Background

Financing high-growth SMEs identified as a key to Canada's innovation performance. KBI firms' difficulties in accessing risk capital represent major challenges and impediments to growth.

Angel investment and VC play a critical role by financing high-growth-potential firms.

Goals

To provide a realistic assessment of the state of VC in Canada, its current role, and its potential impact on Canada's economic policy goals.

To answer four key questions:

1. What is the state of VC activity in Canada? What key trends, strengths and weaknesses characterize the VC industry?
2. What is the state of current government action related to VC? Are the approaches to VC issues consistent across the government?
3. Where are the gaps in the market? How do bottlenecks in the VC industry dampen the development, innovation and growth of Canadian SMEs?
4. How can the policy environment encourage the continued growth and development of Canadian SMEs? How can this environment improve Canada's innovation performance, create jobs and wealth, and encourage these firms to remain Canadian?

What is VC?

VC is long-term, hands-on equity investment made by professional investors in new, young and rapidly growing companies in high technology sectors, such as information technology and life sciences.

VC is expensive and time consuming for entrepreneurs.

Only a few firms have the potential to attract VC interest and a minority will secure VC (677 in 2002 over 1.8 million SMEs compared to 2495 VC-backed firms in the U.S. over 16 million SMEs).

VC is active investment — Venture capitalists hold a large ownership position, monitor and control the destiny of the firm, provide advice, help recruit management, analyze market opportunities and provide access to professionals.

VC is risky and transitional investment — Venture capitalists assume great risks based on performance projections of new concepts. Once rapid growth is achieved, venture capitalists liquidate capital to recycle it into new VC investments. VC is often a bridge between angel investment and initial public offerings.

VC is often made through syndicates and in several rounds of financing depending on the stage of the firms and the achievement of predetermined performance milestones.

Characteristics of Firms Financed by VC

High commitment from entrepreneurs in terms of their own money being invested in their firms.

High-growth and high-returns potentials (35-40 percent).

Strong and experienced management team.

Willing to give up a share of ownership (about 30 percent and up to a maximum of 50 percent)

Solid market potential (international orientation, innovative technology, etc.).

High R&D spending.

Concentrated in information technology, life sciences and other technology sectors.

Financing Context for VC

VC is only one financing option for Canadian SMEs. Other options include debt financing, leasing, quasi-equity (patient capital), love money, angel investment, VC and public market financing.

Financing needs of a firm depend on type of business, growth prospects, stage of development and market conditions.

While debt financing is the most commonly used form of financing, risk capital is more appropriate for fast-growth and KBI firms as it is more flexible and more patient.

VC is more appropriate for start-up firms and firms in the early and expansion stages. As the firm expands and matures, initial public offerings and mezzanine financing provides adequate amounts of capital and exit avenues for venture capitalists.

As a result, there is a strong interdependence between each of the financing markets — factors that affect angel investments and IPO markets will likely affect the availability of VC and vice versa.

Significant economic impacts through the financing of a small number of high-growth, innovative companies that can make significant contributions to economic growth and new wealth creation in Canada.

This impact comes in the form of the financial support provided by venture capitalists and added-value services such as hands-on technical, managerial and strategic expertise that help improve the firms' chances of success.

For these reasons, VC plays a crucial role in financing innovative, high-growth-potential Canadian companies.

To answer the question:

• What is the state of VC activity in Canada? What key trends, strengths and weaknesses characterize the VC industry?

VC industry in Canada is dynamic and experienced solid growth between 1996 and 2002:

• investments increased by 139 percent from $1 billion to $2.5 billion with a peak at $5.8 billion in 2000;
• number of VC-backed firms grew by 38 percent from 490 to 677, with 1006 in 2000;
• average deal size reached $3.0 million in 2002, a 72 percent increase;
• 152 new funds have been created since 1996, bringing the total to 282 in 2002, a 117 percent increase;
• new capital raised grew by 88 percent from $1.7 billion in 1996 to $3.2 billion in 2002, with $4.6 billion in 2001;
• capital available for investment reached $7.4 billion in 2002, a 27 percent increase from $2.5 billion in 1996; and
• capital under management grew by 217 percent from $7.1 billion in 1996 to $22.5 billion in 2002.

Despite slower activity level since 2001, the Canadian VC industry has remained relatively solid and has outperformed expectations.

