Fading 2023 VC performance underscores Canadian tech’s “vulnerability,” BDC reports

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Down rounds rose from seven percent in 2022 to 31 percent last year.

Last year marked a “repeat year of recalibration” for Canada’s venture capital (VC) market as the industry continues to normalize following a record 2021, according to a study from the investment arm of the Business Development Bank of Canada (BDC).

Per BDC Capital’s latest Canadian VC landscape report, which was released today, 2023 also saw softening returns amid a proliferation of down rounds (a round of financing at a lower valuation than a company’s previous round) and markdowns for Canadian technology firms.

As previously reported by the Canadian Venture Capital and Private Equity Association (CVCA), BDC noted that $6.9 billion CAD in VC funding was invested across 660 deals during 2023—declines of 34 percent and 12 percent year-over-year, respectively, as overall activity continued to return to pre-2020 levels.

BDC expressed hope that the Canadian VC market is returning to “a point of sustainable growth.”

“After seeing VC activity come down from record levels in 2021 and witnessing interest rates reach new highs in 2023, the Canadian VC community was understandably feeling bleak last year,” the report states. “The numbers reported here, while not grim, underscore the ecosystem’s vulnerability.”

As interest rates rose to the highest levels since 2001, there was pessimism heading into 2023. BDC’s last report charted declining VC activity, economic growth, and a “gloomy outlook.” But despite some cracks, BDC’s latest study found that this “worst-case scenario” did not come to pass. 

According to the report, 2023 “showcased both signs of resilience and fragility—some cautious optimism is warranted but must be tempered by persistent fundraising challenges and subdued returns.” The insights are based on analysis of data from CVCA, BDC, and PitchBook.

BDC noted that macroeconomic headwinds have led to greater caution among VC fund limited partners (LPs) and general partners (GPs). In particular, “heightened diligence and caution” on the part of LPs has had an impact on Canadian GPs and tech entrepreneurs. LP influence has promoted discipline and improved standards among GPs and raised their expectations for portfolio companies, BDC claims.

Amid a challenging fundraising environment, BDC reported that many VC fund GPs have not been able to achieve their first-close or final-close targets or raise funds at all. Across the board, fundraising is taking longer, the report found.

RELATED: Q1 Canadian VC funding posts mixed results as PE market rebounds, CVCA reports

The report also found that VC returns declined. In 2023, 10-year internal rates of return (IRR) for Canadian VC funds decreased to 11.7 percent, following a similar downward trajectory as United States (US) VC returns, while continuing to “gradually narrow the gap between the two countries’ long-term performance.”

Meanwhile, BDC found that the one-year VC IRR for Canada dropped into negative territory, falling by more than 11 percent, “largely influenced by valuation corrections following the exuberance of 2021.” Contributing factors include an increase in down rounds and proactive adjustments by GPs. One-year IRR for VC globally also fell by a comparable amount in 2023, clocking in at the lowest among all private-capital asset classes.

Ten-year VC net returns also dropped slightly but stayed in double digits last year at above 11 percent, while some vintages were also hit harder than others, the report found. For its part, the median distributed to paid-in capital improved across all vintages in 2023 save for 2020–2022, which remains young.

The proportion of down rounds last year had an impact on these figures. Down rounds rose from seven percent in 2022 to 31 percent in 2023. BDC also found that in 2023, median cash runways got shorter, bridge financings declined, and venture debt funding lost steam.

RELATED: Report: Canadian corporate VC funding is dismal compared to the US

However, compared with global VC investment, Canadian VC experienced a slower decline in terms of total dollars invested in 2023.

Per BDC, late and growth-stage investments were hit hard last year both in Canada and globally. VC put into late-stage Canadian companies was almost cut in half in 2023 relative to 2022, while the late-stage deal count dropped by 19 percent. By dollars invested, early-stage VC saw a smaller decline than later and growth stages.

Sector-wise, the BDC reported that the life sciences and energy and clean technology (ECT) sectors demonstrated some strength in 2023. While the information and communication technology (ICT) sector still accounts for “the lion’s share” of VC investment, Canada has notably seen a “slight reallocation and increased investor interest” in life sciences and ECT, which both drew a larger share of total VC dollars invested last year than in 2022.

At the same time, BDC identified “considerable gaps” at both the earliest and latest stages in the life sciences and energy and ECT in terms of active private Canadian VC funds backing pre-seed, seed, late VC, and growth equity-stage companies.

RELATED: Lack of inclusion, unclear parental leave still hamper retention of women in Canadian VC

The initial public market offering (IPO) market remained cool as only one Canadian VC-backed company—Turnstone Biologics—went public via IPO in 2023, noted BDC. Meanwhile, mergers and acquisitions (M&A) reached record-high exit values last year, driven by a few large deals, including GaN Systems, Chinook Therapeutics, Inversago Pharma, and Carbon Engineering.

For the second consecutive year, the report found over half of VC transactions in Canada included foreign participation. This indicates that investors from other countries, including the US, continued to consider Canadian VC an attractive asset class amid current market conditions.

Investor interest in life sciences and cleantech increased during 2023.

BDC estimates that Canadian-headquartered VC investors hold $10.4 billion in dry powder, or committed but unallocated capital. Citing PitchBook, BDC reported that as of last year, US VCs were sitting on a record $421 billion in dry powder.

Speaking to the outlook for Canada’s VC market in 2024, BDC believes this data “reveals the possibility for slight optimism,” but acknowledged that challenges remain.

“As the industry looks to demonstrate enduring profitability, the bar for new investment will be raised,” stated the report, which added that Canadian tech companies and GPs that are unable to meet these expectations will continue to face difficulties fundraising.

If annual VC returns continue to drop for another year, BDC anticipates that average five-year and 10-year returns will likely drop to single digits. If that happens, BDC expects some institutional investors to reallocate more of their VC dollars to other asset classes.

The report ultimately expressed hope that the Canadian VC market is returning to “a point of sustainable growth.” If anticipated interest-rate cuts come to fruition this year, BDC noted that M&A activity may increase, and the lower cost of capital may help sustain current VC activity.

Feature image courtesy BDC.

Josh Scott

Josh Scott

Josh Scott is a BetaKit reporter focused on telling in-depth Canadian tech stories and breaking news. His coverage is more complete than his moustache.

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