What previous recessions can teach us about the effects of COVID-19 on the Canadian venture capital sector
Posted: Tue Dec 10, 2024 8:45 am
As the country's largest venture capital investor, we are very pleased with the tremendous progress the sector has made over the past decade. Its improved performance has helped foster the emergence of a vibrant technology sector in Canada.
While our research from previous recessions suggests that the COVID-19 crisis may roll back some of this progress, these recessions also set the stage for a boom in entrepreneurship and the launch of major companies.
This suggests that venture capital firms must be prepared to deploy capital to ensure they do not miss out on the next wave of high-growth Canadian companies.
Venture capital firms must be prepared to deploy capital to ensure they do not miss out on the next wave of high-growth Canadian companies.
The COVID -19 crisis is also very different from previous financial crises. Venture capital firms may choose to act differently this time around. We should not assume that past trends will repeat themselves in this downturn.
Still, past recessions undoubtedly have a lot to teach us about where we are today. Here are five trends in Canada’s venture capital sector that you should watch to ensure you’re positioned to weather the recession and benefit from the recovery.
1. A reduction in venture capital investments
The recession of the early 2000s and the financial crisis of 2007-09 led to a sharp decline in venture capital investment, with reductions of 30% to 64% over two to four years. A similar drop in investment would be a setback for the Canadian sector, which had a banner 2019. The $ 6.5 billion in investment in 2019 made it by far the best year on record (Chart 1).
Figure 1. Total early-stage, early-stage and late-stage venture capital investments in Canada
Furthermore, although the Canadian ecosystem is well endowed with capital and annual investments, the growing importance of international investors since 2012 could expose it more to a possible decline.
International venture capital investment has fallen by 34% to 59% year-over-year during the last two recessions. International investors accounted for 56% of total venture capital investment in Canada in 2019.
2. Support for lower-risk innovations
The second trend we have seen in past recessions is that venture capitalists are funding innovations that are lower risk. This deterioration comes on top of the fact that investors are already expected to be reluctant, in normal times, to fund innovations that are higher risk, have higher capital requirements, have longer time frames, and require more basic research.
An analysis of patent quality shows that during stockholder database recessions, venture capitalists tend to back companies that are less original, less influential in their industry, and less connected to basic science. Overall, research shows that the overall quality of innovation by venture-backed companies drops by 29% during recessions (Figure 2).
Figure 2. Impact of recessions on the quality of innovations supported by venture capital
3. A degradation of the output environment
Canadian VC exit outcomes have improved significantly in recent years. The median exit size in Canada increased 3.8- fold between 2016 and 2019. In terms of time to exit from first financing, Canada has reached parity with the United States , reporting a result of 6.1 years over the same period.
However, previous recessions have been marked by longer exit lags (Chart 3), which suggests the same is likely this time around. A slowdown could widen Canada’s long-standing gap in the volume and valuation of exits, limiting the recycling of capital and talent.
Figure 3. Total value of venture capital exits in Canada
4. The technology sector remains resilient
One positive development is that the technology sector has remained strong during the pandemic so far. For example, the NASDAQ index, which includes a large proportion of technology companies, has outperformed other U.S. stock indices. In addition, technology employment has been resilient during both the COVID -19 crisis and the Great Recession of 2007–09. The sector’s rapid growth and economic importance should encourage investors to take a long-term view (Chart 4).
Figure 4. Relative impact of recessions on U.S. technology sector jobs
5. Economic downturns open up opportunities for venture capital firms willing to invest
Recessions and the early phase of recoveries are associated with the creation of a large number of companies (Figure 5). Highly influential companies, such as LinkedIn, Tesla, Facebook, and Shopify, were all launched in the wake of the dot-com bubble burst. Airbnb, Uber, Slack, and Stripe all started during the Great Recession of 2007–2009.
In addition, venture capital holding periods have lengthened and are particularly long for emerging companies in the high-tech sector.
This suggests that venture capitalists should not repeat the mistakes of the past. Investors must be able to get into the market quickly to capture the next wave of innovative, high-growth companies or high-potential risky bets that their risk-averse peers are ignoring.
Figure 5. New entrepreneurs per year in the United States
Venture capital firms must remain vigilant and dynamic
Based on recent recessions, we could see a sharp slowdown in venture capital investment in the coming months. However, recent recessions have also created the conditions for a renewed boom in the technology sector.
