The Problem With VC-Dominated Investing in Canada
Perry C. Douglas
October 19, 2024
From the Globe and Mail: How Georgian Partners, Canada’s venture capital leader, turned into an industry laggard
The descent of venture capital firm Georgian Partners is part of a larger, more curious story about the Canadian VC industry. One that has morphed into operating like just another other asset class; gathering assets and generating fees. The VC industry has developed into a place where you can no longer find authentic opportunities, just more and more funds of funds and hubris fund managers believing they can predict the future. No longer venture investing but investment shopping instead.
Groupthink is the new normal in the VC world. Everyone is chasing the same thing, i.e., generative AI, stifling creativity and innovation, and bullying entrepreneur founders with their capital to alter their visions, resulting in poor returns.
Georgian’s ascent came many years back from federal government (taxpayers’ money) investment programs; cash also came from the Canadian pension funds. The federal government presses pension funds to invest more at home...looking to spur the Canadian technology industry, and tech financing was the priority. The government, likely led by big consultants, like McKinsey & Co., called in the Canadian VC industry, giving them hundreds of millions of dollars to do with, what they wanted. Georgian, the biggest beneficiary of those funds, got a major lift to its business from government investment. And then became dependent on it.
Many VC funds sprung up through the unprecedented government investment programs for tech. Therefore, Georgian didn’t grow because of any stellar past performance, as how it should have, but from easy money government programs.
Instead of putting the money directly into the hands of real entrepreneurs, it put it into the hands of analysts turned fund managers. This allowed VCs like Georgian to build big fee-generating businesses and began to dominate the tech entrepreneurship investing marketspace. Sucking up all the oxygen and capital in the space. Stifling competition, creativity and innovative thinking, and creating a top-down institutional, academic investing system that doesn't work. And as the evidence now tells us, it has brought the Canadian tech space nowhere! Further, it has also not benefited the broader Canadian economy, and taxpayers certainly did not get a return on investment.
In a Harvard Business Review article by Diane Mulcahy, titled Six Myths About Venture Capitalists, based on her comprehensive analysis of more than 20 years of experience investing in nearly 100 VC funds. Her research advises aspiring entrepreneurs against falling victim to common myths about venture capitalist and their ‘funds.’
She warns that VCs are not the primary source of start-up funding; “Actually, angel investors fund 16 times as many companies than VCs,” she says. And it’s also a myth “that VCs take big risks with start-ups. (Often they’re insulated against risk by hefty annual fee streams.)” Another myth that “Most VCs offer great advice and mentoring,” is also not the case.
The big myth is that “VC generates spectacular returns. (Since 1997, less cash has been returned to VC investors than they have invested.)” Her research also reveals the falsehood that “Bigger is not better. (Research shows that fund performance declines as fund size increases above $250 million.)” And finally, the myth that “VCs are innovators. (Apparently not. The innovation is not coming from them whatsoever but from other places.”)
VC funds are basically run like mutual funds and 95% of fund managers don’t ever beat the index averages. This is precisely why we are seeing the rise of do-it-yourself investment companies like WealthSimple gaining consistent market share.
The future of VC investing needs to be and can be disrupted, for example, as WealthSimple keeps democratizing the industry and building accessible platforms, that can provide investment tools for a wider range of investing. Individuals will be able to participate in venture investing without the VC middleman. Enabling platforms already exist, i.e., https://carta.com/, “Carta’s platform of software and services lays the groundwork so you can focus on building the future.” Startups are given the digital back office capacity and other services, and small investors can invest as easily as buying any security online. So the future is already here!
Georgian Partners hyped themselves up, labelling themselves as “fintech,” calling their portfolio of companies “customers,” and developing “education” programs for their companies, “Georgian promoted itself as an innovative financier that took a hands-on approach with the portfolio companies, even building software for them.” They are not venture investors, they are a business model for asset gathering and high fee (2 and 20) generation.
The Globe and Mail article focused on some of Georgian’s greatest blunders; i.e., WorkFusion Inc. was supposed to be a big winner…over-hyped about the generative artificial intelligence (GenAI) “revolution,” however, it’s been a very quiet revolution.
Georgian hyped its “powerful vision” of a GenAI future that would rapidly change the future of work. Making wild predictions with hubris but without any substantiation. Hundreds of millions of dollars began to pour in, and Georgian said that the capital would be invested in “…improving productivity with robotic process automation and software that WorkFusion would deploy to help financial giants automate and optimize business functions,” but nobody bothered to check with the real world. It was a big stupid flop!
