CIBC Innovation Banking Podcast

Announcer (00:09):

Today on the CIBC Innovation Banking podcast.

Kim Furlong (00:13):

It's hard to tell what the next few months will bring. I can tell you this, if you're fundraising today, it's very difficult because it also is based on sitting down with people and pitching, and that is usually more conducive in a face-to-face environment.

Announcer (00:30):

Here is Michael Hainsworth.

Michael Hainsworth (00:31):

Following the years of consistent investment growth across all stages in the ecosystem, Canadian venture capital investment reached impressive new heights in 2019 with a record 6.2 billion invested over 539 deals, 69% more than the 3.7 billion invested the year before.

Michael Hainsworth (00:50):

And then the pandemic hit. With the first half of 2020 in the rear view mirror, what does investment growth look like to the Canadian Venture Capital and Private Equity Association? CEO Kim Furlong joined us for her insight. I started by asking, what should we expect?

Kim Furlong (01:08):

It's a very timely question, Michael. We released our results for the first quarter, 831 million for Q1 over 117 deals. Now, I will say that these numbers mark January to the end of March, and you will know, like me, that the crisis that we're currently experiencing really began mid-March. So these numbers don't reflect at all COVID, and actually are aligned pretty much with what we saw in Q1 last year. It's 7% lower than the 2019 Q1, but also followed on the heels of an amazing year, as you just said, in a $1.5 billion Q4 quarter.

Kim Furlong (01:51):

So the numbers are great, and if we weren't going through what we're going through, we would think that we're still on track. Now, I can tell you that the reporting, which we do on a weekly basis, of the deal flow, both in private equity and venture, basically dissipated in the early weeks of COVID. We were reporting very, very few deals. That has picked up a little bit. So what I would say, is I fully anticipate that Q2 will be extremely low in terms of transactions, but it still remains to be seen what Q3 and Q4 will bring.

Michael Hainsworth (02:30):

It sounds like we're just sort of getting our bearings on this whole new world under quarantine life. Can you cut a deal over a Zoom conference call?

Kim Furlong (02:41):

You can, and it's being done right now. This whole aspect of due diligence, and how do you make decisions in which companies you will invest in, is very complex at a time of social-distancing. I think a lot of people that don't spend a lot of time with their industry would assume that it's simply a transaction of capital from one entity to another, but it's much more than that. The relationship building. If we talk about private equity or venture, let's start with venture, you don't invest only in a company because the company is in its inception. You're really investing in people. You're investing in the vision of a founder, and the team that he or she has assembled around them and the vision for a company.

Kim Furlong (03:31):

If you are an entrepreneur, and many of them are serial, that have done this before, wrapping up a deal on a Zoom call is feasible if you have those preexisting relationships and you've built those relationships, and you have a, the person who has the capital, the venture fund and the entrepreneur, they know each other and they know what they've built in the past, and then you're going on a new journey together. If you're a new entrepreneur and you've never raised money, that absence of being able to get to know each other definitely makes it more challenging.

Michael Hainsworth (04:08):

You also mentioned that there's a difference between strategies for VC versus PE. How are things different here for private equity?

Kim Furlong (04:16):

Private equity invest in established assets. VC is looking at a company that doesn't exist yet, or is just the early onset of a vision and a plan, while the private equity is coming in with so much more information. I will also say that both sides expect growth and to have an exit with some gains attached to it. That being said, private equity can be much more patient in terms of capital and the growth line. And we can talk about PE growth and just PE, regular private equity, but oftentime you will see a lot of process-driven mergers and acquisition to grow companies, which is very different than the early stage in venture.

Michael Hainsworth (05:05):

So let's talk about how those strategies change post-COVID. Because if a venture capitalist is looking for a start-up, and a private equity firm is looking for an established player, as both a start-up and an established player come out of COVID-19, are they going to look substantially different than if we hadn't experienced this?

Kim Furlong (05:28):

I don't know if they'll look different. When I think about private equity and I think about the types of companies that they're looking for, most of the time they're looking for very successful companies that have had a significant growth and are now are having stable returns. The person who's founded the company has grown it to a certain point, they've had a successful career, they have their cottage, they have their house, they have everything they need and the company is doing great, but the company has so much more potential.

Kim Furlong (06:02):

And then you have a private equity firm come in, not only as capital, but also a strategic partner in saying to that person, "Let's take some chips off the table. Let's build this together." Most PE firms will tell you that they feel more comfortable investing in a firm where the CEO will stay and do the course with them for a few years, and then really augment the potential and the productivity and growth of that company.

Kim Furlong (06:28):

A lot of people think about that in retirement years or just pre-retirement. If you look at our data for even the first quarter, 85% of our PE deals were under 25 million. So you're really thinking, mid-market, you're thinking Canada's industrial [inaudible 00:06:47], people that have built companies that are thinking, "Okay, is this time to retire?" In post-COVID, given the uncertainty in the market, you may see some people choose to go towards that kind of partnership, to make sure that their retirement is even more comfortable.