Venture capitalists in Canada remain positive for 2003 with improved confidence in general economic outlook, exit valuations and continued accumulation of available funds.

Structure of VC Industry

VC investors organize VC firms (through private partnerships) that establish one or more VC funds to raise capital and then invest it in SMEs based on pre-established criteria.

The number of funds, their ability to raise capital and their investment preferences have influenced the evolution of the Canadian VC industry and will continue to do so in the future.

During 1996–2002, the number of VC firms increased by 92 percent (from 95 to 182) and the number of VC funds increased by 117 percent (from 130 to 282).

Increasing trends toward specialization of VC funds (e.g. information technology and life sciences) and away from geographic concentration in central Canada (e.g. number of funds increased in all regions between 1996 and 2002).

Both Canadian and U.S. VC investors tend to invest through syndicates (i.e. in partnership with other VC investors) to share the burdens of due diligence, capital contribution and risk. Syndication ratio was 2.2 investors per financing in 2002 in Canada and 2.9 in the U.S.

Canada's VC industry was more diversified and stable than its American counterpart between 1996 and 2002:

• Canadian VC investments increased by 139 percent compared to 78 percent in the U.S.;
• number of financings grew by 39 percent in Canada compared to 9 percent in the U.S.;
• number of firms financed increased by 38 percent in Canada against 17 percent in the U.S.;
• average deal size grew by 72 percent in Canada compared to 59 percent in the U.S.; and
• capital under management grew by 217 percent in Canada against 496 percent in the U.S.

The comparative strength of the Canadian VC industry can be explained by the recent technology burst (which was more pronounced in the U.S.) and by the fact that the Canadian industry is relatively young compared to that in the U.S.

However, the comparison of VC investment and VC under management as percentages of GDP reveals that the Canadian VC market has been less volatile than the U.S. VC market and has averaged comparable performance between 1990 and 2001.

As a result, Canadian VC investments now stand at 7 percent of the value of U.S. VC investments and Canadian VC investment per capita reached 83 percent ($99 per person) of the corresponding U.S. figure ($119), approaching the Innovation Strategy target of raising VC investment per capita to U.S. levels by 2010.

Canada ranked among leading OECD countries in terms of VC investments as a percentage of GDP and second for early-stage and expansion firms as a percentage of GDP.

Caution must be exercised when making international comparisons due to discrepancies in terminology, methodology and definitions.

Due to the significant rise in syndication and the increase in capital raised and invested, the average deal size in Canada grew by 72 percent, from $1.7 million in 1996 to $3.0 million in 2002. The average deal size over the 1996–2002 period was $2.7 million.

This trend toward larger transactions (mostly driven by the growth of deals over $5 million) suggests increasing maturity of the Canadian VC industry in term s of capital raised and in access to growth capital for high technology firms, as well as the general state of the Canadian economy.

However, it does raise an important policy issue: is this trend the result of a shift in VC investors' interest toward more mature, less risky, larger investments in later-stage firms? If so, what are the impacts on seed and start-up firms seeking smaller VC deals?

Another important issue is that despite this increasing trend toward larger deals, an important gap remains compared to the average deal size in the U.S. and some firms, such as expansion firms and firms in the life sciences sector, may not be able to get sufficient capital to expand or to bring a product to market.

With the emergence of the Canadian VC industry in the early and mid-1990s, new financings increased significantly. However, this trend has shifted to follow-on financing since 1996, and particularly since 2001.

Follow-on investments increased by 362 percent from $391 million in 1996 to $1.8 billion in 2002 (versus an increase of only 1 percent of new financings over the same period from $639 million to $646 million).

The typical ratio between follow-on and new financings was 60:40 over the 1996–2002 period (compared to 74:26 in 2002).

While this can be explained by recent market turmoil and the general decline of VC investment in most countries, it does raise an important issue for policymakers related to the functioning of the VC industry and its ability to finance new and young companies seeking first-time VC financing.

Added to the trends toward larger deals and follow-on financings, the stage of development trends confirm the increasing difficulties facing seed and start-up stage firms in securing small and new VC financing.

While early-stage investments have increased by 255 percent since 1996, from $295 million in 1996 to $1 billion in 2002 and represented 42 percent of total investments in 2002 (and 61 percent in 2001), later-stage investments still dominate VC activity in Canada with 58 percent of total investments (or $1.4 billion).

