Is It the Government's Job to Fund VCs?
Earlier this week, OG Canadian investor Matt Roberts wrote a lengthy post on the history of Canadian pension funds and their declining support of Canadian VCs, titled “Who Killed Canadian Venture?” The epic post clocks in at nearly 8,000 words and dives into three main topics:
A history of the Canadian Pension Plan (Canada’s equivalent of the U.S. Social Security system)
The evolving investment strategies of CPP and other major Canadian pension funds, like the Ontario Teachers Pension Plan (OTPP) and the Ontario Municipal Employees Retirement System (OMERS)
The impact of changes in government investment regulations on Canada’s VC ecosystem — specifically, the elimination of mandates that pension funds invest a minimum amount of their capital into Canadian companies
Matt’s post is incredibly well researched and touches on some of the key debates currently surrounding public pension funds, notably the tension between maximizing fund performance vs. leveraging those funds to drive domestic economic development. If you’re in any way, shape or form interested in Canadian venture capital or private equity, I recommend you give it a read.
All of that said, I must admit that I disagree with Matt on one of the underlying premises of his post: that it is the role and responsibility of public pension funds to subsidize the Canadian venture capital ecosystem.
Some Things I Think
I believe that, all things equal, government-affiliated investors should default to investing domestically.
Of course, this shouldn’t be contentious. (And it isn’t.) The Chief Investment Officer of the Healthcare of Ontario Pension Plan (HOOPP), Michael Wissell, said as much in a statement to Matt,
“…all else being equal, we prefer to invest in Canada when the risk and reward are appropriate.”
Where I diverge with Matt is on what the appropriate expectation should be when investment opportunities are not equal. Should a public pension fund be required to invest in a domestic company — say, a VC fund — when that investment is objectively worse than a comparable investment in an international company?
I don’t believe so.
While I believe wholeheartedly that government can — and should — play a role in encouraging new business creation across all industries (more on that later), I disagree with the notion that a public pension fund should be forced to make investments for reasons other than driving financial returns.
In that respect, I share the perspective of Jim Leech, the former CEO of Ontario Teachers’ Pension Plan,
“You’ve got to create the opportunities. It isn’t forcing or enticing people into Canadian investments, it’s providing sufficient good investments in Canada.”
Broadly speaking, pension funds have a singular goal: to maximize the performance of the fund for the benefit of their pensioners. John Ruffolo, who founded pension-backed OMERS Ventures in 2011 and is now the Founder and Managing Partner of PE fund Maverix, recently echoed this sentiment,
“I’m not in favour of mandating pension allocations,” John shared with Betakit this week, “…the world-renowned success of Canada’s pension funds is the singular focus of their mandates: to get maximum returns on their retirees’ money.”
Demanding that a pension fund do anything other than maximize performance is akin to imposing a tax on the pensions of each-and-every person who stands to benefit from the fund. Nobody would think it reasonable to force a 5th grade teacher from Mississauga to pay a tax to support her local VC. Why is it any more acceptable to force the Ontario Teachers’ Pension Plan to do so?
Adapt, Evolve, Compete or Die
American hedge fun manager Paul Tudor Jones famously used this phrase to describe the need for traders to constantly evolve as markets change, and it very much applies to venture capital funds. Our industry is, by definition, intensely competitive. We have to compete with other investors for the privilege of investing in the most ambitious startups we meet and we have to compete with other asset classes to raise investment dollars from potential LPs.
For VCs in Canada, that level of competition has increased significantly in recent years as Canada’s tech ecosystem has continued to reach new heights. Canada’s tech ecosystem today is amongst the best in the world and Canadian startups are second-to-none. As a result, the amount of venture capital money flowing into Canada from around the world — and from Silicon Valley in particular — is greater than it’s ever been.
Sauron’s eye is turning north…
We can choose to look at this development in one of two ways:
It’s a good thing, because ambitious Canadian founders are attracting the best investors from all over the world
It’s a bad thing, because ownership of Canada’s fastest-growing companies (and the subsequent returns generated by those investors) is leaving the country
While there are valid economic considerations for (2), as a former founder, I very much align with the first perspective on this and consider it to be a hugely positive shift for Canada’s tech ecosystem. More capital — and more high-value capital — is flowing into Canadian startups, whose founders no longer need to restrict their search for investment to funds located above the 49th parallel.
Of course, that makes my job immensely more difficult than if the most competitive VC funds in the world politely left their ambitions at the border. But that’s the nature of competition.
These days, Canadian founders are rightly looking me dead in the eye and asking, “why should I take your investment instead of one from XYZ Fund from San Francisco?” And potential LPs are looking at me dead in the eye and asking, “why should I invest in your fund instead of XYZ Fund in San Francisco?” And that’s happening to investors across the country.
And across the country, investors are adapting, evolving and competing. Where I’m based in Vancouver, Version One has established itself as one of the best micro funds in North America, investing in mission-driven founders in both Canada and the US. Active Impact Investments, which recently launched its third fund, is quickly becoming one of the world’s premier early-stage climate tech funds. And Evok Innovations, a growth stage clean tech fund, is leading investments in carbon, clean energy and minerals companies around the world.
But it’s a long, hard road to get there. And that’s where government can help.
Calling in the Reinforcements
Here are some of the ways that governments can support the development and maturation of their domestic venture capital industry without forcing that responsibility onto adjacent stakeholders:
1. Lower Barriers to Investing in VC
Governments can make it easier for individual investors in the private sector to opt in to supporting venture capital funds. Many countries (including Canada) impose restrictions around who can invest in venture capital funds, referred to as accredited investor requirements. Reducing and removing these barriers can unlock new sources of capital for venture capital firms and, as a result, startups.
2. Make it Easier to Create New VCs
Governments can support programs and take other actions that make it easier for new and diverse individuals to launch new venture funds. I’ve previously shared some ways that governments and industry groups can support the creation of new VC funds in this blog post.
3. Create Dedicated Government Fund-of-Funds
To the extent that governments want to subsidize venture capital funds through direct investment, they should create and maintain dedicated allocations of capital to do this. In Canada, many individual provinces have taken this approach and can act as anchor investors in new VC funds.
4. Entice the Private Sector to Invest in VC
Finally, governments can establish programs to entice the private sector to invest in domestic VC funds. In many jurisdictions, tax breaks are used by governments to encourage individual investors to invest in tech startups and other small businesses (e.g. QSBS in California, EBC in British Columbia and SEIS in the UK). Similar programs could be established to encourage LP investments into new and emerging funds.
At the end of the day, there are strong economic arguments for local governments to help foster the creation of new venture funds and the development of a healthy domestic venture industry. But they shouldn’t sacrifice the competitiveness of adjacent stakeholders — such as startups and public pension funds — in order to do this.