Michael Hainsworth (07:03):

Oh, that's very interesting. The idea that we could see post-COVID-19, I'm reluctant to say a flood, maybe you would though, a flood of companies that are established, that end up getting sold either to private equity players or they're the founders who are looking to move on because I just want to take a break, now. 

Kim Furlong (07:25):

COVID may be like an element that brings that decision forward, but the Business Development Bank, BDC, and CVCA, over the last number of years have done some round tables trying to get a sense of peoples' intent when it comes to passing on companies. We've seen a large jump in terms of the willingness of people to sell to someone outside of their family in the past decade.

Michael Hainsworth (07:51):

To what do you attribute that?

Kim Furlong (07:52):

I think less and less people stay in the family business, and more people understand ... Potentially given that private equity has had and continues to grow in Canada, I do think that if you are considering private equity, it's probably because you know someone in your business surroundings that has had a partnership that has been successful, and you understand a little bit better that it is, in fact, a partnership and not just dollars coming into your company.

Michael Hainsworth (08:24):

So how does COVID-19 change the valuations for companies in different industry verticals? Because I can imagine it would be different in say medtech versus fintech, logistics, cleantech, that sort of thing.

Kim Furlong (08:35):

Yeah, that's a great question. Valuations is something that was very top of mind pre-COVID, and everyone, I believe, understands that there is going to be an adjustment or realignment of value. And that is a really interesting thing because you've got the value from the entrepreneur, the founder, and then you have the value from the investor. What we were seeing in the US market was really high valuations and people putting a lot of capital towards these companies, and people putting a question mark on whether that value was indeed there, or if they were overpaying for certain companies. That reality was not fully aligned with what we saw in Canada. Although we did, we were starting to see values going up and a lot of dollars chasing few deals. So just because of the times that it's taking, the delays in due diligence, we may see people feeling like they have more time.

Kim Furlong (09:45):

When we think about the verticals themselves, medtech, life sciences, they have been extremely robust. Those are sectors where we were seeing some very strong performance prior to the first quarter of this year. Last year, life sciences, especially in Canada, has had a tremendous year. And even in the last few days, I saw a number of exits of companies that were in that categories of almost being unicorns or having the potential to be unicorns, having some M&As and going to IPOs. So those valuations, I believe will stay high.

Kim Furlong (10:24):

I think fintech is another space where it's very stable and the solutions that will be brought forward will continue to have investors think that that's a great place to put some dollars. Cleantech, It takes a really long time to exit out of a cleantech deal, and it takes a lot of money. That one, we may see the valuations fluctuate a little bit more. And when it comes to logistics, which was another one of the verticals that you mentioned, that's the one where I think a lot of people are linking COVID and the opportunities of COVID.

Michael Hainsworth (11:04):

The idea that you may want to be able to have logistics facilities closer to various major centers, so that we avoid the repeat of everything shutting down because China shut down.

Kim Furlong (11:16):

Yes, yes. And I would add to that, the new reality post-COVID, and how companies think about what they sell, who they sell to, and how they get their products into the hands of their customers. Will we see some new solutions emerge out of COVID-19 that will address those needs, and can enable these companies to continue to grow by reaching their customers differently?

Michael Hainsworth (11:42):

Do valuations change substantially when we're talking about B2B versus B2C? I can imagine we think a lot about the consumer being under pressure under COVID, closing their wallets, circling the wagons, waiting for the all clear. But ultimately, if they're doing that, businesses aren't seeing cashflow. So how do we figure out what the valuations are in this environment for those two classes?

Kim Furlong (12:06):

Yeah, it's the sense that there would be a huge difference, and you're right. They're linked in some way, either you're a B2B or B2C. I actually think the B2C play, depending on what you're offering, you may see some companies doing extremely well in that space.

Michael Hainsworth (12:29):

What do you have to offer to be able to do well in that space?

Kim Furlong (12:33):

I think the subscription base, like when you ... If anyone were to take a poll today, Michael, of what people are doing in the evenings, people are asking for, "What show have I not watched? What else can people recommend?" So when you think about reaching that consumer who's at home, and then I think about going completely on the other end of the spectrum, if you think about the hospitality business that has been completely ... The surprise of all of this and the idea that your business is shut down, and you have no idea as to when you will be able to receive people as guests in your establishment.

Kim Furlong (13:19):

Restaurants have begun to be very creative in Ontario, enabling the delivery of liquor with food. We've seen people create some curated baskets and things of such. Will that continue? Will there be solutions where you will actually change the way people dine? Will people show up at your place of business or will they expect to have that same experience at home?

Kim Furlong (13:53):

So the valuation, I think, is not necessarily linked to the class, B2B or B2C, but the types of offerings that these companies are putting forward.

Michael Hainsworth (14:05):

And you would have to, as either a VC or a private equity player, have to do a remarkable amount of due diligence on any given company, in a way that maybe you didn't have to think about prior to a global pandemic. There is a survival of the fittest component to this.

