Opinion: As venture capital declines, Canada risks losing an entire industry to the U.S. – again

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

As the lead partner of 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 that what the fund does – invest in novel, yet-to-be commercialized 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’re 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 concerned about their next financing and investors are, predictably, more risk-averse.

All of this makes a lot of sense – until you dig a little deeper. Though market corrections bring a more disciplined investment approach, an even greater risk is emerging. As investors pull back, Canadian deep-tech startups could soon be starving for capital at a time when they – and Canada – need it most. We risk the irreversible decimation of an entire industry, as has happened before.

The deep-tech sector includes startups whose business models are based on high-tech innovation in engineering, or significant scientific advances in areas such as quantum computing, photonics and foundational AI. Their times to market are much longer than those of other companies, yet their impact on the broader economy has the potential to be transformational. For example, quantum computing startups are developing computational capacities that far exceed those of existing supercomputers.

But the market is not co-operating. There were exactly zero technology-related IPOs in Canada in the third quarter of 2022. The Canadian Venture Capital and Private Equity Association reported that, while total investment remained historically high, venture capital dollars invested dropped by a staggering two-thirds in the first half of the year. In the third quarter, VC dollars dropped 50 per cent from the previous quarter.

Some startups are hoping investment will pick up soon, given the amount of capital VC funds hold: an estimated US$290.1-billion globally. But such hopes might be wishful thinking. Funds are clearly withholding, 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 forecasts means there will be no quick return to easy VC money, especially in deep tech, where VCs have hit the brakes at a faster rate than they have in other sectors.

This isn’t a surprise. In a recent paper, several academics, including Harvard’s Josh Lerner, studied the impact of VC market downturns upon innovation between 1976 and 2017. Not only did they find that VC markets are largely pro-cyclical, ebbing and flowing with the public markets and the economy, they also found that, in lean times, VCs were less willing to back startups with more innovative patents. Deep-tech founders should be particularly concerned.

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

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

Canada is uniquely positioned to be a world leader in deep-tech startups. We have world-class research and development capabilities: the World Intellectual Property Organization Global Innovation Index ranked Canada in the top 10 in global innovation input. And there is a national network of top accelerators – such as Creative Destruction Lab, Velocity and Communitech – to help commercialize the science coming out of these labs. Xanadu Quantum Technologies, the Canadian champion in photonic quantum computing, is now a world leader because so many actors within the deep-tech ecosystem supported them through their journey.

But the growing headwinds facing the Canadian VC market put us at risk of losing many of these gains, and will certainly exacerbate Canada’s longstanding R&D commercialization gap. WIPO ranked Canada a disappointing 24th globally in originating and owning patents. Canada’s R&D investments as a percentage of GDP continue to trail the Organization for Economic Development and Co-operation average. The current market situation will further inhibit 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 that foreign investors were able to acquire Canadian intellectual property in AI. Today, Canada has some of the top AI researchers in the world, and yet many are in paid partnerships with foreign tech companies, exporting publicly funded research for others to commercialize.

The BDC Deep Tech Fund was created to stop this from happening again. Our fund invests in Canadian startups with high technical challenges, but the potential to be global champions. Where traditional investors see too much risk, we embrace it. Aside from providing capital, we bring partnerships with the country’s leading research centres, such as Montreal’s Mila, to help these founders overcome their technical challenges.

Canadian universities need to do more to commercialize their research. Canadian corporates need to ignore the accountant’s call for cuts to projects with deep-tech startups. And, as a country, we need to put a greater focus on better fuelling deep-tech commercialization.

At this critical fork in the innovation road, Canada can either meekly validate the trend of a long winter for deep-tech startups, or choose to become a bold outlier and global leader. With a lot on the line, I hope we pick the right path: one that leads to new and exciting Canadian commercial and innovation success.