The typical ratio of early-stage versus later-stage investments was 40:60 for 1996–2002.

Despite the 546 percent increase in seed investments since 1996 (from $15 million in 1996 to $94 million in 2002), firms seeking seed financing continue to experience difficulties in accessing VC with only 4 percent of total VC investments in 2002 going to seed-stage firms (or 9 percent of early-stage investments).

Sectoral VC activity trends since 1996 confirm both the nature of VC, which usually better fits fast-growing and technology firms, and the importance of VC for high technology firms which attracted an average of 80 percent of all VC investments between 1996 and 2002.

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Information Technology — These firms have been driving VC activity (particularly in Ontario) with an average of 53 percent of total VC investments during the 1996–2002 period (and 70 percent and 65 percent in 2001 and 2002). This increased importance of these investments is reflected by 368 percent growth of VC investments in information technology firms from $340 million in 1996 to $1.6 billion in 2002.

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Life Sciences — Despite a constant average share of total VC investments of 19 percent between 1996 and 2002, VC investments in life sciences firms have increased by 103 percent from $228 million to $463 million (with most of this growth occurring in 2000 with $826 million and 2001 with $651 million). Life sciences investments in Canada are concentrated in Quebec and British Columbia.

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Traditional — While VC investments in traditional sectors have declined by 27 percent between 1996 and 2002 — resulting in a decrease of their relative importance to total VC activity — the average share of total VC investments remained higher than that of Life Sciences investments with 24 percent of total investments over the period.

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The increasing importance of high technology firms and their large financing needs may explain the decline in traditional sector investments. VC investments in the traditional sector remained relatively strong in Manitoba and Saskatchewan with an average share of 68 percent and 60 percent of the provinces' investments over 1996–2002.

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Other Technology — While the other technology sectors represented a small average share of total VC activity since 1996 (4 percent of total), the number of financings in these firms increased by 118 percent between 1996 and 2002, which is better growth in the number of deals than in the other sectors.

As seen in other countries (particularly in the U.S.), VC activity in Canada is highly concentrated in a few regions with Ontario (Ottawa), Quebec (Montréal), and British Columbia (Vancouver) attracting the majority of investment. In these three provinces, market patterns are very similar — a dedicated technology-oriented focus.

A number of factors explain this concentration of VC activity: investors' preference for opportunities located within a reasonable distance and for high technology and high-growth-potential firms, which are normally concentrated in a few regions (as suggested by the distribution of KBI firms across regions).

Despite this concentration, a significant increase in VC activity — amount invested, number of financings and number of VC funds — was observed in all provinces and regions over 1996–2002.

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Ontario (Ottawa) is the clear leader of VC activity in Canada with an average share of total VC of 49 percent between 1996 and 2002. VC investments have increased by 165 percent since 1996 from $487 million to $1.3 billion in 2002 (peak at $3.4 billion). Given the strong focus on information technology in Ontario, the average deal size in Ontario was $4.6 million for 1996–2002, higher than the national average of $2.7 million.

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Quebec (Montréal) VC investments are characterized by a higher number of small VC transactions, a strong focus on biotechnology and a relatively low level of foreign VC.

Investments in Quebec increased by 125 percent since 1996 (from $323 million to $722 million), representing an average share of 31 percent of total investment between 1996 and 2002. Quebec dominated all regions in terms of the number of financings with a 48 percent average share of total financing between 1996 and 2002. The number of transactions increased by 50 percent, from 269 in 1996 to 404 in 2002. The average deal size in Quebec was $1.7 million for the 1996–2002 period (and $2.6 million in 2002).

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British Columbia (Vancouver) experienced strong growth in VC activity since 1996, 134 percent from $107 million to $251 million in 2002, with an average share of total VC activity of 11 percent between 1996 and 2002. The average deal size in British Columbia was $3.3 million during the 1996–2002 period, higher than the $2.7 million average in Canada.

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Prairies — Despite an overall 93 percent increase of VC investments in the Prairies from 1996–2002, from $82 million to $159 million, the average share of total investment declined by 19 percent between 1996 and 2002, resulting in an average share of 7 percent for the period (and 6 percent in 2002). The average deal size of $1.8 million was also lower than the national average of $2.7 million, 1996–2002.

