Last week, I attended a gathering of 70 civic and business leaders from Vancouver hosted by the Frontier Collective, an organization dedicated to advancing Vancouver’s standing on the global tech stage. One of the questions that came up was whether Vancouver needs more “home grown” venture capital in order to reach its full potential.

I’m very vocal about the fact that Canada is severely lacking in early-stage venture capital. Whether we like to admit it or not, much of Canada’s recent successes in tech are due to angel investors across the country stepping up to fill the gap in risk-taking institutional capital. Toronto’s size — now firmly the third largest startup ecosystem in North America — provides enough gravitational pull to US VCs to further augment the local sources of capital, but it’s still not enough.

Yet despite that, I don’t believe that we will see a sudden explosion of home grown venture capital firms in Vancouver or any other mid-sized city. Nor should we want one.

Here’s why.

Supply and Demand

A typical VC invests in less than 1% of the startups they meet. Last year, the team at Panache spoke with more than 3,000 founders across Canada. We invested in 16 companies.

What does this mean for an ecosystem?

Assume that a typical VC aims to make 10 investments per year. If each firm invests in 1% of the startups they meet, then the startup ecosystem they operate in needs to reliably generate at least 1,000 new startups per year for every VC*.

This means that for a mid-sized city like Vancouver to support 10 power law VCs investing locally, it would need to produce more than 10,000 new startups per year.

It has only about 2,000 startups in total.

* This simple model doesn’t take into account competition amongst investors, sector focus, startups coming from outside of the region to fundraise, etc., but you get the point.

What Happens if There Aren’t Enough Startups?

If a VC firm is based in an ecosystem that doesn’t produce enough startups to satisfy their investment thesis, then they have only two choices:

Invest Outside of their Local Ecosystem
Adjust their Investment Thesis

Invest Outside of their Local Ecosystem

For power law VCs, the solution to not finding enough startups locally is to look elsewhere. This is what the top early-stage VCs in Canada do. Vancouver-based Version One has made investments in Toronto, San Francisco and New York. Golden Ventures from Toronto has made investments in Vancouver, Boston and Los Angeles. Montreal-based Inovia invests across North America.

(While Panache Ventures is Montreal-based, we consider our “local” ecosystem to be the entire country, which is why we have partners on-the-ground in Vancouver, Calgary, Toronto and Montreal.)

Adjust the Investment Thesis

Regional VCs – investors whose thesis restricts them to investing in a local city, province or region – have a different approach. They focus on delivering a return to their investors based entirely within their local ecosystem. While this might sound amazing (more money for the local ecosystem!), the reality is that outside of Toronto, no ecosystem in Canada generates enough new startups to support power law investing regionally.

The result? Investors who focus their diligence on revenue, sales cycles and short-to-medium term business plans instead of long-term potential, much to the frustration of founders.

Why does this happen? Because regional VCs need to ensure that they generate a return regardless of the quality of startups they meet. If a given VC’s thesis requires making 10 investments per year but the region only generates 2 venture-quality startups that match their thesis, then the fund must find 8 additional “safe bets” to round out their portfolio. These companies are unlikely to generate billion-dollar outcomes but could reliably return 2, 5 or 10x to their investors.

The Paradox of Numbers

If Canada doesn’t produce enough startups each year to support more locally-focused power law VCs, why am I so adamant that their aren’t enough early-stage VCs? Why does it feel like their aren’t enough VCs?

Because not every startup is a match for every VC.

The reality is that most startups are only a fit for 10 or 20% of the VC firms they meet. If a firm like Version One or Golden Ventures could find enough startups that matched their thesis locally, they wouldn’t have to search beyond Canada. But they don’t.

So how can Canada support more VCs if it can’t support more VCs? The solution depends on your perspective.

How Can Ecosystems Fill the Gap?

Cities and local ecosystems can fill the funding gap in two ways:

Help create more local VCs
Wait…didn’t you just say that the solution isn’t more local VC firms…?
While a city like Vancouver isn’t large enough to support power law VC firms focused exclusively on local investments, helping anchor new funds with a broader investment thesis will almost certainly result in more local investments. In other words, having more VCs based in a city — even if they don’t invest exclusively in that city — can have a massive impact on the local ecosystem.
Why doesn’t this happen?
In the US, there are numerous institutional investors that invest in emerging managers (the term for new VCs launching their first or second fund). In Canada, we have zero. That makes it incredibly difficult to launch new funds, even for investors with lengthy track records.
Help attract VCs from elsewhere
Investors from New York and Boston regularly travel to Toronto in search of deals. In Vancouver, we’re seeing increased interest from Pre-Seed VCs based in Seattle and Portland, with the occasional San Francisco VC heading north.
Unfortunately, cities themselves tend to struggle to attract the right types of investors.

(There is, actually, a third option: loudly and repeatedly profess that your city is just “one big exit” away from minting a bunch of super-angels who will magically fill the local funding gap. I don’t recommend that strategy.)

How Panache is Helping Fill the Gap

Panache’s national investment thesis ensures that we meet enough incredible, ambitious Canadian founders each year to achieve our investment goals. However, we feel the VC gap in a different way.

After we commit to investing in a company, we often have to help the founders seek out other investors to fill the round. For example, we might invest $500K into a $750K round or $1M into a $1.5M round. Sometimes we can find other Canadian investors to join us, but often we encounter the same challenges that founders do. There just aren’t enough like-minded VCs in Canada.

Last year, we embarked on an ambitious plan to build a North America-wide co-investor network, starting with a September event where we hosted more than 150 VCs in the heart of San Francisco.

This year, the team from Panache will be in Seattle, Portland, San Francisco, Los Angeles, Miami, Austin, New York, Atlanta, Washington DC, Boulder, Boston and Columbia, MO (iykyk) to champion the Canadian ecosystem and help bring more investors and investment dollars to the Great White North.

We’d love nothing more than to see more home-grown early-stage VCs. And I think it’s going to eventually happen.

But in the meantime, we’re going to go find some.

Why Aren't There More VCs in My City?