Renewed Venture Capital Catalyst Initiative

The Federations of Black Canadians (FBC) work includes advocating for Black Canadians to fully participate in the mainstream economy. Consequently, access to capital is a historically common challenge that constraints the Black Communities across Canada to fully participate in the economy. Against this background, it is of utmost importance that the Government of Canada has developed the Venture Capital Catalyst Initiative (VCCI) as a framework to support Canadians in the Venture Capital (VC) marketplace. Therefore, the Venture Capital Initiative will help improve Canadians including Black entrepreneurs looking to access capital and maximize returns to their investments. To ensure full participation of all Canadians of all racial backgrounds including those previously disadvantaged such as Black communities, the program should have a wider reach to all businesses eligible for Venture Capital Funding (VC), have selection criteria for VC funding that ensure best recipients of the funds include disadvantaged groups like women and racialized communities, provide mentorship of those selected for the VC funds to ensure the success of the projects involved, select sectors to be funded while ensuring the sustainability of the taxpayer’s money set aside in the Canadian Venture Capital Ecosystem (Tourism, 2021).

The Federal Budget of 2017 outlined three streams in which the VCCI will be invested. These streams include large funds-of-funds that will support Canadian VC fund Managers, emerging and diverse managers, underserved regions and sectors, and alternative funds structures, and clean energy technology firms across Canada (VCC, 2017). Recently, the $450 million that was proposed in the 2021 Federal budget to be allocated towards the renewed VCCI. In addition to increasing funds towards Venture Capital initiatives, there is a need to ensure inclusivity of the marginalized groups such as women and racialized communities. Hence the following two questions arise and warrant to be addressed. First, how can Black Communities across Canada benefit from these funds and improve their financial well-being? Secondly, what efforts have been done to date to directly reach out to the Black Canadians Communities? This report, therefore, outlines some recommendations that may be relevant to ministries that are involved in the implementation of the VCCI such as the Ministry of Small Business, Export Promotion, and International Trade and Innovation, Science and Economic Development Canada can consider supporting the government of Canada’s drive to improve access to Venture Capital.

Background on Venture Capital Funding

Venture capital is one of the most common sources of financing businesses worldwide. In Canada, the Venture Capital market has been growing steadily over the past few years providing about $1,8 billion invested in this marketplace (VCCI, 2017). In addition to providing capital to start-up businesses, Venture Capital Funds provide mentorship for privately held early-stage companies that are at different stages of their life cycles usually for about 7-10 years before realizing their return through an Initial Public Offering (Green, 2004; Da Rin et al.,2006; Hoyt et al., 2012; Sipola, 2021). This helps small businesses who would otherwise not have this kind of capital Venture Capitalists often provide before they sell their investments to other private equity funds or strategic buyers (Hoyt et al., 2012). In general, Venture Capital Funds focus on higher-growth companies mainly in the technology space and healthcare and pools capital into equity-linked investments of privately held high-growth companies (Green, 2004, Marco Da Rin et al., 2016).

Over time, Venture Capital Funding has covered other sectors of the economy other than only technology and healthcare (Green, 2004). These funds are generally invested through a VC ecosystem that includes Limited partners (LP) and General Partners (GP). The limited partners usually invest the funds through legal structures via a limited partnership wherein investors commit capital in the VC or VC funds-of-funds. In most cases, the investors in the VC funds-of-funds and VC are high nets worth people, institutional investors including pension funds and family offices, and large investors of high net worth. These individuals and investors aim to get high returns on their investments in exchange for them taking such huge risks. Through these business transactions, wealth and jobs are created supporting the Canadian economy. However, there is often a missing link between the participation of racialized communities such as Black Canadians in this lucrative and thriving market. In most cases, the Black population falls under the poverty datum line and often cannot fully participate in these high capital initiatives due to their lower-income status and lack of skills in this sector. The Black Canadian Chamber of Commerce 2021 report identified a lack of capital and skills for advertising and promotion, personal development and mentorship, and access to capital as the major setbacks for Blacks to succeed in business.

