Growth or Profit – What is the Market Saying?

This year’s crop of IPOs has had lacklustre returns. So much so, in fact that people have begun to suggest that the market is moving away from valuing growth over profit. Of course, given a chance to play with stats instead of working, I picked stats and proceeded to look to see if there is any merit to the claim.

First let’s look at what happened to the 10 biggest tech IPOs of the year in terms of their change in value since opening day close. The following chart shows the dismal returns I was talking about. Only two of the ten have gone up since the end of opening day. In fact Lyft and Slack have plummeted (but in the case of Slack, it has only fallen back to its issue price.)

In terms of Revenue Growth Rates, this is for the most part, a great crop of IPOs.

But at the same time, every single one of these companies is still losing money. And we’re not talking about a little money, but a lot. Gobs and gobs of losses in fact.

And how are they doing? Just fine thanks. In fact they all have very healthy revenue multiples (In fact Crowdstrike’s is frankly obscene.)

And what is the relationship between these factors? There isn’t one and let me tell you I tried to find one. I graphed them all and put in trendlines. I calculated correlations. I even changed my method of analysis to use rankings instead of absolute numbers and I couldn’t get any correlation worth talking about other than between losses and growth. As we know the more you lose the more you can grow.

But as to the assertion made by analysts that the market has forsaken growth in favour of companies that might be able to make money some day? Nope, this data doesn’t say that. What it says is absolutely nothing. (And to think I wrote a blog about statistics that don’t show anything.) Whatever…go back to work and grow, grow, grow. The big stats still show that growth is the best driver of shareholder value so lose away and wait till the next downturn when we might have a new normal.

Does Canada Have Enough Venture Capital?

In Canada, access to venture capital (VC) is cited as a persistent barrier to the creation of world-class firms, prompting the development of programs and funds to overcome it. Policy is operating under the assumption that availability of VC funding is as much a problem today as it was years ago. But what is the current state of VC funds in Canada? Is there a gap? If so, why?

To help us answer these questions, we took a closer look at: the availability of VC funding in Canada in international comparison; the sources and availability of funds by VC stage within Canada; the structure of the Canadian VC system; and the sources of VC flowing into Canada’s leading tech companies.


Contrary to popular belief, Canada performs exceptionally well globally, ranking among the top countries in the world for availability of capital in both absolute and relative terms. Internationally, Canada ranks third in absolute VC dollars invested, behind the United States and China and far ahead of more populous countries such as the United Kingdom, France, Germany, and South Korea. Canada also ranks third on a gross domestic product-basis in VC invested per year, lagging only the United States and Israel.

For a long time, it has been thought that investments from international sources have propped up overall VC funds in Canada, particularly at later stages of growth. But the evidence suggests that this may hold true for earliest rounds of investing as well. In fact, there were 22% more Series A investments made by foreign firms than by Canadian VCs in Canada and more than twice as many foreign firms investing in Canada than Canadian firms making investments. This implies sufficiency of capital for Series A rounds and potentially even later rounds.

The data also helped uncover a major issue with Canadian investors who are less likely to put forward competitive and significant sums of money. Among the companies we analyzed, only 18% financed were exclusively supported by VC firms based in Canada, and nearly 30% had no Canadian investors. In addition, businesses with no Canadian investors received 2.7 times as much money as those with Canadian investors only.

When it comes to leading Canadian technology companies, businesses that relied exclusively on US and other foreign funding in their Series A round eventually raised more money than Canadian-financed firms and were positioned better to become Unicorns.

Perhaps one of the main factors shaping our perception of capital in Canada is the lack of results on the scaling front. Canada ranks last among Unicorn-creating Organisation for Economic Co-operation and Development (OECD) countries. Although Canada ranks third in the world for the amount of VC invested annually, we place last in the world at turning this investment into Unicorns. The situation is so bad that even if we were to create four times as many Unicorns, we would still be in last place.

