As the recession continues to impair the movement of capital, and financial markets worldwide sit dormant, Canadian private equity suffers from a similar malaise, with buyout and venture activity at an almost dead halt. The robust flurry of asset movement within the Canadian buyout and venture capital fields that so energized the industry up to 2007 has been replaced by an uneasy standstill in which investors, entrepreneurs, and fund managers are faced with the rebuilding of the private equity marketplace.
“The impact of the financial crisis has been profound,” says Sacha Ghai of the McKinsey Group consultant/data firm. “Private equity lives off of the availability of credit, and until capital becomes available, it’s difficult for deals to go through.”
Canadian private equity, however, is at a relatively healthy point compared to its counterparts around the world, largely due to the health of Canadian banks. “[Banks] have weathered the crisis far better than they have in the United States, and there haven’t been any that have gone under,” says Ghai. “There is still capital to lend and this has to an extent muted the negative effects on the PE market.”
“The two strengths the market has is its focus on mid-market buyouts ofbetween $30 and 100 million and that buyouts aren’t leveraged asdramatically as they are in the U.S.” –Greg Smith, President, CVCA
Jacques Foisy, president and managing partner of Quebec-based private equity group Novacap, agrees. “When you come up with a good deal, the banks are still there to play,” says Foisy. “It gets more complicated with the larger deals, but overall there is still good banking support for private equity.”
Because of their stable banking network, Canadian private equity, particularly buyouts, suffered less through the crisis than the rest of the world. Canadian buyout and other PE fund managers disbursed a total of $6.7 billion to 562 deals in 2008, down 57 percent from the figures in 2007. This normally would not be perceived as good news, but compared to the losses suffered on a global scale—buyout activity dropped 71 percent from $590 billion in 2007 to just $170 billion last year—it demonstrates that Canada’s PE markets are relatively at ease.
Canadian Venture Capital & Private Equity Association (CVCA) President Greg Smith agrees that the Canadian private equity climate is healthier than some would fear. “The two strengths the market has is its focus on mid-market buyouts of between $30 and 100 million and that buyouts aren’t leveraged as dramatically as they are in the U.S.” Smith says that this more conservative approach has taught PE managers to be able to work within the confines of constrained credit conditions far better than they would be able to otherwise.
As the recession tapers off, many predict that PE will enjoy a quick recovery, largely due to the much-touted $1 trillion in unused investment capital that has accumulated in global PE fund coffers. “The money is still there,” says Foisy. “It’s just not being invested, but it will return to the market.” Moving forward, however, PE companies would be advised to look to operate differently than they did in the boom leading up to the financial crisis, says Ghai: “Investors should look to new markets and new types of investments.”
Ghai points in particular to private investment in public equity (PIPE) transactions, in which private funds look to take large stakes in public companies. “The PE firms need to bring the same virtues to public firms that they would to a private firm,” says Ghai. He also points to the opportunities provided by foreign investment groups, which made up an astounding 54 percent of Canada’s new PE commitments in 2007, and can be expected to resume such activity in the post-recession market.
Though buyouts may appear poised for a comeback, the same cannot be said for Canada’s venture capital industry, unfortunately, which suffered significantly in 2008. While $1.5 billion was disbursed to VC transactions in 2007, 2008 saw this number decline 20 percent to $1.2 billion. By comparison, VC investment in the United States suffered only marginally, dropping from $30.8 billion in 2007 to $28.2 billion in 2008. The losses, according to the McKinsey Group’s year-end findings, “[suggest] more than just a cyclical change in response to broad economic retrenchment,” and “systemic challenges.” “VC is running into a huge capital shortfall,” says Smith, who points to a meager $149 million invested in the first quarter of 2009 that suggests the climate is only worsening.
Canada’s VC field has in the past shown its value in sponsoring innovation across a number of industries. Highlights include the triumph of Research in Motion, the Ontario-based wireless developer responsible for the ubiquitous Blackberry wireless devices—a technological success only made possible through significant fundraising in the late 1990s. Canada currently has almost 1,800 companies vying for an increasingly scarce amount of funding. Returns, however, seem not to justify such investment—Canadian VC investments post 10-year returns of negative 2.8 percent, compared to 10-year returns of 16.6 percent for their U.S. counterparts. “Canadian VC is sub-scale,” says Ghai. “The funds are smaller, the capital commitments are a fraction of what you’d see in the U.S., the hold period is shorter, and it’s a pretty weak venture industry overall. This has a lot of implications, as VC is responsible for sparking innovation and industries, and it’s a bit of a millstone around the neck of Canadian innovation.”
Ghai points out that weak VC performance leads quickly to “death spiral,” in which the worse venture investments pan out, the less likely they are to earn future funding. Smith acknowledges this danger, but points to the government as a possible source of assistance. “People are recognizing that the administration has a role to play in sparking the VC market; the government needs to provide funds, and that’s what they’re starting to do.” Recently-launched government funds such as the $250 million Ontario Emerging Technologies Fund and the $825 Quebec Venture Capital Fund hope to drive start-ups in spite of the tightened investment climate and look to bring Canadian VC back to an even keel. “If the money is there to support a temporary situation, a cash-flow crisis, it’s good for start-ups,” says Foisy. “But it can’t be a long-term solution.” Indeed, Canadian VC is going to have to determine its own path to financing if it wants to continue as a proud pillar of the Canadian marketplace.