The VCCI will thus help improve access to capital and opportunities to Black Canadians and accelerate them to build their wealth in these often high-risk-high return business ventures. Historically, Black people are historically disproportionately excluded from the Venture Capital space due to their economic status (Statistics Canada, 2020; Tourism, 2021). While Canada has been recording higher rates in reducing income inequality which is one of the United Nations’ Sustainable Development Goals (Statistics Canada, 2020), Black communities still lag behind in this measure compared to other racialized communities (Conley, 2010; Winks and Winks, 1997; Block et al., 2019). As an example, in 2016, the racialized population had a higher unemployment rate of 9.2 percent compared to the non-racialized population with 7.3 percent (Block et al., 2019). Racialized women are also disadvantaged with a higher unemployment rate of 8.4 percent compared to the 6.4 percent for their non-racialized counterparts (Block et al., 2019). Therefore, the VCCI will help close down the income inequality gap between racialized and non-racialized communities in Canada through active participation in the VC market.

In addition, most Black Canadians fall into the low-income measure level (See Fig 1.1 for details), characterized by lower well-being and higher poverty (Statistics Canada, 2020; Harding and St-Denis, 2021). There is also a huge demographic dividend as a quarter of the Black Canadian population is young, and four out of five (85.8 percent) of the population falls between 15 and 69 years (Statistics Canada, 2020). In addition, the Black Canadian population is more likely to hold a university degree than Canadians from not a visible minority (Statistics Canada, 2020). This can be tapped into by the VCCI to reach out to these educated young Black Canadians with cheaper capital and mentorship through this initiative. Lack of access to capital to support their businesses has often been recognized as a huge challenge to Black entrepreneurs in Canada (Block et al., 2019). Hence, this Venture Capital Catalyst Initiative is such a welcome proposal that can be used to support racialized communities out of poverty if it is implemented in an inclusive manner.

Fig 1.1. Persons living below poverty line (Market Basket Measure, 2018 base), Canada, 2015 to 2019 

Source: Statistics Canada Income Inequality and Low-Income data

Therefore, for Black Canadians to benefit from the VCCI, first they need to understand what this is all about and see how they can benefit from the program. There are various ways Black Canadians can benefit from the VCCI. First, Black entrepreneurs can be part of the consortium of Angel investors who provide seed capital for start-up capital to founders at the conceptual stage within their first year of operation. To access the Angel investors club, they would need to apply for government grants through the VCCI. Additionally, early-stage VC focus on start-ups that have gained some traction and are raising their institutional round of capital. The Black Canadians can be trained with experienced partners who have been in this business for years to learn before they can stand on their own. For example, Black Canadian Angel investors can start off financing smaller deals before moving up to the highest and more complicated venture capital deals. Series A and Series B can be a training ground as an example. Then, later stages such as Series C-D) are characterized by investors who support start-ups that have scaled up and are starting to attract growth equity investors. 

It must be noted that, in the end, well-structured Venture Capital deals create value for both the entrepreneur and on the other end, offer angel investors a return that compensates for the risk of investing in the business (Chaplinsky, 2018; Mustafa, 2021). This process of interactions between the entrepreneur seeking capital and the angel investor seeking a return on their investment creates a market where Black Canadians can therefore equally now participate in. This is where initiatives such as the Renewed Venture Capital Catalyst Initiative designed by the Canadian Government are a great move to close this gap.

The government can also support Black Canadians in the process of estimating the optimal amount needed to close the VC deal, through its various financial institutions such as the Business Development Bank of Canada and relevant ministries such as the Ministry of Finance Canada that have experienced employees who can support the Black Communities in Venture Capital market. The government can also provide funding for the entrepreneur and investor through the VCCI. The terms and conditions are usually set forth in a term sheet that contains a host of provisions designed—in varying degrees—to protect the value of an investor’s capital (Chaplinsky, 2018). These terms define the investor’s rights as a holder of senior security to common stock and are designed to secure the investor’s ownership position, provide the right to monitor and control important company decisions and facilitate exit from the investment (Mustafa, 2021).

Recommendations

The Venture Capital  Catalyst Initiative is intended to help support the revitalization and growth of the Canadian Venture Capital ecosystem (Tourism, 2021). It is, therefore, crucial to ensure that Black Canadians can also have access to venture capital funds and contribute towards the shared objective of the Venture Capital Initiative. The VCCI aims to support the Canadian economy. Through creating an inclusive economy that supports all citizens regardless of their economic status. As highlighted above, Black communities can participate in two ways, first – as entrepreneurs whose companies are invested by the angel investors or as angel investors. Entrepreneurs benefit from accessing capital to grow their business and Angel investors potentially get high returns on their investments.

