Why Canadian startups still struggle for seed funding

A few years ago, a Canadian startup raising tens of millions of dollars would have been headline news, but it’s now becoming a daily event. Canadian venture capital just had its strongest first half on record, with nearly 400 deals averaging $21 million. VC funding has surged from $1 billion annually a decade ago to more than $8 billion in the past six months, and the world’s perceptions of tech in this country have been completely changed.

We’re awash in blockbuster funding deals, which is great. But the deals to lose sleep over are the smaller ones that aren’t closing.

While Canada’s most advanced startups are well capitalized, there’s a drought at the seed stage, where companies raise their first money to start developing ideas into products and secure initial customers. It’s at the top part of the capital funnel, the beginning of the pipeline for our national tech economy. Funding for these early ventures has barely risen since 2009, and angel investors cut their funding from $163.9 million in 2019 to $102.9 million in 2020 as COVID-19 forced deal-making online, and even as domestic VC funding flourished on the whole.

Angel deal size appears to be returning to normal this year, but even normal levels of early-stage funding are barely sufficient. While headlines and investors mostly focus on Canada’s shiny new generation of scaling tech stars — firms like Think Research, GHGSat, Boast.ai and Prodigy — many VCs still view early-stage investing as too risky. If they’re going to spend the time and money doing deep diligence and managing a portfolio, they might as well focus on more mature ventures, because their research efforts can be parlayed into bigger bets.

Deep knowledge of our rich tech landscape provides a different lens and feeds the pipeline of entrepreneurial activity Canadian tech needs to prosper. Without timely seed funding, a budding Axonify, Fiix, TopHat or Maple might never get off the ground, and there will be fewer great Canadian companies in the pipeline available for later-stage investment.

The good news is that there is a recipe for early-stage investment: sourcing, selecting and syndicating. These are the key ingredients of seed funding, which we have learned and apply every day at MaRS Investment Accelerator Fund, Ontario’s most active seed fund, with more than 150 deals over the past 12 years. Grown to national scale, this model can keep Canada’s pipeline well stocked.

Sourcing: As the top end of the opportunity funnel, seed-stage investing is full of companies that won’t make it; it’s the nature of the beast. This is not the stage to laser focus on one technology, one sector or one business model, as later-stage investors often prefer to do. The world can change in a heartbeat, as we all learned in 2020. IAF prefers to be sector agnostic. We lean toward fintech, cleantech, software and digital health, but that’s because our partnership with MaRS gives us access to a deep bench of expertise in those areas.

Selecting: For 12 years, we’ve been forced to stay within the boundaries of our original mandate from the Ontario government, which was to focus on seed-stage ventures with maximum IAF investments of up to $750,000. While many seed rounds are now larger than our maximum investment, we’re still valued as an institutional investor with extensive ties to later-stage deals. We are an unapologetically research-intensive fund. We get to know our companies well and build strong relationships to help them scale. You often see later-stage funds jockeying for pole position with more mature companies when big dollars are required, and not always getting the access they want. Or they’ll firehose small cheques around to early-stage companies with little diligence, hoping it will pay off with access later on. Neither of those approaches is ideal; our engagement and venture support process has served us very well.

Syndicating: Intimate knowledge of these companies doesn’t just benefit us, but the entire ecosystem. Other investors know how we work, and they pay attention to the decisions we make and the companies we work with. This helps us quarterback deals by building co-investment syndicates, and it helps us spur opportunities for follow-on funding, even if we don’t participate in those rounds ourselves. In the past dozen years, MaRS IAF has had 600 co-investors and driven $1.6 billion worth of follow-on funding.

In other words, seed funding isn’t just about returns. Those are table stakes, but a seed-stage focus is also about pushing the ecosystem forward, building a pipeline of great companies that grow and attract follow-on funding. Seed-stage funding may not be as “sexy” as billion-dollar valuations and blockbuster headlines, but it’s critical, and we’ve developed a model for doing it right. We should be scaling it up to help grow Canada’s national tech economy.