Seed Series Part II:
Alberta’s Early-Stage Capital Market is Broken
Bryan Slauko, CFA, April 2020
Alberta has a younger, less developed innovation ecosystem than British Columbia, Ontario and Quebec, who together received 85% of the total venture capital investment made in Canada in 2019. According to Canadian Venture Capital Association data, $227 million of venture capital was invested in Alberta in 2019. This represents only 3.6% of total Canadian investment activity. Why does Alberta receive such a small portion of total investment? Let’s review a few simple facts.
1) Part 1 of our Seed Series highlighted significant declines in the amount and pace of investment in both the $100,000 to $1,000,000 and $1 million to $5 million deal size ranges.
2) We’ve discussed the importance of these deal size ranges to early-stage start-ups today.
3) We know that 53% of Alberta founders identify as seed-stage start-ups. 62% indicate they need to raise an amount of capital that is less than $5 million. 59% have less than $500,000 in revenue.
Most of Alberta’s founders are caught in a stage where access to capital is very fragile, fragmented and incredibly hard to find. Their capital needs sit right in the range of investment that is being neglected by the traditional venture capital industry. Options are very limited. If Alberta’s early-stage founders cannot access the seed capital required to grow, they can’t hire, create jobs and generate wealth for investors. Alberta’s portion of total Canadian venture capital investment will remain low and we will continue to miss out on all the high-growth opportunities that exist here today.
Part 2 of our Seed Series takes a closer look at 1) the Alberta-based companies that comprise our innovation ecosystem to demonstrate the nature of their needs and the severity of the seed-stage funding gap today, and 2) the need to focus on educating local high net-worth investment communities to encourage investment where it’s needed most.
ALBERTA HAS A LARGE EARLY-STAGE CAPITAL MARKET
The 2018 Alberta Technology Deal Flow Study, released by Alberta Enterprise Corporation in February 2019, identified 1,238 privately held companies in Alberta’s innovation ecosystem. Their findings indicate Alberta has is a large population of early-stage companies needing access to funding that available data shows is not readily available to them. Some important highlights from this study include:
53% Of Companies Are In The Seed Stages Of Development
When we look at revenue later, we’ll see why this number is likely much larger. As illustrated below, only 7% of companies identify as being at the Series A stage. There is extraordinarily little deal flow to match the requirements Series A funds have today. A large funding gap results from the dearth of true early-stage funding sources.
70% Of Alberta Companies are Raising Money
The chart below illustrates the importance of the early-stage, pre-Series A funding market in Alberta, given 70% of companies indicate they are currently seeking funding.
48% of Companies Have Not Developed Traction
As demonstrated below, the study indicates 48% of companies have not developed significant traction yet. This includes 13% who have developed a prototype, 17% that are in commercial product development, and 18% that have launched a product. Many of these companies are experiencing the early-stage funding gap.
45% of companies indicated they have achieved traction and are scaling. ‘Traction’ is a particularly important word in Alberta when it comes to raising capital. To many Series A VC funds, traction means at least $2 million in annual revenue. To many angel investors, it means $1 million in revenue. To many founders, ‘traction’ is rightfully achieved much earlier.
71% Of Companies Have Less Than $1 Million In Revenue
The chart below identifies the reported revenue levels of the companies in the study.
Most of the 71% of Alberta companies with revenue under $1 million have likely experiencing the seed-stage funding gap. An incredibly large proportion of our ecosystem is exposed to a fragile and under-developed local capital market. These companies are too small for traditional venture capital. More and more angel investors overlook them as they look for meaningful revenue. Much of Alberta’s traditional oil and gas wealth sits on the sidelines, lacking the confidence to make impactful investments at this stage. A very high proportion of Alberta’s companies face an enormous funding challenge. One that many aren’t able to solve.
43% Have Less Than $100,000 in Revenue
Those that face the biggest challenge are the pre-revenue companies and those with less than $100,000 of revenue who represent a massive 43% of companies in Alberta. They represent enormous growth and investment potential, but they’re stuck in a familiar paradox – they need capital to grow their revenue but they can’t get capital until they have grown their revenue. They’re often overlooked in favour of companies with larger revenue. Why? Investors like to invest in things they know and are familiar with.
Much of our investment community is not familiar with these earlier-stage companies. They don’t know how to effectively complete due diligence and establish valuation. And there are very few active lead investors they can follow. It’s a primary reason why the early-stage funding gap could have such grave consequences for Alberta’s innovation ecosystem.
62% Need to Raise Less Than $5 Million
The chart below highlights just how critical investment rounds under $5 million in size are here in Alberta.
62% of the companies surveyed indicated they need less than $5 million.
32% indicated they need to raise less than $1 million.
Only 16% need to raise more than $5 million.