The structure of the Canadian VC system also poses some challenges:

  1. We have too many VC firms with too little capital, potentially causing competition for deals and smaller investments, far less than the companies need to grow fully.
  2. With smaller investments, these companies have less capital to support losses and important business functions (e.g. marketing and sales) that would help them grow faster.

Our current report has put forward evidence that there is, in fact, sufficient capital for Canadian companies, especially when international flows of monies are considered. Certainly, there is some disconnect between data and the general VC insufficiency narrative commonly heard in Canada. Overall, we believe that significantly more effort should be focused on exploring the underlying causes of the capital (in)sufficiency problem. Only then will we be equipped to design and deliver meaningful solutions that get at the underlying “disease”, rather than the symptoms alone.

Why WeWork Blinked

I met with someone yesterday who has an office at WeWork and was pleased to see the relaxed atmosphere, posters advertising Meditation Hour, and beer on tap. (It was morning so I couldn’t have any beer.) That visit reminded me that I wanted to look at their prospectus and check out issues relating to their valuation as it had been under attack recently. Lo and behold, yesterday happened to be the day that WeWork delayed their IPO. After looking at their prospectus, I understand why.

In total, the company has raised $5.6 billion of equity and has revenue last year of $1.8 billion. That’s a ratio of 3.1 times which isn’t far above the ratio of 2.3 times for software industry IPOs over the last six years. (Check out our recent report on IPOs for data.) The problem is that WeWork isn’t a software company but it looks like they tried to value themselves like one.

The average software company going public has a gross margin (Gross Profit/Revenue) of 65% whereas WeWork has one of 16%. (Bear with me here, I’m about to get even more boring.) That means the Capital to Gross Margin ratio is 18.7 times, way more that that of the software industry’s recent IPO ratio of 2.59 times. 

WeWork has a great growth rate, 105% in the last year which puts them well above software industry IPOs of 55% over the last six years. They were initially looking for a valuation of about $47 billion and this would imply a revenue multiple of about 26 times. Even this would be high compared with Shopify’s which was worth a revenue multiple of 20 times for an equivalent growth rate. 

The problem is that you can’t use a revenue multiple similar to software companies when the gross margin is so low. WeWork is a high cost operation so a better way to look at it would be to look at a Gross Margin Multiple. Software industry IPOs over the last six years averaged revenue multiples of 8 times. This would be equivalent to a Gross Margin Multiple of 12.3 times. WeWork was looking for a Gross Margin Multiple of 157 times. 

Even if you factor in their high growth rate, they might have deserved a gross margin multiple of 30 times. This would have valued the company at under $10 billion. They had already reduced expectations to a valuation of $20 billion. The problem was that with a valuation of below $10 billion, it was less than half their valuation at the beginning of the year. Someone was about to get a haircut.

Overall, I think they are in a great market with a very needed product that users love. There may be a problem though with unit economics. The average software company is losing 60% of revenue or 100% or so of gross margin. WeWork is losing 89% of revenue which is not out of line. What is out of line is losing 536% of gross margin. Overall, something has got to change in their business model as these numbers do not point to a company that can ever make money and whose valuation was justifiably questioned.


The Narwhal List – July 2019 Update

There has been a lot of action in the Canadian tech scene over the last six months. Deals are happening with increased regularity and for bigger amounts. We thought it would be worthwhile to update the Narwhal List for July 2019 to show what has happened over the last six months. July itself has been a busy month and this update doesn’t include anything happening in July.

First of all, four companies graduated from the list. Milestone and Lightspeed went public and H&R Block acquired Wave Financial for the princely sum of $398 M US. Wealthsimple, a company we hoped would become the next Unicorn exited the list as Power Financial ponied up for another round and became a majority shareholder. Here’s to hoping that Wealthsimple goes out and raises another round from an external party and becomes independent again.

Eleven companies including Vena Solutions and Lungpacer are either new or returning to the list. These 11 companies raised an average of $36 million US each.

