Policy experts and innovation practitioners have criticized Canada’s scaling problem – its inability to grow and scale companies. This has been a baffling issue because Canada’s technology sector has been successful at starting companies and generating innovations with high potential.
But identifying the root causes of Canada’s scaling problem has been a challenging endeavour. Certainly, the shortage of venture capital (VC) is cited frequently as a contributing factor. The reasoning is that since Canada does not have the capital available to fuel late-stage growth, our high-tech companies are sold well before they have a chance to become globally competitive players.
In this study we wanted to approach the problem from a slightly different angle: Is the way in which Canadian companies raise funds also adding to the scaling problem?
To this end, we looked at 49 private US companies that had received $100 million–$295 million in VC funds since inception. We compared them to 49 of Canada’s largest funded tech companies that had attracted $30 million–$250 million in VC funds per firm.
The data reveal three critical issues:
- Canadian companies wait longer before they start raising funds.
- They raise funds less often.
- They raise less money over time.
These fundraising patterns demonstrate remarkable differences between high-tech firms in North America. What US companies raise in four years, Canadian companies take ten years to raise. US companies (in this study) have six times the capital on hand to spend in their first five years of existence on critical functions, such as marketing and sales, which contribute to growth and long-term sustainability. The result is that, starved for funds, Canadian companies grow at a 47% compound annual growth rate (CAGR) while US firms grow significantly faster at a CAGR of 63%.
These funding trends also create companies that don’t look attractive from an investment perspective, lending validity to questions such as “Why would a US VC who is willing to locate offices in Europe, China, or India relocate to Canada to invest in slower-growth companies?” or “Why wouldn’t a Canadian VC sell a company that cannot get sufficient capital to compete globally?”
In fact, a simple calculation shows that while Canadian VCs earn a 27% internal rate of return (IRR) on a single 5´ exit multiple, US based VCs earn a 115% IRR. In computing the return of a fund as a whole, at a 10´ multiple on a 20% success rate of total investments in a VC fund, the IRR of the fund in the US would be 36% relative to 8% for Canada..(An exit multiple is defined as the terminal multiple at which a project is exited once a desired return on investment is obtained.)
These fundraising and investment patterns over time have given Canada the unflattering label “farm team”, a term that clearly suggests we sell our companies to other countries before they reach global status and scale.
But even though innovation centres, accelerators and provincial and federal governments have shifted their focus from starting to growing companies and to programs to support the scaling of startups and small- and medium-sized enterprises (SMEs), it may be too late. By the time Canadian companies need late-stage capital, their historically slower growth rates have already made them less appealing to investors used to dealing with quickly growing businesses.
The lesson for business advisors, policy experts, and government agencies involved in scaling Canadian firms is that we must encourage smaller companies to start raising money earlier, more often, and in larger amounts. This way firms can spend more money on critical functions such as marketing and sales (M&S) and research and development (R&D) and position themselves as attractive investment opportunities to fuel further growth.