Morneau Economic Growth Council recommending end of life-saving VCAP program

Mark McQueen

If the rumours are true, Canadian entrepreneurs will be getting a lump of coal in their stockings this Christmas.

Word is that Finance Minister Bill Morneau’s Advisory Council on Economic Growth is essentially recommending that he not proceed with a second installment of the highly successful $400M Venture Capital Action Plan in the upcoming Federal budget.  It sounds as though the Advisory Council believes that $400M envelope is better “invested” in a new initiative, whereby the government would issue 12% coupon loans to pre-revenue, Angel-backed companies.  If the Liberal government can’t afford both concepts, the Advisory Council is signaling the end of the life-saving VCAP program by favouring this untested pre-revenue loan scheme.

If true, and I have every reason to believe that it is, this will be brutally disappointing to almost everyone involved with Canada’s Innovation ecosystem.  It was less than a year ago when folks like us were celebrating the success of a program that the experts, including, Canada’s Venture Capital & Private Equity Association (CVCA), advocated for over a six year period (see prior post “Flaherty’s VCAP doing its thing with new IVP and iNovia fund announcements” Jan. 27-16).

As I understand the pitch to Minister Morneau, one very high profile and influential member of the Advisory Council claims the VCAP is poorly designed because it pays “fees on fees”, and for that reason alone the program should be shelved permanently.

For those who don’t know what he’s complaining about, “fees on fees” refers to the ~50 bps annual management fee that the four VCAP managers (Teralys, Harbourvest, Northleaf and Kensington) are paid to manage their own portfolio of Canadian venture capital funds.  To take you back to the beginning, in 2008 the CVCA recommended that the Feds designate a few private sector Fund-of-Fund managers to pick and choose which VC funds were worthy of receiving commitments from the proposed VCAP program (see prior post “CVCA letters to Messers Flaherty, Clement and Ignatief” Dec. 26-08).  The late Jim Flaherty understood that it didn’t make sense to have bureaucrats size up a venture fund when Canada had saavy and experienced experts, such as Jacques Bernier, to do it for him.

For those Canadian funds that received a $15M or $20M commitment via the VCAP, that only came to pass as a result of thorough review, just as the Fund-of-Fund manager would have performed for one of their private sector or pension plan clients.  Ontario’s Liberal government launched the OVCF via a similar third-party managed structure.

It is worth noting that a Montreal-based $120M IT-focused venture fund with, say, $20M of VCAP funding succeeded at raising $100M from other institutional investors and Family Offices.  That’s how the team got to $120M.  Do the math: $6.5M of Federal money (the Feds represent about 1/3rd of VCAP’s capital) seeded a $120M fund.  That sounds dreamy to this taxpayer.

The fee on the fee arises when the venture fund manager charges her/his LPs 2% per annum to hire staff, rent space, travel, conduct due diligence, prepare audited financials and so forth.  The high profile Advisory Council member in question thinks that’s insane, and that the government should wipe out both managers (the VCAP manager plus the underlying VC) and invest the same $400M of capital directly into companies, “saving” about 2.5% per annum for the next 10 years.

It’s a bit more complicated than that, of course, since the government will need to hire additional Public Servants to invest in the same business plans that a VCAP-backed VC would have invested in.  It’s not as though the Feds can blindly wire $500k or $5M to a start-up.  Someone on the government payroll will need to pick and choose between the various neat ideas — and Canadian entrepreneurs generate thousands of them in any given year — which is never known to be the role of a modern, democratic government.

Or so U.S. President Barack Obama would say.

Although our firm didn’t tap VCAP, I know that most venture funds in the Canadian ecosystem did, whether they were in the IT, Energy Tech or Life Science space.  As promised, the $400M VCAP program generated more than a $1 billion of committed funds via additional commitments from institutions such as banks and insurance companies; the kinds of private sector institutions that fled the venture space between 2002-05.

These VCAP-backed VC funds are now actively investing in the Canadian economy.  If the private sector is putting up two dollars for every one allocated by the taxpayer, that seems like excellent leverage to me; and the funds intend to generate a suitable risk-adjusted return, too.

Taxpayers should profit when all is said and done, and the companies these VCs fund invariably create new jobs as they help founders commercialize the R&D being done on campus or in garages across the land.

VCAP is doing what it was designed to do, and entrepreneurs credit the program for re-energizing the Canadian venture community and restocking its coffers.  The VCs are doing their jobs, too, as entrepreneurs raised 53% more in venture funding in 2015 as compared to 2012 (VCAP was launched in 2013), creating the very high-value innovation jobs that Justin Trudeau said he had in store for Canada during the last election.

For the members of Minister Morneau’s Advisory Council who worry about “fees on fees” issue, the irony is this: the last time I did the math (see prior post “Why is CPPIB’s MER higher than its peers?” Jan. 9-13), CPP Investment Board cost Canadian workers more than 50 bps a year to operate.  And tens of billions of our CPP funds are invested in third party PE funds like KKR, Silverlake and TPG.  Fund managers who in turn charge Canadians a 2% annual fee plus 20-30% of the upside.  The very same “fees on fees” that has certain members of the Advisory Council all fussed.  If that’s good enough for the CPP, surely it’s not a reason to cancel VCAP.

By any measure, VCAP is doing exactly what it was designed to do.  Canadian entrepreneurs are raising more capital than at any time since the end of the financial crisis, more financings are closing, and there’s even a pending Tech IPO market.

Now’s not the time to do something goofy and suck the oxygen out of the innovation ecosystem.



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