Canada’s Venture Capital ChallengeCanada’s Venture Capital Challenge

Prepared for Canada’s Venture Capital & Private Equity Association

Kirk Falconer, Director of Research, Private EquityThomson Reuters (Canada)

August 2012

Canada’s Venture Capital Challenge

What the data tell us

• Canada’s venture capital industry is young by US standards, as market-shaping investor groups & entrepreneurial firms reached a critical mass only in the late 1990s

• Post 2000 continuous deal-making that builds innovative sectors has been undermined in Canada by a growing crisis• Post 2000, continuous deal-making that builds innovative sectors has been undermined in Canada by a growing crisis on venture capital’s supply side

• The data indicate that weak fund-raising has contributed to flat or declining levels of Canadian venture capital fund activity in recent years

• This has reduced domestic capacity to support high-growth technology companies & respond to new opportunities as they emerge

• The data suggest that sustained supply challenges have created or reinforced market gaps

• Among the most important is under-funding of high-growth companies going head-to-head with international competitors*

• Deal capitalization levels are integrally linked with the issue of Canadian fund sizes• Deal capitalization levels are integrally linked with the issue of Canadian fund sizes

• The data also point to lagging activity in market segments that most depend on Canadian funds, such as first-time financings & seed-startup financings

* Related studies from the perspective of Canadian entrepreneurs include: ICAP-Strategic Counsel, 2004; Equinox Management Consultants, 2006

0.6%

$6 000

$7,000

Venture Capital Invested in Canada, 1998-2011 (C$ Mil), % of Domestic GDP

0.54%

0.4%

0.5%

$5,000

$6,000

0 2%

0.3%

$3,000

$4,000

0.34%

0.12%

0.1%

0.2%

$1,000

$2,000

0.12%

0.07%

0.0%$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

VC invested in Canada % of GDP

As % of GDP, Canadian venture capital invested has steadily decreased since 2000

Venture capital disbursements to domestic economic output (GDP) peaked during the internet boom, reaching 0.5%

Since then, disbursements to GDP have fallen, averaging less than 0.1% over the period 2008-2011

1.20%

Venture Capital Invested, % of GDP, Canada & the US, 1998-2011

0.80%

1.00%

0 40%

0.60%

0.20%

0.40%

0.00%1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Canada United States

Venture capital invested to GDP in the US is more than double Canada’s

Market activity to GDP in the United States hit 1.1% in 2000, & then briefly converged with indicators in Canada (2002)

However, per-annum US disbursements to GDP have typically been more than twice Canadian rates, averaging 0.2% in recent years

$7,000

Venture Capital Invested in Canada, Total & Domestic Funds, 1998-2011 (C$ Mil)

$5.87B

$5,000

$6,000

$3.75B

$3,000

$4,000 $3.75B

$1 68B$2.05B

$1,000

$2,000

$1.68B$

$1.04B

$1.60B

$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

VC invested in Canada VC invested by domestic funds

Post-2000 venture capital invested in Canada has not increased substantially during growth cycles

A key factor has been flat levels of investment activity on the part of domestic funds

Recent years of market growth (e.g., 2007) relied more on foreign funds, which have gradually increased their share of all disbursements: from 20% in 1999 to 30% in 2011

$3 500

$4,000

Venture Capital Invested in Canada by Fund Type, 1998-2011 (C$ Mil)

$2,500

$3,000

$3,500

$1,500

$2,000

$500

$1,000

$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

VC invested by non-private Canadian funds VC invested by private Canadian fundsVC invested by US & other foreign funds

Canada’s mix of active venture capital investors has changed dramatically over the past decade

Since 2000, the domestic fund-management industry has seen major consolidation, as large numbers of corporate, government & retail venture capital funds have merged or wound upgovernment & retail venture capital funds have merged or wound up

This has placed a greater onus on Canadian private-independent funds & cross-border investors

$180.0

Venture Capital Invested Across North America, 1998-2011 (C$ Bil)

$120.0

$140.0

$160.0

$60 0

$80.0

$100.0

$20.0

$40.0

$60.0

$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

VC invested in Canada VC invested in United States

Well-established US venture capital market activity dominates in North America

In the early-to-mid 2000s, Canadian market activity accounted for approximately 6-7% of all disbursements in North America

In more recent years, the Canadian share has been reduced to 4-5% of all disbursements, on average

