Toronto lawyer Suzanne Dingwall Williams wrote a piece for the CVCA blog this week lamenting how often the startups she works with choose to seek investment from American VCs over their Canadian counterparts.

If that's the case, it sounds like another significant difference between the Toronto and Waterloo startup communities. In these parts, if you go much farther than Toronto to look for early stage capital you risk being accused of being exotic. It happens, but not often. Of the six seven-figure seed/early-stage deals we saw last year, I think only one involved a foreign investor. That seems to be consistent with the national statistics, which saw most foreign investment being put into later stage deals.

In the same post, Dingwall Williams also writes about the reputation of Canadian VCs being tarred by American brushes, but from a Waterloo perspective, I'd be shocked if one startup founder in ten here knows anything about Blackstone and Stephen Schwarzmann, to use the example she cites. Actually, my guess is that's true in Toronto as well. Some may be aware that VCs have been very well paid and that—with some exceptions—they haven't come close to delivering results consistent with that compensation. But that's made-in-Canada tar. The CVCA and others have published rates of return for Canadian VCs and the numbers don't paint a flattering portrait of the industry. There may have been an emperor-has-no-clothes epiphany on the part of LPs and entrepreneurs toward Canadian VCs but, from what I've seen, this has had more of an effect on LPs than on startup founders.

From any perspective, I don't agree with her view that startups should feel a "moral imperative" to get funding from Canadian VCs. That's straight out of "buy Canadian" campaigns that encourage you to buy products that you would otherwise avoid just because it might help keep people employed and extend the amount of time they spend making second-rate products. If that's the best pitch we can make for Canadian VCs we might as well just shut the whole industry down now. [Actually, with Canadian VCs collectively showing almost zero rates of return, from a strictly economic perspective it would have been better if we had let American VCs make those investments and put our money to more productive use. I wouldn't recommend that either. :-)]

Startup entrepreneurs should go where they can get the best deal for their companies. Fortunately, that will often be with a Canadian VC. What we do seem to be seeing, though, is that a greater percentage of startups today are companies where bootstapping or sub-VC funding are all that's needed to get a product to market, and often to get companies to a point where they are acquired (usually by American firms ... at that point you don't hear many complaints about foreign ownership). Of those six deals from 2007 I referred to, only one of them involved a VC, and even that also included angels.

For that reason, there has been the disconnect between startups and VCs that Dingwall Williams refers to. But that's okay. Not all promising startups need VC funding. That was really an artifact of the boom years. As long as companies get the funding they need, I'm not going to lament that a shrinking percentage of startups are paired with a VC.

Unfortunately for the Canadian VC industry, many of its current problems are linked to matters of history that can't be rewritten with better mission statements and promotional campaigns (although, on the subject of marketing, I think Rick Segal has done an amazing job of both getting himself over and improving the reputation of the entire Canadian VC industry). But the message from startup entrepreneurs I'm hearing in Waterloo is more that they often don't see the need to work with VCs, not that they are avoiding Canadian VCs in favour of American investors.

Congratulations to online drugstore Well.ca, which announced today that it has closed a round of funding—one that has been several months in the making. The size of the round wasn't disclosed, but the investors were Jim Estill and Toronto's Maple Leaf Angels. It's the first external funding for the company and also seems to be the first deal that Maple Leaf Angels has announced.

It's the latest in a string of angel-backed deals for local startups. As I mentioned before, we had six companies raise seven-figure seed rounds in 2007 and every one of them involved angels (although one—AideRSS—was led by VC firm Tech Capital Partners).

Through Communitech, I first talked to Well.ca founder Ali Asaria late in 2006, and the entire entrepreneur services team—and I think just about everyone else at Communitech too—has enjoyed working with Ali and his team ever since and I think he's been to all our WatStart get-togethers, so it's been fun to see his company succeed.

The Canadian Innovation Exchange (CIX) is being held in Toronto at the end of this month. If selected, a company looking for early-stage funding pays $600 to give a presentation to an audience that includes several VC firms and other potential investors.

