Venture Capital in Canada 101

This article provides an in-depth explanation of venture capital (VC) investing in Canada, describing the process of funding high-growth, early-stage companies in exchange for equity and guiding them from inception to exit. It covers the lifecycle of VC funding, from deal origination and due diligence to post-investment support and exit strategies. The article also discusses different funding stages, including pre-seed, seed, early-stage, later-stage, and growth, as well as various sources of capital available to startups in Canada, such as government grants, angel investors, accelerators, and venture studios.

What is venture capital?

Venture capital (VC) involves investing in early-stage, high-growth companies, often startups with significant potential pre-revenue or profits. VC firms offer financing, expertise, and support in exchange for equity, aiding these businesses from early development to a potential IPO. While VC is part of the broader private capital asset class, it differs from traditional private equity by targeting younger, higher-risk companies. Unlike private equity firms, which often acquire ownership stake while investing, VC firms typically take minority positions in the companies they invest in. 

It’s important to note that securing capital beyond initial grants and angel investments is more difficult than many startups anticipate. Only a small percentage of companies successfully attract venture capital investment, so it’s essential to enter fundraising with a clear plan, realistic expectations, and strong alignment with investors.

Lifecycle of Venture Capital Funding

Venture capital is an alternative investment typically provided by institutional investors or specialized venture capital firms (VCs). The process starts with a venture capital investor identifying a promising startup/early-stage company with high growth potential. These investors provide capital, along with mentorship and strategic guidance, to help grow the business over several years. The venture capital firm will eventually exit the investment through a sale, share buyback, merger, or initial public offering (IPO), aiming to generate a return on their initial investment.

Most commonly, a venture investment will follow the process outlined below:

  1. Deal Origination: VCs actively seek potential investments through various channels such as networking events, industry conferences, referrals from trusted sources, and online platforms. Upon identifying a promising startup, VCs begin an evaluation process to assess its viability and growth potential. This involves a thorough analysis of the startup’s business model, market opportunity, team capabilities, and competitive landscape. Additionally, the opportunity must align with the firm’s investment thesis, particularly in terms of the investment stage and sector or vertical focus.

  2. Due Diligence: Once a company passes initial screening, the entrepreneur will have an opportunity to present their business idea, growth plans, and unique value proposition. If the venture capital partners are impressed and the opportunity aligns with the firm’s investment thesis, they enter the due diligence phase. This phase involves an in-depth examination of the startup’s financials, market position, intellectual property, and legal compliance to ensure the investment’s viability and potential for success.

  3. Investment: After successful due diligence, the venture capital firm and company will enter negotiations to finalize the investment terms. This process involves determining the amount of funding the company will receive in exchange for a specific percentage of equity or ownership in the business.

  4. Post-Investment Support: After making an investment, VCs will often utilize their expertise, network, and resources to help the entrepreneur scale their business, explore new markets, and secure additional funding rounds if necessary.

  5. Growth & Exit: As the company grows, it may be acquired by a larger entity or go public through an IPO. The venture capital firm will plan its exit through various options like a sale, share buyback, merger, or IPO, aiming for a return on the initial investment. In these cases, the firm will sell their shares, realizing profits and returning gains to their limited partners, aligning with their investment strategy and financial objectives. 

Pre-Seed & Seed Investment in Canada

Pre-seed funding: Pre-seed funding represents the earliest stage of investment in a startup, where the business idea is still in its infancy and a product might not yet exist. The goal for VCs at this stage is to back promising founders and concepts with small amounts of capital to develop a prototype, conduct initial market research, or establish proof of concept. These investments are typically riskier and are sourced from angel investors, friends, family, or early-stage venture funds, often in exchange for convertible debt or equity. For VCs, the focus is on securing a position early in a potentially high-growth company, setting the stage for later rounds of financing.

Seed Funding Rounds: Seed funding is the next phase of startup financing, typically occurring after a prototype or minimum viable product (MVP) has been developed but still requires further refinement and market validation. This stage helps startups build their teams, conduct market tests, and enhance their product or service offerings. Seed funding is crucial for gaining initial traction and proving the business concept. It is generally sourced from angel investors, early-stage venture capital firms, or accelerators specializing in supporting startups at this developmental stage.