Kim Furlong (14:24):

There's definitely a lot of due diligence. I actually think that founders, VC firms, private equity firms, will be looking to have conversations with the entrepreneurs that they support, in terms of the creativity and thinking outside the box, and not necessarily trying to just gain some market share. Who's going to come to them with an idea where you think, "Yes, that's an unmet need, and let's double down on that offering."

Michael Hainsworth (14:49):

Do you feel your members will be able to raise capital to support the ecosystem in this environment?

Kim Furlong (14:55):

There's capital out there, and capital needs a place to go. The ability to fundraise, it will be hard. What we're hearing is the potential retreat of some LPs. In the early onset of COVID, a lot of people attributed the potential decrease in the LP base to the losses in the public markets, which would have given them a higher exposure to our asset class. That has rebounded.

Kim Furlong (15:23):

It's really interesting to watch the public market and see how well they're doing. So it's hard to tell what the next few months will bring. I can tell you this, if you're fundraising today, it's very difficult because it also is based on sitting down with people and pitching, and that is usually more conducive in a face-to-face environment.

Michael Hainsworth (15:46):

What's the leading indicator that you will be looking for for evidence that ... After a record 539, 6.2 billion worth of deals in the height of 2019, down to the depths of COVID-19, what do you look for for evidence that we're coming up on the other side of this?

Kim Furlong (16:06):

I think we're going to be looking at corporates and whether they stay the course.

Michael Hainsworth (16:10):

What do you mean by that?

Kim Furlong (16:12):

Their share price has stabilized, and depending on which business they are, they play two roles. They are an investor in some funds, and they are often a source of exits. So depending on where they position themselves, they took a step back in the first few weeks of March and through April. But it's not to say that they won't have the foresight to be very strategic and stay the course. Because the companies that they're following or investing in are often companies that may change the course of the sector they're in or even their companies themselves. I think family offices will be interesting to follow as well. A lot of them in the last five years have kind of pivoted and created more structure approaches to how they invested in venture capital. And again, there's a question mark on whether they will stay the course.

Kim Furlong (17:08):

One thing that I think a lot about at CVCA, and I speak to our members about, is how do we ensure that the institutional investors are writ large in Canada, see the benefit of writing large checks at the end of the growth journey? Which often, we've seen, have come from the US. I like to think that our growth in Canada, we keep the equity local in the growth [inaudible 00:17:42], in making sure that all the wealth that's created by these exits are kept here in Canada, and we can benefit from it as a society.

Michael Hainsworth (17:50):

A key factor in the success of our Canadian innovation sectors comes from our investors' ability to grow and scale with their investments. So what role does the CVCA play in working with government to ensure that the mechanisms are in place to ensure that Canadian-based venture capital and PE funds remain strong, as we've seen over the past few years?

Kim Furlong (18:11):

Well, we've been having a lot of these conversations, Michael. We've been in close coordination and communication with the government. We've advocated in the early onset of COVID for a number of measures, that I'm glad to say that the government agreed with us. So from convertible notes, and we went to BDC and asked them to consider bridging people that were close to their first close, which would enable them to put dollars that they had fundraised to work, and they agreed with that. We asked for SHRED credits to be expedited and delivered to those companies that do R&D. They agreed with that. And we of course asked for a wage subsidy for the companies to get through this storm. And that too, came our way now.

Kim Furlong (19:01):

So those were the, in the midst of crisis, what do we need to do to keep all of the gains, all the companies we've built here, continuing to grow and not have an exodus of a lot of these companies leave Canada, in terms of at least in their ownership by having other people come in. So that's a conversation we're having right now. What will we need in the next number of months to make sure that there is Canadian capital going into these growth rounds?

Kim Furlong (19:31):

The Harper government had the foresight of doing VCAP. And the Trudeau government did the follow-on program, VCCI, which basically puts dollars on the table and says to the private investors, "Come and add your money to ours, and we will de-risk it by ensuring that we're there at first, and we stay the course and come out last." Those have been extremely successful programs. And what we're saying to the government today, is when you look at a year like 2019 at 6.2 billion, and for the government, this is an investment, they make money, they make returns off of that program, let's stay the course. Continue to be a partner with us and let's look at the third program and what it could look like. So those conversations are ongoing, but the singles are extremely positive.

Michael Hainsworth (20:24):

What role does the Canadian innovation sector play in driving investment in this country under these circumstances? What can the sector do?

Kim Furlong (20:34):

It needs to continue to innovate. I think the entire sector is one that takes risks and looks to really change the course of business and bring new solutions to market. Canada, I often, I think this is something that most people would agree with, we're way too humble, we do so much, I just think we need to speak very loudly and proudly about the types of companies that we're building. We need to ask for large amounts of money. Entrepreneurs need to step up and say, "This is what I need. This is my vision. This is my vision for growth."

Kim Furlong (21:09):

And I think together, we'll be able to build something very special. We're already on the road towards that success. We just have to keep on course and keep doing the work.

Michael Hainsworth (21:18):

Kim, thank you so much for your time and insight.

Kim Furlong (21:19):

It was a pleasure. Thank you for having me.

Announcer (21:23):

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