Last year was record-breaking for venture capital funding in North America. Canadian firms invested $2.15 billion into startups and scale-ups in the first half of 2019, and deal value is on pace to pass $100 billion for the second year in a row in the U.S. This funding is supported by the largest global amount of available private capital dry powder since before the 2008 financial crisis: $2.44 trillion.
At first glance, this high level of activity may appear to signal a vibrant ecosystem of growth-stage companies and investors. But these numbers may not be all good. Having spent much of my career in Canada’s venture market, I can tell you that in order to democratise access to wealth and encourage innovation, a few things will need to change.
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Growth-stage companies opting to stay private longer
Thanks to the unprecedented value of VC deals, growth-stage companies are opting to stay private longer — often providing liquidity to investors through M&A rather than a public listing.
Despite some drawbacks of VC funding — liquidity preference, shareholder agreements, and preferred shares — VCs have the ability to provide deep pools of quick-moving capital that can be vital for fueling growth of startups and venture-stage companies. In contrast, while mechanisms like a “bought deal” can deliver investment to public companies almost overnight, the orientation of public markets toward long-term growth of viable businesses may seemingly correspond to slower, longer-term financial gains.
There’s a problem with this scenario. With companies choosing not to list on public exchanges, only the few VCs who invest in early rounds — and their own high net worth investors — see benefits. In short, the current landscape for startup funding means the broader public cannot participate in some of the greatest phases of wealth creation. Not only is this a missed opportunity for would-be investors, but it also has ripple effects of further exacerbating the wealth gap in North America.
The negative impact on the distribution of wealth
Alongside the negative impact on the distribution of wealth, the current trends in VC funding are likely to have a broader impact on growth and innovation within our tech ecosystems.
To start, despite a record amount of private capital available, the number of deals is shrinking across both the U.S. and Canada. In the U.S., 43% of all VC investment went into 185 mega-deals of over $100 million. In Canada, meanwhile, 42% of all dollars invested in the first half of 2019 went to 11 mega-deals of over $50 million.
The increasing number of mega-deals suggests venture capitalists are focusing on a few companies instead of distributing the wealth among a variety of growth-stage enterprises. But they shouldn’t be. Companies like WeWork and Uber are proving that sky-high valuations aren’t always sustainable — something investors should be wary of as these companies work toward public listings and their early backers seek liquidity.
VCs opting to invest in later-stage companies
In the same vein, VCs are largely opting to invest in later-stage companies with clear-cut products and business models. This creates a funding gap for early-stage companies that may be considered underdeveloped — even though they require less funding — and makes it harder for them to acquire seed or Series A and B funding. By restricting access to funding, we’re handicapping future growth.
Public markets have long been a viable source of growth-stage capital competing with private VC dollars. Public markets offer a potential avenue for growth-stage companies to access the investment they need to develop their products, create jobs, and foster economic stability. As an added bonus, these exchanges allow the public to participate in the early stages of various organisations — increasing their potential for a profitable return. Governments should be evaluating incentives to encourage and reward that investment activity.
We’re already seeing it happen in British Columbia, where the successful eligible business tax credit program has helped support growth in the technology industry. This practice is one that could be expanded to support public companies. Australia also has a capital gains rollover that defers capital gains as long as investors continue supporting companies. These successes are all the more reason why other governments globally should start actively encouraging and supporting public participation in equity markets.
On a more granular level, regulators also need to compare the burdens of being a private versus a public entity so they can more effectively reduce the barrier to entry to public exchanges. As it stands, disclosure obligations and associated audit and legal costs are deterrents for many.
Governments and regulators across the globe should pay close attention to the current state of VC funding. The numbers may be appealing, but the reality is it’s time to streamline how companies access investment within both private and public markets. Our burgeoning economies — and the general public — stand to benefit.