Canadian crowd-out

With a new report showing that VC activity in Canada is falling as big buyout funds suck up all the oxygen, the industry continues to shift from being primarily a VC market to one dominated by buyout funds. Dave Keating reports.

Canada’s private equity market reached a record in 2006 according to a new report issued yesterday by management firm McKinsey & Co, reaching C$65.5 billion ($61 billion, €45 billion). Rising foreign investment helped increase private equity capital under management in Canada by 16 percent from 2005.

But not everyone was celebrating the report’s findings yesterday. The large increase in attention to buyout funds concurrently meant a decrease in venture capital activity as money managers increasingly turn their focus to buying out established businesses rather than start-ups.

Buyouts made up 58 percent of Canadian private equity deals in 2006, up from 43 percent in 2002. At the same time venture capital deals dropped to 34 percent of the total, down from 47 percent the previous year, according to the report.

The report’s authors had big projections for Canadian buyout funds, anticipating that the next year will see more private equity firms taking over large Canadian publicly listed companies, and predicting it will also see more interest from US and other foreign investors in these companies. Predictions for VC were less rosy. The authors reported that conversations with Canadian venture capitalists indicate they expect the fundraising environment ahead to remain challenging, with few Canadian funds being able to raise capital outside their home country.

Still, a number of major new venture capital funds emerged in 2006, including ARC Financial Corporation’s latest entry, ARC Energy Venture Fund 5, which will focus on the oil patch and alternative energy sectors and brought in C$648 million. JLA Ventures had a final closing of C$121 million on its JL Albright Venture Fund. Many of the new vehicles came out of Quebec, including the final close of Propulsion Ventures III, which focuses on software and IT investments. And Quebec-based GeneChem’s third life sciences fund, AgeChem Ventures, held its first close. Quebec’s venture performance on the whole has actually seen impressive growth. The latest numbers from Thomson Financial show that in the first quarter of 2007 VC investment in Quebec firms grew by more than 50 percent from the same quarter last year.

But despite the emergence of several important first-time and follow-on partnerships, new commitments were lower in 2006 than in the past five years. Canadian venture firms will likely have to start raising smaller funds and figure out how to achieve good returns on C$100 million to C$250 million exits, while limiting IPOs to only the very best companies.