Even though there's a Communitech logo on the site (which I had nothing to do with—I've had no contact with anyone organizing this event), and my colleague Ron Neumann is a scheduled presenter, I have mixed feelings about these kind of events.

For entrepreneurs, it certainly seems convenient to get your company in front of several investors with just one pitch. I'm sure some would say that the amount of time saved when compared to arranging individual meetings with each investor justifies the fee by itself. And there's no question that there are some good speakers scheduled for CIX.

On the other hand, these events reinforce the myth that companies need to pay intermediaries (in this case, the event organizers) to get in front of VCs, or at least that it's beneficial to do so. It's something I mostly associate with the leeches and hangers-on who try to charge startup entrepreneurs a fee for introducing them to VCs. Thankfully, there aren't as many today as there were back in the bubble era, but it still goes on.

Here's a little secret: it's not difficult to get a Canadian VC to look at your business. Getting them to invest is, but that's equally true for companies that present at VC events. They aren't hard to find and contact, and it won't cost you anything.

I know people at most Canadian VC firms (including almost all of the firms whose logos appear on the Canadian Innovation Exchange site) and can guarantee you that, if you have a good investment opportunity for them, almost all of them would be happy to come to Waterloo to hear more. You won't have to hope to be selected for some dog-and-pony show in Toronto and pay hundreds of dollars. Introductions certainly help, particularly coming from someone investors believe will filter out the junk, but you don't have to pay for them. If you have a VC-fundable business, every member of Communitech's entrepreneur services team can hook you up with VCs at no cost.

I agree with Alec Saunders, who last week compared the event to a beauty pageant and said he found a lot not to like in the model. If there had been more U.S. investors participating (there are some), I might have found it to be more valuable. There are so many of them, your degrees of separation will likely be greater than one—which won't be the case for Canadian VCs—and most will expect you to go to them, which starts getting expensive.

But to get in touch with most of the people scheduled to be at CIX, I can't say that signing up for an event would be the way I'd go about it.

Going over the numbers for 2007, it looks like it was a record-setting year for startups in Waterloo Region.

We had six companies close seven-figure seed or early stage rounds (that is, pre-A-rounds) of funding in the year, which I don't think has happened before. And that's not including the $10 million in funding for RapidMind, another Waterloo Region startup.

Of those six deals, only one was announced in 2007, so even if you read every news release, every newspaper, every report from Thomson Financial, and every issue of the Ontario Securities Commission Bulletin, you wouldn't have come across any of the other five. 

Despite the tales told through the year of the imminent collapse of venture capital in Canada, data released by the Canadian Venture Capital & Private Equity Association (CVCA) last month showed no decline in activity by Canadian VC firms in 2007 and a 21% increase in VC investment in Canada, taking the total to $2.1 billion, thanks to increased participation of foreign investors, particularly U.S. VC firms.

Just over half (by dollars) of all investments went into IT firms, with $1.1 billion invested in 194 companies. That's an average deal size of $5.7 million, so obviously a lot of what's going into this total are not early-stage investments in software companies.

These numbers apparently include American Capital's announced $160 million investment in Geosign. American Capital later said that it recovered a "substantial" part of its investment after Geosign's business model collapsed shortly after the deal closed.

Canadian VC firms raised $1.2 billion in 2007, according the the CVCA, down from $1.6 billion the previous year. About 62% of the money raised in 2007 went into labour-sponsored funds. The CVCA says the drop in investment in LSIFs was much smaller than the drop in funds raised by non-LSIF funds—despite the scheduled removal of the LSIF tax credit in Ontario.

The number that might give the most reason for concern is the difference between amounts raised and invested in Ontario. According to the CVCA data, in 2007 Ontario VC firms raised less than one-third of the amount that was invested in Ontario companies.

As I've discussed before, no one really knows how much capital is invested in Canadian companies. Even the federal government doesn't know. What the CVCA data includes are the deals that were disclosed, which would provide a floor for the actual number. In another post I'll take a look at some of the numbers for Waterloo Region, which suggests that this "floor" number may not be a very good estimate of the total.