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Atlantic Canada attracted a small portion of total VC investments since 1996 with only 2 percent of the total. This share of total VC activity was similar to its share of total KBI firms (3 percent), but lower than the region's share of GDP (6 percent). Total Atlantic investments still grew 33 percent, from $33 million in 1996 to $44 million in 2002. The average deal size, lower than the national average, was $1.7 million for the 1996–2002 period (and $2.2 million in 2002). The number of VC funds more than doubled from 5 in 1996 to 11 in 2002.

While the relative importance of each investor type has varied between 1996 and 2002, LSVCCs and foreign investors clearly drive most of the VC activity in Canada.

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LSVCCs (dominated by a few very large players, such as Vengrowth) had the largest average annual shares of total VC investment in Canada with 22 percent of the market over 1996–2002. However, this period also marked the decline of the LSVCCs' market share from 40 percent in 1996 to 25 percent in 2002. This trend was the result of relatively modest 53 percent growth of LSVCC investments over the period (from $410 million to $627 million in 2002).

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Foreign Investors (mostly from the U.S.) followed closely with an average of 20 percent of the overall VC investments — from just 3 percent in 1996 to 26 percent in 2002 — a 766 percent increase. This was the result of a remarkable 2021 percent increase in foreign investments over the period (from $31 million to $650 million, with a peak at $1.5 billion in 2000).

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Institutional Investors were the third largest players (mostly large public sector pension funds toward the end of the 1996–2002 period) with an average share of 7 percent of total investment. While this represents a 52 percent decline in their market share, from 15 percent in 1996 to 7 percent in 2002, their total investment grew by 15 percent over the period (from $159 million to $182 million).

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Private Independent Funds were fourth with a 17 percent average annual market share over the 1996–2002 period (dropping by 32 percent from 19 percent in 1996 to 13 percent in 2002). Their investments grew by 58 percent over the period from $198 million to $313 million.

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Corporate Funds increased investment by 34 percent over the period (from $108 million to $144 million) capturing an average annual market share of 9 percent (which represents a 40 percent decline from 10 percent in 1996 to 6 percent in 2002).

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Government Funds increased their activity by 433 percent over the 1996–2002 period from $62 million to $329 million with an average annual share of 11 percent.

Investment made by Canadian VC firms outside Canada experienced a remarkable 757 percent growth since 1996 and particularly since 1999 from $62 million in 1996 to $347 million in 1999, to $997 million in 2000, and to $536 million in 2002.

Average deal size of these investments wa s $4.4 million in 2002, higher than the national average deal size of $3 million in 2002. This can be explained by the strong focus on information technology and life sciences and on large deals.

Investment preferences are toward follow-on investments with an average ratio of 60:40 between 1996 and 2002 and 57:43 in 2002; later-stage financings with a typical ratio of 60:40 between 1996 and 2002 and 58:42 in 2002; and information technology and life sciences sectors with 39 percent ($208 million) and 35 percent ($187 million) of total VC in 2002.

These numbers suggest a growing trend toward globalization of the VC market in North America and improved networks between Canadian and American investors.

Strengths

Solid overall growth of Canada's VC market since 1996, despite a shaky economy and difficult market conditions. Compared to the U.S., the Canadian VC industry has demonstrated a more gradual and continuous growth curve since 1990 and has showed more stability since 2001.

Canada is among the leading OECD countries in terms of VC investments as a percentage of GDP, particularly for early-stage financing.

The average deal size, while smaller than in the U.S., has increased significantly since 1996, from $1.7 million to $3 million in 2002.

The early-stage focus of Canadian VC activity in recent years has shown an appetite for higher risks by Canadian venture capitalists. This stronger focus on early-stage investments has not been seen in the U.S.

Trends in sectoral distribution of VC activity since 1996 reinforce the critical importance of VC for high-growth and technology firms — firms that continue to attract the majority of VC activity in Canada and in the U.S. They also support the fact that, because of its nature and characteristics, VC is generally used by a limited number of high-growth-potential firms and, as a result, plays a critical role in Canada's innovation performance.

Despite the concentration of VC activity in Ontario, Quebec and British Columbia, the total pool of VC activity and the number of VC funds have increased significantly across all regions since 1996. This demonstrates a certain level of dynamism, even in provinces and regions that have traditionally been on the outside of the VC community.

