Opinion: As venture capital falls, Canada risks losing an entire industry to the US – again

As investors pull out, Canadian deep-tech startups could soon be starving for capital when they — and Canada — need it most.Markus Sommerfeld

Thomas Park is Lead Partner of the BDC Deep Tech Fund and co-founder of the Asian Canadian Ventures Collective.

As a lead partner in the Business Development Bank of Canada’s $200 million deep tech fund, I live by my values.

I want to make a meaningful impact on the lives of Canadians, and I believe what the fund is doing – investing in novel, uncommercialized technology, or “deep tech” – is the best way for me to do that. After our first year, we’re proud of the investments we’ve made, including positions in Xanadu Quantum Computing and Armilla AI.

But while we still have plenty of capital to invest in Canadian deep tech founders, we are concerned about current market conditions and their long-term impact on the deep tech ecosystem.

The perfect storm for the Canadian venture capital market has landed. Founders are worried about their next round of funding and investors are predictably more risk-averse.

All of this makes a lot of sense – until you dig a little deeper. Although market corrections bring a more disciplined investment approach, there is an even greater risk looming. As investors pull out, Canadian deep-tech startups could soon be starving for capital when they — and Canada — need it most. We risk irreversibly decimating an entire industry, as has happened before.

The deep tech sector includes start-ups whose business models are based on high-tech innovations in engineering or major scientific advances in areas such as quantum computing, photonics and fundamental AI. Their time-to-market is much longer than other companies, but their impact on the wider economy has the potential to be transformative. For example, quantum computing startups are developing computing capacities that far exceed those of existing supercomputers.

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But the market is not playing along. There were exactly zero tech-related IPOs in Canada in the third quarter of 2022. The Canadian Venture Capital and Private Equity Association reported that invested venture capital dollars fell by a staggering two-thirds in the first half of the year, even as total investment remained historically high for the year. In the third quarter, VC dollars fell 50 percent sequentially.

Some startups are hoping investment will pick up again soon given the amount of capital VC funds are holding: an estimated $290.1 ​​billion worldwide. But such hopes could be wishful thinking. Funds are clearly being held back as prospects for raising additional capital remain uncertain. Instead, their capital will likely be used to support existing portfolio companies.

Continued volatility in public markets coupled with anemic economic growth projections means there will be no quick return to easy VC money, particularly in deep tech, where VCs have hit the brakes quicker than other sectors.

That’s no surprise. In a recent article, several scholars, including Harvard’s Josh Lerner, examined the impact of downturns in the VC market on innovation between 1976 and 2017. Not only did they find that VC markets are largely procyclical and related to public markets and public markets ebb and flow, they also found that when times were down, VCs were less willing to support startups with more innovative patents. Deep tech founders should be particularly concerned.

While this tighter regime may be necessary for the broader tech sector, deep tech startups cannot afford an additional liquidity crunch. And Canada cannot afford not to support them.

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Paradoxically, one of the best opportunities to invest in Canadian deep tech is now. Downturns mean that the brightest founders stay the course, highly specialized talent becomes available and the best investors stay in the market.

Canada is uniquely positioned to be a global leader in deep tech startups. We have world-class research and development capabilities: The World Intellectual Property Organization’s Global Innovation Index ranks Canada in the top 10 for global innovation contribution. And there is a national network of top accelerators — like Creative Destruction Lab, Velocity, and Communitech — to support the commercialization of the science emerging from these labs. Xanadu Quantum Technologies, the Canadian champion in photonic quantum computing, is a global leader today because so many players within the deep tech ecosystem have supported them along the way.

But the growing headwinds facing Canada’s VC market puts us at risk of losing many of those gains and will certainly exacerbate Canada’s longstanding R&D commercialization gap. WIPO ranked Canada a disappointing 24th in the world for the granting and ownership of patents. Canada’s R&D investment as a percentage of GDP continues to lag the Organization for Economic Development and Cooperation average. The current market situation will further limit our ability to design, manufacture and export high-tech products.

We’ve seen this before. In the mid-2000s, a weak deep-tech ecosystem meant foreign investors could acquire Canadian intellectual property in AI. Today, Canada has some of the best AI researchers in the world, and yet many are in paid partnerships with foreign tech companies and export publicly funded research for others to commercialize.

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The BDC Deep Tech Fund was formed to prevent this. Our fund invests in Canadian startups with high technical challenges but the potential to become global champions. Where traditional investors see too much risk, we address it. In addition to providing capital, we bring in partnerships with the leading research centers in the country, such as B. Mila in Montreal to help these founders overcome their technical challenges.

Canadian universities need to do more to commercialize their research. Canadian companies must ignore accountant’s call for cuts on deep-tech startup projects. And as a country, we need to focus more on driving deep tech commercialization better.

At this critical fork in the innovation journey, Canada can either gently confirm the trend of a long winter for deep tech startups or choose to become a bold outlier and global leader. With much at stake, I hope we are on the right track: one that leads to new and exciting Canadian trade and innovation successes.