Both pre-seed and seed funding play pivotal roles in Canada’s startup ecosystem by enabling entrepreneurs with promising business ideas but limited financial resources to validate their business models and develop prototypes of their products or services. Seed funding specifically serves as the initial stage for entrepreneurs to launch innovative ideas and kickstart their ventures. As businesses progress and demonstrate growth potential, these early funding stages pave the way for subsequent funding rounds to further scale operations and expand their market presence.

Click here to see where seed investors are investing in Canada.

Later Stages of Venture Capital Financing

As portfolio companies grow, they will navigate through various stages within the VC funding process. Certain venture capital funds specialize in specific stages, while others are stage agnostic (open to investing across all stages).

  • Early Stage: Companies have a product or service in testing or early production phases, and it may be commercially available in some cases. Funding is generally through Series A and B rounds.

  • Later Stage: Companies have a commercially available product or service generating revenue, but they may not yet be profitable. Funding is generally through Series C and beyond rounds.

  • Growth Stage: Significant minority investments are made to drive growth and scale, sometimes combined with secondary transactions for existing VC investor liquidity.

Sources of Capital for Startups in Canada

Canada’s startup ecosystem has expanded significantly over the past decade, driven by strong investor support, government grants, and initiatives. Entrepreneurs benefit from a diverse range of investors to help launch their ideas. 

  • Government Grants: The Canadian government, both at federal and provincial levels, serves as a significant funding source for startups through various grant programs. While not a traditional investor, government grants provide capital for specific types of projects but come with restrictions that may be challenging for startups. One example is the Canada Growth Fund, which offers funding to cleantech businesses and startups focused on deploying technologies to reduce carbon emissions. However, startups must be aware of the conditions and limitations attached to such funding. For Canadian entrepreneurs, consider starting with the Business Benefits Finder here.

  • Angel Investors: angel investors are individual backers, such as high-net-worth individuals (HNWIs) or even friends and family, who provide funding to early-stage startups, often in smaller amounts and with more flexible terms than venture capital firms.

  • Angel Groups: Angel groups consist of networks of individual angel investors who pool their resources to collectively invest in startups. This collaborative approach allows them to invest with greater confidence, offer larger check sizes, and reduce individual exposure to risk. The prevalence and organization of angel groups have been on the rise, becoming increasingly popular within the startup ecosystem.

  • Accelerators & Incubators: Startup accelerators are short-term, competitive programs offering education, resources, and mentorship to early- or mid-stage founders with a developed minimum viable product (MVP). In exchange for a small equity stake, accelerators provide seed funding and access to extensive mentorship networks.On the other hand, incubators support founders at earlier stages who have innovative business ideas. They offer resources and guidance to help transform these ideas into viable businesses, focusing on building a strong foundation before product development.

  • Venture Studios: Venture Studios are organizations that focus on building startups from the ground up. They are deeply involved in every phase of a startup’s journey, from ideation and market validation to forming the founding team and supplying early capital. Unlike accelerators or incubators, Venture Studios take a hands-on approach in daily operations and strategic decisions, significantly shaping the startup’s growth trajectory. This model allows for greater control and alignment, fostering a more structured and supportive environment for creating successful new ventures.

  • Venture Capital: Venture capital (VC) firms play a critical role in fueling innovation and entrepreneurship by offering funding, mentorship, and strategic support to startups and high-growth companies in exchange for equity. These firms typically invest across various stages of business development, from early to growth stages, aligning with their investment criteria. Beyond capital, VC firms provide access to networks, operational expertise, and strategic guidance, which can be vital for startups to achieve milestones, scale operations, and position themselves for successful exits such as mergers, acquisitions, or IPOs. The venture capital (VC) market peaked in 2021 with $15.5 billion invested across 843 deals. Despite a decline in total investments due to economic uncertainty, seed-stage investments hit a record high in 2023, with 383 deals securing $1.1 billion, reflecting sustained interest in early-stage companies. Read more here.

  • Corporate Venture Capital: Corporate Venture Funds are investment arms of corporations that invest in startups and early-stage companies, typically through minority stakes. Unlike traditional venture capital, corporate venture funds (CVFs) focus on strategic objectives like gaining access to new technologies, products, or talent that align with their core business. In Canada, CVFs have become increasingly active in the investing landscape, leveraging these investments to drive innovation, enhance their competitive edge, and support internal research and development. This trend has seen growth, particularly in sectors such as technology, healthcare, and cleantech, where strategic alignment can provide substantial benefits.