through the years. Regional clustering of VC investment is common across OECD nations, and tends to centre on areas with high technology, manufacturing and services close to financial centres, such as Silicon Valley and Massachusetts in the U.S., and London in the U.K. This illustrates the difficulty in achieving regional balance in VC activity in most countries. VC goes where there is a critical mass of high-growth-potential firms, and where entrepreneurial culture flourishes.

^{Footnote 75} Claude Mason et al., The Role of Venture Capital in the Development of High Technology Clusters: The Case of Ottawa (United Kingdom: Hunter Centre for Entrepreneurship, 2002).

^{Footnote 76} Manitoba, Saskatchewan and Atlantic Canada did not receive any foreign VC investment in 2002.

^{Footnote 77} Claude Mason et al., The Role of Venture Capital in the Development of High Technology Clusters: The Case of Ottawa (United Kingdom: Hunter Centre for Entrepreneurship, 2002).