In addressing current gaps in the VC ecosystem, it is important to ensure Black Canadians understand how Canadian companies work and access capital. Black people are generally disadvantaged in terms of access to the Venture Capital ecosystem (Tourism, 2021). This can be achieved through the following measures;

  1. Offering a quota for Black communities to participate in two ways, first as entrepreneurs and secondly, as Angel investors;
  2. Improving reporting on diversity to legally ensure Black communities also participate in this initiative (Tourism, 2021). Also, issues of gender balance to be captured in the screening process to ensure  that women from minority groups have a fair chance to participate in the VCCI.  

Also, leveraging private capital to support the mentorship of the Black Canadians interested in partaking in the Venture Capital marketplace. In taking a market-based approach and emphasizing private-sector leadership, the renewed VCCI is expected to leverage a significant amount of private sector capital (Tourism, 2021). This will help in leveraging all potential sources of funding such as federal, provincial, and business to take up more diverse candidates for venture capital funding.

The size of the capital required and available from Venture Capitalists (demand and supply mechanisms in the Canadian VC market). The optimal fund size needs to be optimal to ensure that the entrepreneurs can grow their business while on the other hand, the Angel investors get a decent return for their capital which is benchmarked at between 5-7 percent annually (Tourism, 2021). The optimal capital invested in each business could be influenced by such factors as (Entrepreneurship side);

a) Nature and stage of business;

b) Stage of business;

c) Place at which technology develops and products are adapted;

d) Relative size of the business;

e) Capital business needs, how much and when it is needed;

f) Debt, equity, governments grants or mix;

To the Venture capitalists side;

a) Money and how much is available;

b) Available Investment banking or brokering assistance to close the deals;

c) Determine the projected value of the company at a future date (Terminal Value);

d) Discount the Terminal Value using targeted investors Internal Rate of Return (IRR) i.e., Vpost  – C = Vpre where C is the amount of capital being invested post-financing valuation, Vpre the amount of capital being invested pre-financing valuation;

e) Calculate the percentage of ownership required for the investor by dividing the amount of capital being invested by the discounted terminal value ie. % ownership – C/V post;

f) Geographic representation. Venture capitalists prefer to invest in local companies in a specific geography (Hoyt et al., 2012). The popular area for VC in Silicon Valley and as such the VCCI is a crucial initiative in the Canadian context.

References

  1. Chaplinsky, S. 2018. Early-Stage Term Sheets.
  2. Da Rin,M., Nicodano, G., & Sembenelli, A. (2006). Public policy and the creation
  3. of active venture capital markets. Journal of Public Economics, 90(8-9),1699-1723.
  4. Green, M. B. (2004). Venture Capital Investment in the United States 1995-2002. Industrial Geographer, 2(1).
  5. Hoyt, D., Ranzetta, T. G., & Strebulaev, I. (2012). Venture capital deal sourcing and screening.
  6. Mustafa, M. (2021). Deal Structuring, Term Sheets, and Deal Terms. In Angel Investing (pp. 165-204). Palgrave. Macmillan, Singapore.
  7. Sipola, S. (2021). Another Silicon Valley? Tracking the role of entrepreneurship culture in start-up and venture capital co-evolution in Finland’s entrepreneurial   ecosystem 1980–1997. Journal of Entrepreneurship in Emerging Economies.
  8. Conley, D. (2010). Being black, living in the red: Race, wealth, and social policy in America. Univ of California Press.
  9. Winks, R. W., & Winks, R. W. (1997). Blacks in Canada: A history. McGill-Queen’s Press-MQUP.
  10. Block, S., Galabuzi-Grace, E., & Tranjan, R. (2019). Canada’s Colour Coded Income Inequality. Ottawa, Ontario: Canadian Centre for Policy Alternatives.
  11. Tourism, S. B. (2021). Designing the renewed Venture Capital Catalyst Initiative.
  12. https://www.ic.gc.ca/eic/site/061.nsf/eng/03139.html. Accessed October, 8 2021.
  13. https://www150.statcan.gc.ca/n1/daily-quotidien/210323/dq210323a-eng.htm. Accessed October, 8 2021.
  14. https://www150.statcan.gc.ca/n1/daily-quotidien/210323/t003a-eng.htm. Accessed October, 8 2021.
  15. https://www.bdc.ca/en/about/mediaroom/news-releases/new-report-examines-barriers-facing-black-entrepreneurs-canada. Accessed October, 8 2021.

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