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And finally, 8 companies already on the list raised an average of $38 million US of capital and moved up. At the top end of these companies was Fusion Pharmaceuticals which raised an eye-popping $105 M US.

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You can see a completely updated list of the Narwhal List for July 2019 at

Sonder is a great “Started in Canada” story!

Today’s article in the Globe and Mail about Sonder, the San Francisco based travel company tells a great story. Founded in Canada in 2012, they moved quickly to the US where 90% of their 560 or so employees now reside. (Employee data from LinkedIn.) They are heading to $400 million in sales this year and just raised a $210 million US D round of capital (CBInsights). So far they’ve raised $340 m US and are officially a Unicorn. In Narwhal List terms, Sonder has a Financial velocity of 48. This is 39% higher than Canada’s leading tech Narwhal, Element AI which has a Financial Velocity of 35.

If you paid attention to our latest research summary, you’ll see why we think they are doing it right. First of all, they are in a horizontal consumer market. This is where all sorts of strong growth is possible. Secondly they are amassing copious amounts of capital. With last year’s revenue of about $200 million they now have 1.7 times as much capital as revenue. They have employee growth of 94% in the last year and 244% in the last two. This is exactly the growth they need to propel them towards an IPO.

Why this is great for Canada

You may be asking why I think this is a great Canadian story. After all, they are now based in San Francisco. It is sad that Sonder had to move south to be successful. But it’s great because it shows that we can create good ideas here and have the entrepreneurs to propel them to glory. It’s great because Sonder is now about to bring a second headquarters back into Canada and that’s a place where we can incubate new talent. Most of all, we’ll be building employees with the experience of working in fast growing companies and that can only be good for our ecosystem.

If we get enough of these stories, the Shopifys and Sonders, we will eventually have enough anchor companies around which a more successful ecosystem can flourish.

The Narwhal Project

Three years ago, I started doing research at the Impact Centre at the University of Toronto to discover the root causes of Canada’s challenges in creating a world-leading innovation economy. I thought it would be useful at this juncture to summarize our findings. This report highlights some of the issues we have identified. This blog also announces the move of our content to this new site and the launch of what we are calling the Narwhal Project, an exploration through research of what it takes to scale a tech company. I promise to blog more frequently again but meanwhile, you can check out a summary of our findings in our latest report.

For fifty years, the federal and provincial governments have been spending billions to improve our innovation economy, but without performance improvements. The usual discussion is centered on Canadian businesses and their lacklustre performance on research and development (R&D) and intellectual property (IP) protection. In addition, our productivity has lagged relative to the US because of insufficient investments into productivity-enhancing technologies, along with the lack of available capital and talented people to grow technology firms. 

But we believe that a critical challenge is our inability to scale companies to a world-class size. Larger companies boast several advantages. They have greater revenue per employee, pay better salaries, undertake more R&D, and take out more patents.

We lack large companies, particularly in the technology sector. We have only one Unicorn (with perhaps another one qualifying but not listed as such at the date of this publication) compared with over 150 in the US. Few tech companies in Canada grow large enough to go public. This means less R&D, fewer patents, and, ultimately, lower income per capita and productivity. 

Perhaps the solution to our innovation challenge is not more R&D and more patents, but rather scaling and building of companies. But why are we challenged do this in the tech field? What we have found is that:

  • Few Canadian companies are founded in large consumer markets capable of generating the desired scale.
  • We invest less per company relative to the US.
  • Canadian firms spend less on marketing and sales (M&S), activities that are critical to building the customer base.
  • We have fewer qualified people in marketing functions.

The underinvestment and underspending result in lower growth rates for Canadian tech firms compared to their US counterparts. Fundamentally then, Canadian firms do not look as attractive as potential investments due to slower growth. Because of this, they do not attract large amounts of late-stage capital and are often sold before they can scale to world-class size.

All of these factors converge to create serious barriers to growth of Canadian companies, thus necessitating smarter and more strategic thinking about how we will overcome these challenges.

You can get a full copy of the report here.