The nature and role of different types of VC investors in Canada have evolved in lock step with the overall development of the market over the last 7 years:


Canadian VC investors increased their investments outside the country by 757 percent between 1996 and 2002, with most of this growth occurring since 1999.

Weaknesses
Structure of VC Industry

Smaller size and lower specialization level of Canadian VC funds — The Canadian VC market remains behind the U.S. VC market in terms of maturity and sophistication. Canada has fewer funds (and these are not optimally funded), and probably lacks the expertise and experience required for greater specialization. This hinders the ability of the Canadian VC industry to appropriately fund seed and start-up firms in a number of key industries (e.g. biotechnology). As well, there are impacts on the capacity to support the continuous expansion and growth of mid- and large-sized firms, which usually have higher capital needs.

Too few venture capitalists with management experience and knowledge — A recent study from Industry Canada and Wayne Clendenning (2002) revealed that Canadian venture capitalists (90 Canadian VC investors reviewed) tend to originate in the financial and banking industry and may not have the expertise required to understand or accept the risks related to a specific industry. On the other hand, some other VC firms are highly specialized, but may lack the financial skills required to adequately assess risk. As a result, building strong VC fund managers in Canada appears to be a key element and may support the future growth of the Canadian VC industry.

Lower performance returns in Canada — Recent data published by the CVCA show much lower mid- and long-term performance for Canadian VC funds (with returns of 15.7 percent for 3 years and 13.3 percent for 5 years compared to 49.3 percent and 36 percent in the U.S.). While the returns for one year (as of December 31, 2001) were higher in Canada, these mid- and long-term results raise significant structural challenges for the Canadian VC industry — they may send negative signals about the quality of Canadian investment opportunities. Furthermore, VC investors, who seek to maximize returns, may choose to invest outside Canada, where investment returns are higher.

 

Demand for VC

Lack of "investor-ready" firms — Several structural factors in the Canadian VC market act as brakes on new investment: business plans, market knowledge and managerial acumen are underdeveloped; business owners are unwilling to relinquish managerial control in exchange for liquidity. In fact, the lack of managerial skills is often identified as the major challenge faced by Canadian venture capitalists in finding investment opportunities. Therefore, there is a strong need to improve the managerial skills of Canadian firms so that they can develop to their full potential. This is also important as the lack of good opportunities may result in the constriction of deal flow for future rounds of VC investments. Fostering an environment that ensures a sufficient pool of VC, one that is conducive to the establishment of innovative firms, and one that encourages the commercialization of research, should be the cornerstone of any new policy on VC.

Lack of knowledge about the demand for VC and informal investments — The importance of VC's role in financing high-technology firms cannot be understated. However, VC is only appropriate for a limited number of firms in specific sectors with high-growth potentials. Very little information is available on the demand for VC by Canadian firms. For example, how many Canadian firms really need VC financing or how many firms have sought VC and what is the approval rate? This review also raises the issue of the lack of information on the demand for informal investments and quasi-equity investments. This lack of information about the real demand for risk capital is a major barrier in identifying the gaps in the market. Looking at the supply side only provides half of the story.

 

Supply of VC

Low participation from institutional investors due, in part, to a lack of knowledge about the performance of VC funds, and high costs associated with due diligence and deal selection, and linked to the lack of experienced VC fund managers in Canada; lack of an institution-friendly market infrastructure with effective advisors, such as American-style gatekeepers; and lack of vehicles that address organizational barriers to participation, such as funds-of-funds. (However, three funds-of-funds have recently been created in Canada to assist Canadian pension funds in making VC investments.)

Low funding and participation of private independent funds compared to the U.S. If the Canadian VC industry continues to grow as a viable and sustainable private sector industry, private independent funds should become the dominant players in the industry (as they are in the U.S.). Without greater participation of pension funds in Canada, private VC firms in Canada are unlikely to raise the capital needed to become the cornerstone of a viable and sustainable private sector VC industry.

Role and impacts of LSVCCs — While LSVCCs have undoubtedly played a critical role in the development of the VC industry in Canada, a detailed review of their importance and future role is appropriate. For example, does the Canadian government play a larger role in the Canadian VC industry than the U.S. government in its market? What are the impacts of LSVCCs on the Canadian VC industry compared to the impacts of SBICs in the U.S.?