$160.0

$180.0

New Commitments to Venture Capital Funds, Canada & the US, 1998-2011 (C$ Bil)

$120.0

$140.0

$

$60 0

$80.0

$100.0

$20.0

$40.0

$60.0

$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

VC funds raised in Canada X 10 VC funds raised in US

US venture capital market benefits from a more resilient fund-raising environment

Post 2000, American fund-raising bounced back in 2003, grew annually until 2008, & showed growth again at the time of the market’s renewal in 2011market s renewal in 2011

Over the same period, Canadian fund-raising has been comparatively flat, contributing to flat investment activity

10%16%

Canadian Venture Capital Invested by Sector, Domestic Funds, 2004-2011

25%

2%16%

47%25%

Canadian venture capital fund profile

Clean-tech IT Life sciences Other tech Non-tech

Of the C$8.5 billion invested by Canadian funds over 2004-2011, 47% went to IT firms, 25% to life sciences firms & 10% to clean-tech firms

Due to their broad coverage of Canadian regional sub-markets, domestic funds have also accounted for a high proportion of non-tech investment activityy

In the same period, 57% of domestic dollars went to expansion & other late-stage firms, while 43% went to early-stage firms

10%

1%

Canadian Venture Capital Invested by Sector, Foreign Funds, 2004-2011

10%

32%

3%

54%

Foreign venture capital fund profile

Clean- tech IT Life sciences Other tech Non-tech

Of the C$3.9 billion invested by US & other foreign funds in Canada over 2004-2011, 54% went to IT firms, 32% to life sciences firms & 10% to clean-tech firms

Cross-border investors usually partner with Canadian funds in follow-on financing syndicates backing companies based in urban technology sector clustersgy

Consequently, 66% of foreign dollars went to expansion & other late-stage firms, while 34% went to early-stage firms

600

Canadian First-Time Financings, Domestic vs. Foreign Funds, 1998-2011

400

500

300

100

200

01998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Canadian VC funds US/Foreign VC funds

95% of Canadian first-timers go to Canadian funds

First-time financings: Deals involving firms utilizing venture capital for the first time & a vital indicator of future trends

As domestic funds are close to local sector clusters, they can effectively evaluate & leverage new opportunities; most foreign investors lack this capability

600$2,500

Canadian First-Time Venture Capital Invested & Deals Done, 1998-2011 (C$, Mil)

400

500

$1 500

$2,000

200

300

$1,000

$1,500

100

200

$500

0$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Total VC invested Total financings

First-time deal-making has been flat or in decline for much of the past decade

Particularly in dollar terms, first-time investment activity has shown little or no upward movement over recent market cycles

Without better-capitalized Canadian funds, it will be difficult to address this market gap

400

Canadian Seed & Startup Financings, Domestic vs. Foreign Funds, 1998-2011

250

300

350

150

200

250

50

100

150

01998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Canadian VC funds US/Foreign VC funds

Canadian funds also account for 95% of seed & startup financings

Like first-time deals, financings of seed & startup activity are driven by domestic funds operating locally & with knowledge of innovative ecosystemsinnovative ecosystems

Most foreign funds are not well-positioned to assist Canadian firms at their earliest stages of development

350

400$1,400

Canadian Seed & Startup Venture Capital Invested & Deals Done, 1998-2011 (C$, Mil)

250

300

350

$1,000

$1,200

150

200

$600

$800

50

100

$200

$400

0$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Total VC invested Total financings

Dollar flows to seed & startup deals have been particularly weak in recent years

For a variety of reasons (including fund-raising conditions), many venture capital funds increasingly focus on later-stage deal-makingmaking

Closing this gap requires more supply directed to local balanced & specialty funds with early-stage investment mandates

$11.2

$10.2 $9 7 $9 9

$12.0

Venture Capital Invested per Company, Canada & the US, 2004-2011 (C$ Mil)

$9.7 $9.9 $9.2

$8.7 $8.1

$9.0

$8.0

$10.0

$4.2

$5.1

$3 6 $3 5$4 0

$6.0

$3.1 $3.1 $3.6

$3.1 $3.2 $3.5

$2.0

$4.0

$-2004 2005 2006 2007 2008 2009 2010 2011

United States Canada

Relative to competitors, Canadian venture capital-backed firms are under-funded

In recent years, Canadian companies have secured, on average, less than 40% of the dollars going to counterparts in the United StatesUnited States

