🤑 venturing out
Is there really a role for the government in VC?
The market’s reality check is a welcome forcing function to rethink venture funding in Canada.
The market correction and the subsequent layoffs announced at a slew of Canadian tech darlings are an opportunity to reflect on how we have been overly optimistic in the booming markets of the past.
A little while ago - all in one week - jobs cuts were announced at Lightspeed Commerce Inc., Clutch, Hootsuite, Thinkific Labs Inc. and Clearco. For the latter two, it was their second round of layoffs.
Among the issues to consider is an often overlooked one, that on the hook for the failures of many such companies are not just venture capitalists. It’s also you and me, the taxpayers.
Some of venture capital in Canada is dependent on the taxpayer, because government programs like the Ministry of Innovation, Science, and Economic Development’s Venture Catalyst Initiative (VCI) funnelling fund from the state. That means that everyday people are backing some of the bets that venture capitalists make in Canada.
The money is tricky to track because of the ‘fund of funds’ structure. Consider Clearco: their Series A was partially supported by HarbourVest, and they got funds from the VCCI in 2017 and 2022. There’s hundreds of millions of taxpayer dollars going through funds, to funds-of-funds, to different companies. There’s accountability to the partners of course - but the flow of funds itself is murky.
In October 2022, Minister Ng announced new venture capital investments. If Canada is ranked third for VC investment according to the OECD (as cited in the press release – this seems to be a little bit of a zombie stat) – why is there a government support program for VC investment? And if VC investment doubled between 2019-2021 to $14.7B, why was (and is) the government still subsidizing VC?
This moment in the market’s cycling should invite Canada to rethink how it intervenes in venture capital and private equity markets. Governments should choose to get out of the business of venture funding, for that lies at the crux of our national innovation failure: the reality that banks and businesses are hardly backing risk with substantive funds of their own.
Instead, that often falls on government programs and public pension funds like the Ontario Teachers Pension Plan (“Teacher’s”), OMERS or the Caisse de Dépôt.
Venture capitalists should take the bold risks of investing because they are properly incentivized to succeed. If a VC gets sloppy and loses massively on an investment, that’s their problem. There is nobody to bail them out because there is no need to – the primary responsibility of VC funds are to their limited partners (LPs), and they are supposed to take the highest risks in capitalism.
Public pension funds, on the other hand, probably shouldn’t be making the same gambles with your retirement plans. As it stands, the Government of Canada is being asked to bail out these funds. These funds are not punished by the market for failure. Instead the taxpayer has to backstop venture capital.
To be sure, the government does have a venture function of sorts where it can stimulate additional investment in sectors like critical minerals and quantum computing through the construction of national strategies with associated expenditure.
But when VCs want money for big bets on high risk ventures in Canada, they often look to the government and not private peers to pool funds. In May of last year, the CEO of the Canadian Venture Capital and Private Equity Association foreshadowed “no more government aid requests.” Yet just recently, the lead partner of the Business Development Bank of Canada (BDC) Deep Tech Fund argued for more government support during this downturn.
We could benefit from more pioneering firms willing to allocate patient capital needed to invest in decarbonization, genomics, and deep tech and other research-intensive commercialization enterprises. And Canada is right to pursue so-called “responsible innovation,” and should continue to facilitate the ongoing dialogue between entrepreneurs and regulators to improve outcomes. But the reality remains: even with venture funding, startups fail, and they fail fast.
Social media chatter continues to marvel at the investments and implicit endorsements of SBF’s cryptocurrency exchange FTX which has been revealed to be a captivating Ponzi scheme. Without substantial subsidization from venture capital, the prices for DoorDash, Uber, WeWork, and Airbnb have become more realistic and stark.
On VC, the Government of Canada can’t lead and shouldn’t follow. It should just get out of the way.
📻 Last week, I got to co-host Short Cuts with Jonathan Goldsbie.
🗞️ I also wrote about a missed opportunity to GO BIG on consumer protection.
From another reader, with permission:
Love this.
Also not sure about Can stats but in the US, VC functions as private cash advances from white guys to other white guys to build their whim “innovations.” For ten years, less than 3% of VC money has gone to companies founded by women. Women of color is so low it’s embarrassing.
In 2018, all female founders put together received $10 billion less in funding than one e-cigarette company, Juul, took in by itself (source: https://fortune.com/2019/01/28/funding-female-founders-2018/)
The stat peaked a few years ago and is now down below 2% again…so yeah…progress. (https://techcrunch.com/2023/01/18/women-founded-startups-raised-1-9-of-all-vc-funds-in-2022-a-drop-from-2021/)
Emailed from a reader, posted with permission:
You are right that the government should not be in the VC business and you are right that VCs and their LPs (and not taxpayers) need to take risk and bear the fruits and brunt of investments.
But some clarifications about who is who are required. Pensions like OMERS, Teachers, and the CPP are not the taxpayer, and their gains or losses do not come out of the hide of taxpayers (different for PPSP). They are perfect LPs for VC. They run large, diversified pools that can and should tolerate substantial risk in portions of their portfolio and which need exposure to a wide range of assets classes including especially private equity (of which VC is a small subset). Either direct or through funds, they absolutely should be investing in VC, and a huge part of the challenge in Canadian innovation has been the historic excessive caution of LPs like pensions and insurance companies.
In fact, historically, Canadian pensions assumed massive underperformance risk by investing too cautiously - this is a huge and underappreciated concern that puts pensions at risk and is much more common in Canada than the converse, which is taking too much risk to try to generate excess returns (much more common problem in the US).
Banks are not suitable LP investors in VC. Not at all. In fact, banks are not and should not be in the business of investing their capital.
That said, I am pretty sceptical about the ability of most Canadian VCs to generate decent returns. There is not much evidence that investing in VC produces good returns - and that, frankly, is the most plausible explanation of why there is a chronic complaint that there is insufficient VC. Put another way, if the investing market is even close to efficient, $ would pour into Canadian VC if Canadian VC could prove that it produces solid risk-adjusted returns as a class.