Increasing difficulties for new and younger firms to access VC, in particular, small financing amounts of less than $1 million, new deals, and seed financing for commercialization of new ideas and products.

Challenges for mid-sized and expansion firms in accessing larger VC for their continuous growth — Lower average deal sizes and anecdotal evidence suggest that the Canadian VC industry may have a limited capacity to support and fund mid- and large-sized firms. As a result, Canadian firms have to seek funding in the U.S. and eventually move part of their business and operation south. More research is being conducted to better understand the impact of foreign VC investments on Canadian firms.

Regional concentration — The disparity in the regional concentration of VC activity and venture capitalists' affinity for high technology firms is not unique to Canada. These trends may reflect a number of weaknesses at several levels, including a continued reluctance of venture capitalists to invest in remote areas due to the need to oversee and provide value-added services to their portfolio firms, a lower level of KBI firms and regional activities in high technology sectors (despite the recent emergence of technology centres in some regions), more limited access to significant markets (e.g. U.S.), a lack of demand for VC in some regions and a lack of marketing skills in some regional firms.

To answer the question:

What is the state of current government action related to VC? Are the approaches to VC issues consistent across the government?

Most of the responsibilities aimed at ensuring an efficient fiscal, regulatory and policy framework that supports business development and encourages a strong private sector VC market lie with the Department of Finance.

Industry Canada's policies, programs and services support the development of an innovative economy that will create new jobs and wealth across Canada. Industry Canada strives to achieve these goals by working in several different areas: innovation through science and technology, trade and investment, growth of SMEs and the economic growth of Canadian communities.

The Industry Portfolio is composed of 16 organizations (departments, agencies, tribunals and Crown corporations) that report to the Minister of Industry or through the Minister to Parliament. It has a total budget of approximately $4.7 billion, and its member organizations employ 18 000 people across the country.

Coordination between the various members improves governance, policy, legislation and program coordination and assures that programs and services are consistent with government objectives.

The provincial government also plays a critical role related to the VC market through different tax measures and incentives and direct and indirect programs targeted at both SMEs and the suppliers of VC.

The federal government's basic role in the VC market is to establish a fiscal, regulatory and policy framework that fosters an effective marketplace by supporting business start-ups and growth and encourages a sustainable private sector VC industry. The government has several instruments available to reach these ends: balanced budgets, low inflation and interest rates, low and competitive tax rates, efficient regulations that balance the need for investor safety and investors' risk appetites, well-funded R&D, etc.

Over the last several years, federal and provincial governments have sought to improve SMEs' access to risk capital, including patient capital, VC and other financing instruments. There are three broad areas of government intervention — indirect measures oriented toward the suppliers of VC, such as tax and regulatory measures and LSVCCs; direct quasi-equity or equity government investment programs; and programs and initiatives aimed at building a critical mass of VC-ready Canadian businesses — that provide general assistance, information and support to Canadian SMEs.

While there are a few key direct investment government programs in place, only a few of them are major (e.g. BDC and EDC) and most of the programs reviewed and presented in Part III are indirect measures targeted at the suppliers of VC rather than at SMEs (e.g. LSVCC tax credits and tax measures aimed at supporting foreign and pension fund investments).

In total, investments by provincial and federal government funds accounted for 38 percent of total VC investments. However, the future of the VC market in Canada will depend, in large part, on the participation of private sector players, particularly institutional investors.

Institutional investors in Canada have been much less active in the VC market than their counterparts in the U.S. American institutional investors accounted for 78 percent of funds raised over 1996–2002, while Canadian institutional investors contributed 12 percent of the funds raised during the period. In 2002, however, Canadian institutional investors accounted for 54 percent of the total funds raised. The increased contribution of institutional investors will be key to the continuous expansion of the Canadian VC market.

To answer the questions:

Where are the gaps in the market? How do bottlenecks in the VCC industry dampen the development, innovation and growth of Canadian SMEs?

How can the policy environment encourage the continued growth and development of Canadian SMEs? How can this environment improve Canada's innovation performance, create jobs and wealth, and encourage these firms to remain Canadian?

An imperfection or weakness related to geography, laws, transaction costs or regulations that impede supply and demand from clearing in the market, with the result that the market does not function efficiently. Information asymmetry, which occurs when the suppliers of capital have less information than the owners of the firms seeking financing, can result in shortages in the market or market inefficiencies.