This trend reflects a major gap, as high-growth innovative firms must go head-to-head with competitors in a global economy

$10 3

$12.0

Venture Capital Invested per Communications & IT Firm, Canada & the US2004-2011 (C$ Mil)

$10.3

$9.4 $8.8 $8.7

$7.6 $7.2 $6 9

$8.1 $8.0

$10.0

$7.2 $6.9

$3.8 $3.8

$4.8 $5.5

$3 6 $3.8 $3.9 $4.3

$4 0

$6.0

$3.8 $3.8 $3.6 $3.8 $

$2.0

$4.0

$-2004 2005 2006 2007 2008 2009 2010 2011

United States Canada

Canadian IT attracts only 50% of venture capital invested in US IT

Though under-funded, Canadian IT firms obtain slightly higher average infusion levels than firms in other sectors

A key factor: Foreign deal-making in Canada is weighted to activity in communications, software, internet-focused & other IT sectors

$14.4

$ 3 3$14 0

$16.0

Venture Capital Invested per Life Sciences Firm, Canada & the US, 2004-2011 (C$ Mil)

$12.6 $12.3 $13.3

$11.7 $11.0

$9.4

$11.2

$10 0

$12.0

$14.0

$9.4

$4 7

$6.2

$8.9

$5.1 $5.3 $6.1

$6.0

$8.0

$10.0

$3.7 $4.7 $5.1

$3.7

$2.0

$4.0

$-2004 2005 2006 2007 2008 2009 2010 2011

United States Canada

US life sciences firms take more than twice the cash injected in Canadian competitors

Capital-intensive companies in Canada have recently seen, on average, only 45% of dollar flows to companies south of the borderborder

This has occurred despite increased foreign disbursements to domestic biopharmaceuticals sectors since the early 2000s

$18.0 $18.0

$20.0

Venture Capital Invested per Clean Technology Firm, Canada & US, 2004-2011 (C$ Mil)

$13.1 $12.8 $13.0 $12.0

$14.0

$12 0

$14.0

$16.0

$8.5 $9.5

$6.7 $5 6 $6.0 $6.2

$8.0

$10.0

$12.0

$2.4 $2.3

$4.8 $5.6 $5.1

$6.0

$2.0

$4.0

$6.0

$-2004 2005 2006 2007 2008 2009 2010 2011

United States Canada

Canada-US deal capitalization gap especially wide in clean technology

On average, venture capital-backed companies in the United States receive 2.5 times more financing than counterparts in CanadaCanada

This gives American firms a major advantage in fast-emerging alternative energy, conservation & other clean-tech sectors

$6.5 $6.2

$5 8

$6.6

$5 8

$7.0

Venture Capital Invested per Early-Stage Firm, Canada & the US, 2004-2011 (C$ Mil)

$5.5 $5.8 $5.6 $5.5

$5.8

$4.0

$5.0

$6.0

$2.8 $3.2

$3.5

$4.0

$3.0 $2.9 $3.4

$2.9 $3.0

$4.0

$1.0

$2.0

$-2004 2005 2006 2007 2008 2009 2010 2011

United States Canada

Getting started, young Canadian firms also face a funding discrepancy

Domestic seed projects & company startups have recently seen average funding at less than half of the US level

This trend is closely linked to supply-strapped Canadian venture capital funds, given their essential role in early-stage deal-making

$13 6

$16.0

Venture Capital Invested per Expansion & Late-Stage Firm, Canada & the US2004-2011 (C$ Mil)

$13.6

$12.1 $11.9 $12.4 $11.4

$10.3 $10.3

$12.1

$10 0

$12.0

$14.0

$4 8$5.8

$6.0

$8.0

$10.0

$3.4 $2.9

$4.8 $4.1

$3.1 $3.1 $3.8

$2.0

$4.0

$0.02004 2005 2006 2007 2008 2009 2010 2011

United States Canada

Shortfall in Canadian late-stage financings is particularly substantial

Late-stage firms in the United States garner triple the venture capital going to comparable Canadian firms, on average

This points to an inability of some domestic companies to complete full cycles of growth & development & the potential for premature exits

$6.0

Average Early- & Late-Stage Investment Sizes, Domestic vs. Foreign Funds2004-2011 (C$ Mil)

