Seed Series Part II:

Alberta’s Early-Stage Capital Market is Broken

Bryan Slauko, CFA, April 2020

OVERVIEW

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.

The <$5 million and <$1 million round sizes are the most needed in Alberta. However, funding in these ranges was down 20% and 50%, respectively, in 2019, as we identified in Part 1 of our Seed Series. These sizes of investments are at the core of the early-stage funding gap in Canada.

AVERAGE VC DEAL SIZES ARE BEYOND REACH

CVCA data tells us the average size venture capital investment in Alberta in 2019 was $5.8 million. As illustrated below, it’s grown quickly over the past three years to a level that beyond the needs of almost two thirds of our entire ecosystem. Alberta very clearly needs a more established early-stage capital market to serve these founders.

INVESTOR EDUCATION IS CRITICAL TO FILLING THE GAP

The #1 reason investors choose to make an investment is confidence. Uncertainty leads to capital staying parked where it is safe.

Alberta has a large investment community of high net-worth individual and family office investors who are deeply rooted in oil & gas investing. Much of this capital is sitting on the sidelines, watching and waiting to figure this ecosystem out. We need to mobilize this capital.

The biggest challenge we face in doing this is that our collective education level on investing in the ‘tech sector’ is limited given a lack of history of direct investing in the ecosystem. Further, opportunities for investment through the public markets are very limited as companies stay private much longer today than they used to. Public markets are how most investors get exposed to different industries and educated on their fundamentals.

Further, much of this wealth is transitioning between the first generation that earned it and the next generation that is starting to actively manage it. Previous public and private market experience may be lost in this transition. It’s difficult to gain confidence investing in something that you have very little experience with. The inexperienced and the younger generation may be more conservative until they’ve gained the experience that makes them confident. The easy decisions that result are to either:

1) remain on the sidelines while you watch and learn, or

2) as is very common, invest a small amount of capital based on what you are willing to ‘throw away’ if things don’t work out.

Neither of these strategies helps Alberta’s ecosystem or economy, and both mean that investors are missing out on significant opportunities to create wealth for their families. An educated investor is much more likely to develop a proactive portfolio approach to investing in our innovation ecosystem. Educated investors better understand the need for growth in their portfolio and diversification benefits that come from investing in private equity and venture capital in a meaningful way.

There Is No Tech Sector

Investing in innovation is deeply rooted in Alberta’s history. We’ve been investing in new ways of doing things for decades. Investing in our innovation ecosystem is no different. All we’re really doing is investing in companies that use technology to digitally transform industries we’re very familiar with. We’re helping to solve problems and create new opportunities. As investors, we’re evaluating many of the same business fundamentals as oil & gas investors.

Often used terms such as ‘tech sector’ are misleading. There is no ‘tech sector’. Technology is prevalent across all sectors of our economy. This kind of lingo creates perceptions of a mysterious black box that’s hard to understand and summons memories of the dot com era for many. That will easily scare investors away. Let’s keep this as simple as it really is, make it relatable and make the asset class more accessible to investors.

Now is the Time

We believe it’s up to us as private investors to step up and make change happen. We can complain and wait for government incentives that are out of our control, may disappear over time, and aren’t a primary driver of investment decisions for much of Alberta’s high net worth investment community. Or we can take control and invest in something that will never disappear – the education of our investors.

We’ve demonstrated a very inefficient early-stage capital market here in Alberta. Inefficiency is music to the ears of professional investors. It’s where money is made. And it’s where many innovative investors will build wealth and ensure high quality jobs for their families, their kids and for future generations.

Part 1 of our Seed Series, ‘Canada’s Seed Stage Founders are Being Neglected‘, focused on trends in venture capital investment and identified the gap exposed as a result of the focus of traditional VC investment on larger and later-stage deals.

Part 3 of our Seed Series, ‘What the Funding Gap Means for Founders‘, looks at the impact of the changes in venture capital on founders, the challenges they are facing, and how they need to adjust their plans to attract the funding that’s actually available to them.

METIQUITY VENTURES

Metiquity Ventures is a Calgary-based early-stage growth equity fund partnering with innovators to modernize the regional funding ecosystem, unlock emerging growth potential and protect our families’ futures.

We partner with innovators in emerging innovation hubs who are creating long-term, systemic business value and are on the cusp of commercialization and significant growth, regardless of industry. We focus on early-stage investments where we can amplify the impact of our expertise and help partner companies accelerate growth by implementing the efficient use of systems, processes, and a well-defined purpose. We make meaningful lead investments in up-and-coming companies using technology to digitally transform and fundamentally disrupt the way traditional industries operate.