In his latest column, Celtic House's Andrew Waitman discusses how winning startups can be distinguished from losers at an early stage, or at least some of the warning signs that a startup might not be accelerating down the runway headed for takeoff.

He identifies three things to look for:

• The skills, experience and drive of the management, employees, board and advisors
  
• The company's track record in identifying and achieving goals and priorities
  
• Revenue growth

The Ontario government announced today (or re-announced, since this was part of the March 2006 budget) that it is creating a new $165 million Ontario Venture Capital Fund. OMERS, RBC Capital, BDC, and Manulife Financial are listed as partner investors, with the government providing $90 million.

Included in the government's news release is a statement from a Manulife VP that "the supply of venture capital in Ontario is less than optimal"—which is 180 degrees removed from what the government said two years ago when it announced it was putting an end to the LSIF tax credit.

The manager of the fund has not yet been announced.

The venture capital industry in Ontario may be in for a bit of a shakeup over the next couple of years, with challenges on the horizon to both retail and institutional funds.

At the retail level, 2008 is scheduled to be the last year for the full 15% LSIF tax credit in Ontario. The credit will then drop 5% per year, vanishing in 2011 (currently, there is also an additional 5% credit for research-oriented funds). The 15% federal tax credit has been untouched, so far, but with the historically weak returns-on-investment of LSIFs, there doesn't seem to be anyone who expects that a 15% credit will be enough to sustain the LSIF industry in Ontario. LSIFs had already been in trouble before the Ontario government announced in 2005 that it was putting an end to the provincial credit.

The LSIF industry, with the support of the CVCA, tried to turn the LSIF tax credit into an Ontario election issue, but were met with a resounding chorus of cricket chirps from all four major parties. I didn't see a single response to the two news releases issued during the campaign asking for a return of the tax credit. And with Dalton McGuinty's government returning to power so handily, it really wouldn't have mattered anyway. The only small glimmer of hope for the LSIF industry may be that finance minister Greg Sorbara has chosen not to return to cabinet, but there's been no sign from the government—or from the opposition parties—that there's any interest in reversing Sorbara's decision to kill the credit.

At the same time, the institutional pools of money that have been the backbone of our VC industry are increasingly looking to invest their money outside of Canadian VC funds. It's not surprising, given the poor return rates that VC funds as a whole have delivered. Numbers published by the CVCA show that Canadian VCs have a negative net IRR over a 10-year horizon (and these numbers were based on partial, largely voluntary, unaudited data from VC firms, which are almost certainly higher than the real numbers). While U.S. VCs and real estate and other investment options have delivered huge returns (if the reported numbers are accurate), in Canada our VC firms and their highly paid managers have collectively delivered a weaker rate of return than your penny jar, according to numbers published by their own industry association.

So now we're starting to hear some "death of VC" forecasts, usually accompanied by inaccurate statistics passed off as comprehensive surveys of the level of Canadian venture capital. Some VCs may very well die, especially those that have failed to deliver the goods to investors. Welcome to the business world, where at some point you're actually supposed to provide value to your customers. VCs have been pulling the plug on bad investments for years. Now it seems that many of them are bad investments too. Live by the market, die by the market. Seems fair.

Other VCs will be successful and continue to attract funds. And companies that present themselves as strong investment opportunities will continue to find investors. In many cases, that funding may not come from a traditional VC firm. In Waterloo Region this year, we've seen a string of financing deals close, very few of which involved a VC firm. And these are seven-figure or high six-figure deals, not just $25,000 from an angel—although they're great to see, and there have been several of those too. It's been hard to take the "death of VC" stories seriously when one company after another has been successful in raising funds (or, in some cases, in receiving funding offers that they've turned down).

There's still lots of money out there looking for good opportunities. That's not going to change. If there's money to be made, there will be investors to be found. And, as I've always said to people claiming a shortage of venture capital, name three companies that should be funded and haven't been able to get funding offers. Maybe they exist somewhere, but I sure don't see them in Waterloo.