$4.0

$5.0

$3.0

$1.0

$2.0

$-2004 2005 2006 2007 2008 2009 2010 2011

Early-stage/domestic Early-stage/foreign Late-stage/domestic Late-stage/foreign

Cross-border investments play a major role in Canadian financing sizes

Foreign fund investments in early- & late-stage firms have recently been 3X larger than domestic fund investments, on average; this contribution is vital to high-growth financing syndicatesaverage; this contribution is vital to high-growth financing syndicates

Across the spectrum, Canadian funds encounter limits to maximizing deal capitalization levels

$4,500

New Commitments to Canadian Venture Capital Funds, Private & Retail Fund-Raising 1998-2011 (C$ Mil)

$3,000

$3,500

$4,000

$1 500

$2,000

$2,500

$500

$1,000

$1,500

$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

VC funds raised in Canada Private funds raised Retail funds raised

Lower levels of Canadian fund-raising activity linked to major fund types

From its 2001 peak level, retail fund-raising has steadily declined due to legislative changes & perceived performance issues

As the result of an eroded supply base, private fund-raising has largely been unable to offset this trend

$4,000

New Commitments to Canadian Venture Capital Funds by Source, 1998-2011 (C$ Mil)

$2 500

$3,000

$3,500

$1,500

$2,000

$2,500

$500

$1,000

$-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Corporations Governments Individuals Pensions Other domestic sources Foreign sources

Mix of supply sources to Canadian venture capital has changed over time

A key aspect of lower fund-raising levels has been the reduced market exposure of individual & institutional sources

Government sources have recently played a more important role, while corporate & foreign sources have backed select private funds (Note: pension spike in 2011 due to launch of OMERS Ventures)

Canadian Venture Capital Under Management by Fund Type, 2010

4% 8% 4%31%

53%

Corporate funds Government funds Institutional funds Private funds Retail funds

Canada’s venture capital pool continues to contract

As a result of on-going consolidation & flat fund-raising activity, the domestic venture capital industry has experienced net capital outflows of over $3 billion in recent years (since 2003)capital outflows of over $3 billion in recent years (since 2003)

Outflows have primarily been accounted for by corporate, government, institutional & retail funds (outside of Quebec)

Venture Capital Funds Managers & Funds, Selected Characteristics, Canada & the US, 2010 (C$)

Number of fund managers: 124 833

Number of funds: 166 1,240

Capital under management: $14.9 billion $187.5 billion (US$182.2 billion)

Average firm size: $119.4 million $225.0 million (US$218.7 million)

Average fund size: $89.4 million $151.2 million (US$146.9 million)

Note: Estimates of fund managers & funds include both those making new investments & those primarily managing existing portfolioassets.

Canadian venture capital funds are less well supplied than US funds

Venture capital firms in Canada manage just over half of the resources of firms in the United States, while Canadian funds are p g j ,41% smaller than US funds; these 2010 results are comparable to previous findings

Fund sizes are a key determinant of minimum/maximum investment & deal sizes in a given market

160

Active Canadian Venture Capital Fund Managers(i.e., Investing $1 Million or More Per Annum), 1998-2011

136 active VC’s

100

120

140

81 active VC’s

60

80

100

65 active VC’s

20

40

01998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Canadian fund managers investing > $1 million

Number of active Canadian venture capital investors has been in decline

Active investors: Firms that have invested $1 million+ annually (in the United States, the measure is $5 million+ annually)

Active Canadian investors have fallen in tandem with fund-raising, with the result that only 52% of existing fund managers fit this definition in 2010; a decade ago, this share was closer to 80%

Deloitte 2011 Canadian Technology Fast 50, Percentage Financed with Venture Capital

38%

62%

VC Financed Not VC Financed

Canada’s fastest-growing innovative firms rely on venture capital

A number of technology indices point to a very high proportion of domestic firms with risk financing histories

For example, 62% of companies in the Deloitte 2011 Canadian Technology Fast 50 are currently backed, or were previously backed, by venture capital

Information used in this report derive from VC Reporter & PricewaterhouseCoopers/NVCA MoneyTree databasesof Thomson Reuters

These databases are the source of official statistics of Canada’s Venture Capital & Private Equity Association & the NationalVenture Capital Association in the United States

Sources of Gross Domestic Product (GDP) data are Statistics Canada & the US Department of Commerce’s B f E i A l iBureau of Economic Analysis