Bridging the gap: How Canadian tech startups find elusive growth capital

Bridging the gap

The “why” of the funding gap is a complex question that mostly boils down to a difference in risk appetite within Canada, yet there are positive signs for change.

Audit Partner, Enterprise and TMT

KPMG in Canada

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Canada’s reputation as a great place for tech entrepreneurs is growing. Activity within Canadian hubs such as Toronto, Vancouver, Waterloo, Ottawa and Montreal has been especially strong the past few years. Venture capital investment has increased to over $2 billion (CAD) annually, and while the Canadian economy has suffered a recent slowdown, activity within the tech industry remains strong. However, one area where Canada is still lacking is in the availability of funds to help accelerate growth of new tech startups prior to Series A funding.

While creating a new business is relatively painless, especially with the range of available tax incentives and government funding, many new startups struggle to overcome the funding gap in the years that follow. Once a firm grows beyond “friends and family” backing, finding funds in the range of $0.5 million (CAD) to $5 million (CAD) can be a considerable challenge. When funding is available, it often comes from international sources, most frequently the U.S. The result is that many rising stars in the Canadian tech industry have a majority foreign ownership.

The “why” of this funding gap is a complex question that mostly boils down to a difference in risk appetite within Canada. American venture capital and private equity funders are generally more established and operate on a significantly larger scale than we see locally, making them open to riskier business propositions. Canadian funders, however, look for safer bets: companies that have an established platform, positive cash flow and more. Investment firms that are willing to help from the ground floor, providing support and capital from the idea stage onward, are considerably rarer.

Yet there are positive signs for change and other opportunities to secure needed funding:

New targeted growth funds. Early in 2016, Canadian entrepreneur and WIND Mobile founder Tony Lacavera made headlines by announcing the creation of a $100 million venture capital fund specifically designed to bridge the funding gap. While this fund won’t address needs on the lower end of the scale, instead providing between $2 million (CAD) and $5 million (CAD) for funding rounds of up to $25 million (CAD), this type of targeted investment is absolutely needed within the local ecosystem. The hope is that other investors will soon follow suit.

Crowdfunding. Many Canadian entrepreneurs are now looking to crowdfunding as a viable option to address smaller-scale funding needs. Stories about Canadian crowdfunding successes were in the news already this year, like Revols, creator of contoured Bluetooth earphones that raised $2.5 million U.S. on Kickstarter. While crowdfunding looks to be a strong option for many new tech companies, it should not replace the role of smaller VC funders. Additionally, forthcoming government regulations or the effect of negative publicity stories about misused funds may impact long-term viability.

Commercial lenders. For some firms seeking smaller amounts, the answer may be not to pursue venture capital funding at all, but rather look to other sources. There are lenders within the Canadian ecosystem – both boutique and commercial – who can offer entrepreneurs a range of options, including lending on SR&ED, a tax incentive program that provides credits or refunds to support R&D activities. Many founders shy away from the additional security required for such funding and the different possible risk/reward balance, but for some entrepreneurs such funds might be the bridge they need to cross the gap and reach Series A.

Pursue the right VC funders. Some of the responsibility for closing this gap also rests with the entrepreneurs themselves. In my experience, too often do founders try to pursue what they see as the “best” venture capital firms – generally big names seen in media headlines – not realizing that many don’t support their niche area or provide funding at their level. This is wasted time with zero return on investment. Through research and networking, founders can pursue the right players at their level of investment.

I’ve heard it said that we should look to the government to help bridge the gap in startup funding and encourage growth at companies’ earliest stages, but I think that this is the wrong path. Once we’ve seen some local venture capital firms take a shot at providing companies with critical seed capital pre-Series A and having success, other funders will quickly follow suit. While there is greater uncertainty in early stage investment, if even one supported company becomes a unicorn it will make up for all the rest – and have a huge impact on the health of the Canadian tech sector for years to come.

 

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About the author

Sunil Mistry, Audit Partner, Enterprise and TMT

Sunil is an Audit Partner in KPMG’s Enterprise and TMT practice with over 20 years of experience. His clients include private companies that are private equity or venture backed, entrepreneur owned or local subsidiaries of larger private foreign corporations. These include high growth technology and professional services based companies. He is also a member of the KPMG Enterprise Global Innovative Startups Network. In this role, he coordinates with KPMG offices around the world and brings back best practice to the Canadian practice for KPMG’s global initiatives as it relates to working with the innovation ecosystem, including entrepreneurs, fast growing private equity and venture backed companies.

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