Looking for excellent investment opportunities and superior returns? Look no further than the Great White North

Looking for excellent investment opportunities and superior returns? Look no further than the Great White North

Written by Pascal Tremblay, Managing Partner Novacap Technologies for Private Capital Magazine Summer 2012

In today’s business world, institutional investors are looking to outperform the foreseeable long period of low returns of the public and fixed incomesecurity markets caused by the economic turmoil of the last few years. They are looking to invest in alternative vehicles such as venture capital and private equity firms that benefit from demonstrable competitive advantages in territories where they invest which, in turn, provide unfair advantages to the companies they are investing in against their global competition.

Moreover, as we now know, the world has become a small oyster. Venture capital and private equity backed companies can no longer focus only on their home market, whether they are based in Canada, in the U.S., in Europe or in Asia. Factors

such as the growth of the digital infrastructure and of distributed computing architectures (think cloud computing), access to all information anywhere and anytime, and the creation of low-cost manufacturing and distribution have significantly reduced the traditional barriers to entry for out-of-market competitors. As a result, companies need to think globally for all aspects of their operations and not only for their sales and marketing, as has traditionally been the case.

Venture capital and private equity investors seek to create value the following way: harvest creativity by driving capital efficient innovation and growth; improve operating margins and obtain multiple expansion at exit. As it happens, building a leading global business goes a long way in achieving these value creation drivers.  Although these lessons are not new, there is a new way for investors to employ this formula: Think Canada!

Today, Canada presents an excellent environment in which venture capital and private equity investors can invest and create superior returns for their limited partners. Why is this market now so appealing, especially in the face of the attention being paid to emerging markets around the world such as Brazil, China, India and Russia?

1. Depth of talent

In many industries such as technology, new media, telecommunications, natural resources and energy, to name a few, Canada possesses an extensive pool of talent. This pool provides a mix of entrepreneurial spirit coupled with the maturity of managers who have “been there and done that.”  This combination provides investors with an employee base that will always seek innovation and growth, but with recognition to turn such innovation into value for the company’s stakeholders.

Likewise, because Canadian companies needed to learn long ago how to access the U.S. market in  cost-efficient manner, there is a large supply of experienced executives and professionals whose talents can be applied to building distribution on a global basis. Moreover, most leading Canadian venture capital and private equity firms have developed extensive international contact networks that give them access to key resources when needed.

2. Affordable labour costs

For venture capital and private equity investors, labour costs always receive a lot of attention. This is for good reason, as it is one of the largest line items on the profit and loss statement for most companies. The prevailing environment for wages in Canada is typically far less than that in the U.S. and Europe. This has much to do with the cost of living and historical compensation expectations in Canada, which typically trail the other developed countries.

Another contributing factor to the reduced labour costs is the existence of numerous tax credits a company can obtain for R&D and other development conducted in Canada. As a result, the combination of reduced labour costs and tax credits allows for a more efficient cost structure to drive greater innovation and profitability.

3. Proximity to and free trade with the U.S.

Canada is the largest trading partner of the U.S. and vice versa. The U.S. is the most important market for the success of the vast majority of Canadian companies. It is the largest market for many products and services, and its capital markets remain among the largest and most liquid in the world. Changes to regulations over the last few decades (e.g., the North American Free Trade Agreement) in both Canada and the U.S. permit easy access to U.S. capital markets and the free trade of goods and services between the two countries.

4. Canadian commercial banking industry

Essential for the growth of business is a stable commercial banking industry. An active and stable lending market allows for access to less expensive capital to drive growth. In addition, a stable market allows for predictable behaviour during turbulent markets, allowing for a more constructive dialogue between lender and borrower during such times.  The major leading commercial banks in Canada have historically been active lenders to growth companies in Canada. Even during the recent global economic turmoil, these banks remained active due to the strength of their balance sheets and business practices.

5. Size of deal market

By most measures, the Canadian economy (in terms of GDP) is typically 10 per cent of that in the U.S.  Although there are some variances based on industry verticals, this is a good general rule of thumb. Since most economic statistics generally exist in a similar ratio, one would assume that Canadian venture capital and private equity deal activity would represent 10 per cent of the U.S. deal activity from a volume and size perspective. Based on data from Thompson Reuters, however, Canadian venture capital and private equity deal activity is only 4 per cent of that in the U.S.  The significance of this ratio is that purchase price multiples or pre-money valuations are typically 10 to 25 per cent lower in Canada versus that in the U.S.  As companies grow and become more global, these valuations move closer to U.S. valuation benchmarks, allowing for multiple expansion at exit for the investors in those companies.

In light of these factors, among many others, Canada represents an exceptional opportunity for investment. Companies across sectors have access to capital and talented management to help drive cost-efficient innovation and strong growth. As these companies build up in size, low cost labour and its close proximity to the U.S. allow for lower operating costs and drive superior operating margins. Lower investment entry valuations provide for better returns for both private equity and venture capital.

Finally, if becoming global is a pre-condition for success in today’s business climate, Canada offers an inviting environment to achieve this. Therefore, if investors are looking to outperform public and fixed income security markets, look no further than Canada.

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