Bryan Slauko, CFA, June 2020
Alberta’s early-stage startups are in desperate need of capital that traditional venture capital funds are not going to provide and local investors are not ready to provide. Alberta’s early-stage risk capital market is very inefficient and unstable as a result. A massive early-stage funding gap persists where promising companies can’t access the capital they need when they need it the most.
Headlines Hide Real Challenges
Venture capital had a record year in Alberta in 2019, as it did across Canada. This is largely driven by a trend where VC funds are investing in larger, later-stage deals. $227 million of venture capital was invested in Alberta in 2019, an incredible increase from $100 million in 2018.
- It’s notable that 5 investments accounted for $105 million or 46% of the total 2019 investment and most of the annual increase.
- These investments range in size from $10 million to $40 million.
They are great local success stories. But these 5 large investments mean only $122 million was invested in smaller deals. Alberta desperately needs more sources of smaller, earlier stage investment. The challenges faced by many early-stage founders are very real and they’re holding Alberta back. Great ideas and talent are useless without the capital to fund them.
The average early-stage funding (Source: Startup Genome. Global Startup Ecosystem Report 2019) per start-up in Edmonton and Calgary is insufficient to be competitive with leading markets in Canada and the U.S., as demonstrated below.
Too many founders choose to leave Alberta and sometimes Canada as a result. Others simply run out of time and miss their opportunity. Either way, the wealth and well-being of our society loses out.
A sole focus on the success of these large investments masks two major problems Alberta is facing that will prevent our ecosystem from building the strong funding foundation it needs, if we don’t address them.
1. A significant discrepancy exists between the funding needs of Alberta’s innovators and the investments being made by traditional venture capital funds.
Our ecosystem is relatively young. According to Alberta Enterprise Corp.’s latest Alberta Technology Deal Flow Study:
- 71% of our companies have less than $1 million in revenue.
- 59% have less than $500,000 in revenue.
- 32% need to raise less than $1 million.
- 62% need less than $5 million.
Traditional venture capital funds do not generally focus on investments in companies that need to raise less than $5 million or have less than $2 million in revenue. Without access to venture capital funds, Alberta’s founders face a significant shortage of professional investment capital that meets our primary needs.
We estimate there is demand for roughly $300 to $500 million of early-stage capitalin Alberta that is not being met.
Canadian Venture Capital Association data highlights the challenge with smaller investment needs. According to the CVCA, in 2019:
- The amount of venture capital invested in deals between $100,000 and $1 million in Canada decreased by 50% compared to 2018 and totaled only $40 million.
Source: Global Startup Ecosystem Report 2019, Startup Genome.
- This represents only 1.4% of total venture capital investment in 2019.
This range is critical to Alberta’s founders as they begin to commercialize. Startup costs have declined dramatically over the past 10 years. For founders, $500,000 is the new $5 million.
- The amount invested in deals between $1 million and $5 million dropped by 20% in 2019, to $375 million.
This range is also critical to Alberta’s early-stage startups as they grow and establish product-market fit.
So where is all the investment in Canada going? In 2019, growth in mega-deals, or investments greater than $50 million, accounted for 85% of the $2.5 billion annual increase in total Canadian venture capital investment in 2019 (read more on this in Part I of our Seed Series: Canada’s Early-Stage Founders are Being Neglected).
There is clearly growth in venture capital investment in Alberta. It’s just not focused where our ecosystem needs it the most.
2. Local and regional investment is insufficient to sustain Alberta’s innovation ecosystem.
Early stage investment typically happens at the local and regional level. Investors like to be close to the companies they invest in. Knowing we can’t wait for traditional venture capital to fill the funding gap, we need active lead investors in our local investment community to play a major role. We need to mobilize Alberta’s large community of high net-worth individual, family and family office investors to help fill the funding gap.
Much of their capital is sitting on the sidelines, watching, and attempting to figure out how to invest in the ecosystem. We have a number of challenges to overcome:
- Much of this community has little experience investing directly in the ‘tech sector’ and doesn’t understand the fundamentals that drive value.
- Opportunities for exposure through similar high growth investing in the public markets are extremely limited as companies stay private much longer today than they used to.
- Much of this wealth is transitioning between the first generation that earned it and the second generation that is starting to actively manage it. Investment experience will be different. Perceived risk and appetite for risk may also be different.
Local investors need more opportunities to gain experience, knowledge, and confidence investing in the ecosystem.
We need to educate investors on the importance of private equity, including early-stage growth equity and venture capital, as part of a well diversified investment portfolio.
We must eliminate the mystery perceived by many investors and focus on the business fundamentals that will bring real accessibility and unlock this critical source of capital.
There Is No ‘Tech Sector’
To be successful in mobilizing this capital, we must simplify the investment community’s of innovation and the business models used to generate investment returns. We need to stop using terms such as ‘tech sector’, which are misleading and scare investors. There is no ‘tech sector’. Technology is prevalent across all sectors of our economy.
Innovation, disruption and transformation are nothing new for Albertans. Albertans have been investing in new ways of doing things for decades. Investing in today’s innovation ecosystem is no different. Innovators are simply using a new set of tools. Smart investors are, however, still evaluating the same familiar business fundamentals.
Locally Focused Lead Investors are Essential
Alberta’s early stage capital market lacks sufficient true lead investors who are focused on making the needed $250,000 to $1,000,000 investments in pre-revenue and early-revenue companies right here in our province.
Signaling theory plays a major role when a company lacks a lead investor. Very few investors are comfortable being the first in. Raising $1 million with $25,000 or $50,000 committed does not send a positive signal to the market. It makes potential investors wonder why nobody is investing. Most will take a pass or wait and watch. Especially if they’re not experienced investors in the ecosystem.
Raising that same $1 million with a lead investor in place who a) has completed and is willing to share its due diligence and b) is investing $250,000 to $500,000, sends a very positive signal that makes it much easier for other investors to follow. We need more investors to lead with strong conviction.
It’s Time to Modernize Alberta’s Early Stage Capital Market
Traditional venture capital has a strong presence in Alberta but in its current form, it can’t provide the strong foundation our early-stage capital market needs to thrive. Alberta’s early-stage risk capital market may not be broken. But it needs to evolve and mature, like many other developing ecosystems around the world. This includes:
- The growth of professionally managed, early-stage investment funds that truly focus on making the smaller investments needed in the funding gap identified above, and are willing to lead with conviction.
- A conscious effort to educate investors and operate with the transparency and alignment required to make investing in Alberta’s innovation ecosystem accessible to our local investment communities.
Read a more in-depth analysis on Alberta in Part II of our Seed Series. Part I, Canada’s Early-Stage Founders are Being Neglected, focuses on recent venture capital trends. Part III, What Alberta’s Early-Stage Funding Gap Means For Founders, addresses the impact of these trends on founders.
Metiquity Ventures is a Calgary-based early-stage growth equity fund founded to unlock growth potential for innovative founders on-the-cusp of commercialization and pioneering investors who invest capital alongside them.