Unfortunately, there is a significant shortage of information on the demand for VC. Therefore, it is extremely difficult to determine whether there are gaps in the VC market and, if there are, to identify them clearly. There is a need to improve the quality of data on the demand for VC by type of firm and location, and to assess the approval/rejection rate and reasons for rejections.

Breakdowns of recipients of VC across stages of firms, age of firms, regions and their growth record to investigate "gaps" related to the supply of VC investment available to firms at various stages of development.

Studies over time of the trends in the size of VC investments and its impact on the supply of VC available to early-stage and mid-sized firms.

Specialized studies of pension plan and other institutional participation in the VC market.

Studies of the linkages between business evolution, ownership structure and managerial capabilities of firms.

Specialized studies of the breakdown of management ability by stage of firm to assess management competencies at various stages of development.

Fundamental role of government is to put in place a fiscal and policy framework that will support business development and growth and encourage a viable and sustainable private sector VC industry.

Key basics for development of any policy action in VC:

1. Fill a market gap in the private market — Taking into account the definitional challenges outlined above, any government actions should be aimed at addressing an identified gap in the market and preferably exit when private sector takes over.
2. Minimize distortion to VC industry and other risk capital markets — Government intervention should be the last, rather than the first, resort and should take into account any potential distortion that could result from government intervention. The goal of government policymaking is a sound VC market (viable, sustainable and growing) that can support the growth of innovative, productive, outward-oriented businesses. This orientation needs to consider VC in the wider context of the risk capital markets.
3. Develop partnerships with the VC industry and stakeholders.

Lower returns of Canadian VC funds compared to U.S. VC funds and other investment vehicles.

Lower participation of institutional investors and the concomitant lack of funding and participation of private independent firms.

Shortage of investor-ready firms in terms of management and marketing skills.

Shortage of VC fund management expertise and experience.

Difficulties securing VC for early-stage firms and firms seeking first-time VC.

Low level of awareness about recently published performance information on Canadian VC funds.

Lack of information and knowledge of the actual demand for VC.

Regional disparities in VC investment levels in the Prairies and, to a lesser extent, Atlantic provinces (compared the regional levels of GDP and KBI firms).

Considering the key outstanding issues and principles for the development of government policy actions discussed above, the following questions are aimed at guiding future discussion between private sector stakeholders and government regarding the elaboration of any actions to address the key outstanding issues faced by the Canadian VC industry and by Canadian SMEs.

• Given these gaps and outstanding issues and the role of government, what should be done by both private sector stakeholders and government to encourage the continued growth and development of the Canadian VC market?
• Many of the challenges facing the Canadian VC industry appear consistent with the challenges faced by many adolescent industries, which fall within three broad categories: 1) the market infrastructure, including the policy environment; 2) the supply of VC, including fund-raising and investment environment; and 3) the demand for VC.

In this context:

• What can Canada do to ensure the Canadian VC industry successfully navigates these challenges?
• How can Canada accelerate the creation of more experienced and skilled managers of high-growth companies (e.g. management and marketing skills) and of VC funds?
• How can Canada better support pre-VC and seed financing of high-growth firms, as well as expansion financing of mid-sized firms, and encourage these firms to remain Canadian?
• Where are we in terms of LSVCCs and other government-owned funds and programs? Have these reached maturity? Are there duplications of efforts? Are these initiatives and programs still appropriate or sustainable in the long term to ensure a growing private VC industry?

In addition to these questions, following are a number of areas and issues for further research. These research ideas or initiatives could be conducted in partnership with or collaboration between the federal and provincial governments, as well as with private sector and industry organizations.

Current Research Projects

• Institutional investments and private equity in Canada
• Actual versus potential angel investments in Canada
• Assessment of the importance, impact and future role of LSVCCs in the Canadian VC market.

Potential Future Research Initiatives to be considered

• Evaluation of actual and potential demand for VC
• Assessment of management ability of Canadian SMEs
• Review of funds-of-funds and gatekeeper models
• VC fund management skills development
• Due diligence and evaluation of business proposals
• Database of government-funded firms at the pre-seed VC firms
• Review of the U.S. Small Business Investment Corporation (SBIC) program
• Performance of Canadian IPO market.