With this in mind, Canadian venture capital firms must avoid adopting defensive strategies that could cause them to miss out on golden deals. Instead, they must remain vigilant to seize the right opportunities and be determined to take advantage of promising deals that arise.
While our research from previous recessions suggests that the COVID-19 crisis may roll back some of this progress, these recessions also set the stage for a boom in entrepreneurship and the launch of major companies.
This suggests that venture capital firms must be prepared to deploy capital to ensure they do not miss out on the next wave of high-growth Canadian companies.
Venture capital firms must be prepared to deploy capital to ensure they do not miss out on the next wave of high-growth Canadian companies.
The COVID -19 crisis is also very different from previous financial crises. Venture capital firms may choose to act differently this time around. We should not assume that past trends will repeat themselves in this downturn.
Still, past recessions undoubtedly have a lot to teach us about where we are today. Here are five trends in Canada’s venture capital sector that you should watch to ensure you’re positioned to weather the recession and benefit from the recovery.
1. A reduction in venture capital investments
The recession of the early 2000s and the financial crisis of 2007-09 led to a sharp decline in venture capital investment, with reductions of 30% to 64% over two to four years. A similar drop in investment would be a setback for the Canadian sector, which had a banner 2019. The $ 6.5 billion in investment in 2019 made it by far the best year on record (Chart 1).
Figure 1. Total early-stage, early-stage and late-stage venture capital investments in Canada
Furthermore, although the Canadian ecosystem is well endowed with capital and annual investments, the growing importance of international investors since 2012 could expose it more to a possible decline.
International venture capital investment has fallen by 34% to 59% year-over-year during the last two recessions. International investors accounted for 56% of total venture capital investment in Canada in 2019.
2. Support for lower-risk innovations
The second trend we have seen in past recessions is that venture capitalists are funding innovations that are lower risk. This deterioration comes on top of the fact that investors are already expected to be reluctant, in normal times, to fund innovations that are higher risk, have higher capital requirements, have longer time frames, and require more basic research.
An analysis of patent quality shows that during stockholder database recessions, venture capitalists tend to back companies that are less original, less influential in their industry, and less connected to basic science. Overall, research shows that the overall quality of innovation by venture-backed companies drops by 29% during recessions (Figure 2).
Figure 2. Impact of recessions on the quality of innovations supported by venture capital
3. A degradation of the output environment
Canadian VC exit outcomes have improved significantly in recent years. The median exit size in Canada increased 3.8- fold between 2016 and 2019. In terms of time to exit from first financing, Canada has reached parity with the United States , reporting a result of 6.1 years over the same period.
However, previous recessions have been marked by longer exit lags (Chart 3), which suggests the same is likely this time around. A slowdown could widen Canada’s long-standing gap in the volume and valuation of exits, limiting the recycling of capital and talent.
Figure 3. Total value of venture capital exits in Canada
4. The technology sector remains resilient
One positive development is that the technology sector has remained strong during the pandemic so far. For example, the NASDAQ index, which includes a large proportion of technology companies, has outperformed other U.S. stock indices. In addition, technology employment has been resilient during both the COVID -19 crisis and the Great Recession of 2007–09. The sector’s rapid growth and economic importance should encourage investors to take a long-term view (Chart 4).
Figure 4. Relative impact of recessions on U.S. technology sector jobs
5. Economic downturns open up opportunities for venture capital firms willing to invest
Recessions and the early phase of recoveries are associated with the creation of a large number of companies (Figure 5). Highly influential companies, such as LinkedIn, Tesla, Facebook, and Shopify, were all launched in the wake of the dot-com bubble burst. Airbnb, Uber, Slack, and Stripe all started during the Great Recession of 2007–2009.
In addition, venture capital holding periods have lengthened and are particularly long for emerging companies in the high-tech sector.
This suggests that venture capitalists should not repeat the mistakes of the past. Investors must be able to get into the market quickly to capture the next wave of innovative, high-growth companies or high-potential risky bets that their risk-averse peers are ignoring.
Figure 5. New entrepreneurs per year in the United States
Venture capital firms must remain vigilant and dynamic
Based on recent recessions, we could see a sharp slowdown in venture capital investment in the coming months. However, recent recessions have also created the conditions for a renewed boom in the technology sector.
With this in mind, Canadian venture capital firms must avoid adopting defensive strategies that could cause them to miss out on golden deals. Instead, they must remain vigilant to seize the right opportunities and be determined to take advantage of promising deals that arise.