They misunderstood AI's utility function in the workplace or how fast, if at all, it would be adopted. It was all hype! WorkFusion blew the tires and ended up in a ditch, while reality passed them by. Georgian took a write-down from US$275.2 million invested to US$ 91.2 million. “Georgian wrote down 28 investments in 21 companies – wiping out US$430-million in book value – across its five oldest active funds,” as reported by The Globe and Mail.
This highlights the bigger problem in the VC sphere, “Georgian led a wave of emerging managers that [emerged] a decade ago,” Georgian Partners raised more money than anyone else, US$4.3-billion from investors, and manages US$5.6-billion in assets. But “they haven’t lived up to the hype.”
“Its funds have been backed by crown corporations Business Development Bank of Canada (BDC) and Export Development Canada, and pension giant Caisse de dépôt et placement du Québec. Bank of Montreal invested in several Georgian funds and put more than 100 asset management clients. Georgian was one of the largest indirect beneficiaries of a federal program that put hundreds of millions of public dollars into venture capital.”
--The Globe and Mail
Many of these VCs invested at inflated prices and then subsequently slashed valuations of portfolio companies “once destined for windfall exits.” BDC alone devalued its VC investment holdings by $1-billion over the past two years, which is just astonishing! Where is the accountability and responsibility?
Georgian Partners made all the classic mistakes, led by arrogance and hubris, with no identifiable investing system relative to the AI and digital transformation narrative they touted.
Taking a look at the charts below, why would any rational thinking investor invest in VC funds—funds-of-funds…for an average 10-year return track record of 15.1% when the 5-year return for Nasdaq is 17.6% versus the VC average of 17.1%; and the 10-year Nasdaq 15.8% vs. the VC 15.4%. Additionally, the stock market provides liquidity, and actual cash returns have been scarce for many VC funds. Even the S&P 500 would have provided a better risk-return situation.
VC funds develop biases based on their past experiences and environment; VC have no disciplined methodology, just smoke and mirrors, and ego, often relying heavily on patterns and trends in the macro environment, making predictions and failing to understand the dynamics of the founder and business. This nonsense herd mentality continues to generate cycles of bias and leads to poor decision-making over time, says Aki Kakko, Founder of Alphanome.AI — Finance AI Research Lab. "Very few Canadian venture capital funds or fund-of-fund types have returned any meaningful cash distributions to investors over the many years."
This has been a widespread investor complaint, particularly since the tech downturn began in 2021, according to another Globe and Mail article titled Wealthy Canadians Investing More In Government-backed Venture Capital Funds.
Georgian’s “five oldest active funds are in the single digits,” and to add insult to injury, they’re mostly invested in the United States after being funded by Canadian taxpayers and pension funds. It's almost worse than how McKinsey & Co. fleeces governments with bogus ‘consulting services.’
Georgian got lucky because of its early entry to Shopify, and it “made the most of an early win on Shopify. Now, it needs several portfolio companies across several funds to spring back.” But that's another ten year journey and who with any sense, would take it with them?
Georgian is the largest VC in Canada but at the bottom quartile of funds of their vintage, according to the Globe and Mail. But to be fair to the broader VC industry, by contrast, Power Corp. of Canada’s Portage Ventures has a 33.3-per-cent IRR to date in its 2016 fund. Nevertheless, the average VC returns remains at 15.1% as per the chart provided above.
There are many excuses put forward for Georgian’s bottom quartile returns, “Georgian grew too fast,” they “overpaid,” “too many inexperienced managers, too enamoured with the companies they invested in,” “they were not necessarily focused on managing future down cycles.”
If those are the excuses, then why are they managing people’s money? The Canadian VC sector has only proven that it can’t consistently deliver strong returns nor wean itself off federal support.
Georgian was “willing to pay up as valuations soared... When they crashed, Georgian was left with many overpriced holdings that were eventually devalued—Georgian missed or ignored several chances to cash out at high prices and didn’t sell as others bought in at penthouse prices, taking increasingly bigger bets as the market peaked.”
From the 107 employees listed on its website last December, 32 have left, including its chief financial officer and heads of finance, innovation and product, AI and information security, investors and engineers, just last month, a dozen people left through layoffs. Georgian is now down to 87 employees, according to the Globe.
I was going to take one last dig at Georgian Partners to end the article, but Sean Silcoff, the Globe’s reporter and author of the article, had a good enough zinger: “If only Georgian could create software to solve [its] problems.”
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