Why some U.S. venture capitalists are seeking out deals with Canadian startups
Note: This post originally appeared in National Post. Story by Anwar Ali.
When it comes to raising money, there’s little room for patriotism, Carl Mercier, co-founder and chief executive of Toronto-based VarageSale, contends.
Last April, VarageSale announced a $34-million Series B round of financing led by Menlo Park, Calif. heavyweights Lightspeed Venture Partners and Sequoia Capital — the latter one of the most recognizable names in U.S. tech exits, with just shy of 12 in the past 2½ years.
Mercier admitted he likely could have raised the same amount with Canadian investors, but with fewer firms dealing in that capital tier, it would have been a lot harder. And along with U.S. money comes the prestigious Silicon Valley stamp of approval, he said.
“We wanted to make sure we were very well connected to the Valley. In our space, everything happens in Silicon Valley. Being isolated only in Canada felt like a risk.”
A third of all venture-backed deals in Canada last year involved foreign capital, and nearly three-quarters of the $1.98 billion raised was a mix of Canadian and foreign dollars, the Canadian Venture Capital & Private Equity Association (CVCA) said. The numbers in 2015 are trending along similar lines, with 75 deals worth $656 million in combined foreign and Canadian money raised in the first six months.
While greater exposure has Canadian startups seeking financing in the U.S., the motivations vary for why U.S. venture capitalists trek north. In September, several U.S. investors attended the Venture North Conference hosted at MaRS in Toronto. Some said they came for reconnaissance, others were checking in on firm commitments already in place.
In most cases, VCs have a mandate to look for ideas beyond geographical boundaries, but there’s something that makes Canada uniquely compelling to some.
“I’ve always had a passion for working with Canadian entrepreneurs. I know what they’re capable of. They have a chip on their shoulder,” said Tim Wright, a partner at GrandBanks Capital in Boston, adding that chip is born from the constraints of dealing with less money and resources than their U.S. counterparts.
Wright has a long history of deal-making in Canada and built SoftKey alongside Kevin O’Leary before selling it to Mattel for more than US$3 billion in 1999. Wright said his firm has had immense success with its Canadian investments, which comprise a quarter of the firm’s portfolio. GrandBanks achieved positive returns on all five of its exits, including its most recent, Razor Suleman’s Achievers, which was sold to Blackhawk Networks for US$100 million in June.
“Our deals here, we’re batting 100 per cent. We’ve made money on every deal. We can’t say that about the U.S.,” he said.
Not every VC firm that comes to Canada can match that success rate, while others focus on certain growth stages or sectors, and are location agnostic.
“Sometimes the leader or promising company in [a particular] category happens to be outside of Silicon Valley,” said Aydin Senkut, founder and managing director of Palo Alto, Calif.-based Felicis Ventures, an early investor in Ottawa-based Shopify, which raised $131 million in a May IPO. Felicis has seven investments in Canadian startups.
Ajay Royan, a Canadian investor based in San Francisco, also likes to explore beyond the Valley. “Growth is really hard to find. You have zero to negative growth in most parts of the world right now,” said Royan, managing partner and founder of Mithril Capital Management, which has raised US$540 million. Geographically, Mithril’s investments range from Munich to Toulouse and Kansas, because the firm values communities where there’s “high conviction.”
Royan also is attracted to innovation clusters including Waterloo. “Those are rare. Every city worth its salt argues that it has one. Very few have world-class winners come out of their ecosystem.” While Mithril has yet to invest in Canada, Royan said the firm is actively watching and has several non-disclosure agreements on the go with Canadian startups.
The role of the U.S. investor here is evolving, said John Ruffolo, CEO of OMERS Ventures, one of Canada’s largest investors. Canadian startups used to go south to get early stage risk capital because it barely existed here, he said. But now, with the emergence of a new class of firms such as Real Ventures and Georgian Partners, that niche is being served, deferring the deeper U.S. pockets to later financing rounds.
“When you go into scale mode, a lot of the talent is actually not here. It’s not a deep enough bench,” Ruffalo said. “You need that foreign risk capital, particularly in the Valley or New York or Boston to cut the big cheques and to help scale the company.”
OMERS and other Canadian firms cannot put up the entire sum growing companies demand, he said. Partnering on deals with Canadian investors offers U.S. venture capital firms a couple of things: a local market expert, and a gateway to currency-leveraged discounts at reasonable valuations.
Grandbank’s Wright said Canadian startups tend to be more advanced than U.S. startups at the same financing round. “A Canadian Series A and a U.S. Series A look very different. A Canadian Series A [company] has customers; they have revenue; they have a product that’s generally available.”
U.S. firms, though, draw the line at establishing a physical presence. For a boutique firm like Felicis, it’s not financially possible and strategically, it doesn’t make sense. “It’s not a great idea for us to open up an office here and think that coming from Palo Alto we can add value,” Senkut said.
As for rumours of talent drain, VarageSale’s Mercier noted: “We raised money from the U.S. and we’re still here. I think investors understand that asking a company to move across the continent for them to write a cheque doesn’t necessarily make a lot of sense.”