Last year’s edition of our newsletter’s lead article was entitled “Greenshoots vs Storm Clouds” where we pondered that the venture capital industry was seeing greenshoots signs of a return to life in both fund raising and investing. This was clearly an optimistic perspective that proved to be wrong. Just as the great ice storm of the past winter in Toronto killed many golf greens in the GTA, winter kill was present in the VC world.
VC fund raising declined 24% from the previous year’s $1.5 billion. In fact it was worse than that when you adjusted for capital allocation to established dedicated pools. Independent funds raised $629 million down 51% from 2012. Quebec’s labour sponsored funds raised $488 million regardless of the high profile scandals, up 18% to more than 37% of the national fund VC fund raising. It is important to remember the funds raised in Quebec must be invested in that province.
Last year the Canadian VC’s invested $2.0 billion which is 1.5 times the amount of new funding raised.. Unless new funding accelerates for the industry, VC investing activity will have to be curtailed in the not so distant future.
Further upstream the Canadian PE community had a record raising some $16 billion which is more than triple the 2012 fund raising level. Last year we saw storm clouds on the horizon for the PE firms. Sure enough the storm clouds have arrived . The combination of low interest senior and mezzanine interest rates, loose debt to equity lending ratios plus more than a $1 trillion of dry powder has resulted in PE firms now paying 10 times EBITDA as the norm for deals compared to eight times in less frothier times. Eking out gains is hard to do at those purchase multiples. The Economist estimates that the promised annual returns have slipped from 20-30% to half that level because of higher purchase price multiples.
In other words, the PE industry has matured. The fat profits for PE management firms of the past decades have resulted in a crowded field with more than 5,000 firms competing for deals. Together they have raised more money from investors than they know what to do with. Inevitably this will lead to disappointing returns and then a decline in PE funding.
So, for institutional investors or family offices contemplating the PE world, we would suggest being a contrarian and look at funding a late stage VC fund where deal flow is robust and cash is king. Don’t follow the herd-that way lies disappointment.