Things I Think I Think - Q2 2024
Q2 has come to a close and we’re into that sweet, sweet Canadian summer.
In homage to legendary sports columnist Peter King, here are 5 Things I Think I Think - Q2 2024 Edition:
1. Toronto is Back 🔥
Summer came early to Canada’s largest city.
In my Q1 2024 update, I noted that the Panache team introduced more companies to our ICM in Q1 than we had in any quarter since 2022.
That number doubled in Q2. More notable: 70% of the activity we saw in Q2 was based in Toronto.
Unpacking the recent quarter a bit more:
There was a considerable surge in the number of strong repeat founders fundraising in Q2, particularly in Toronto.
The increase in fundraising activity was very much concentrated in Toronto proper (folks in Ontario love to lump together Waterloo and Toronto — aka the “Toronto-Waterloo corridor” — but this was all about the 416).
While there were certainly a lot of AI-related startups, the companies we met with were from a wide spectrum of industries (this wasn’t a case of activity being purely driven by hype/FOMO/AI-for-the-sake-of-AI).
What about the rest of the country?
Fundraising activity increased across Canada in Q2, however, the increases were far less pronounced than in Toronto. From our (very unscientific) vantage point, Montreal experienced the second-largest increase in the country, followed by Vancouver and then Calgary. So while overall activity was up across the country, the majority of Canada still feels sluggish relative to Toronto (and certainly in comparison to the US).
2. Everyone’s Jumping on the Preemptive Term Sheet Bus
One of the topics I discussed in my Q1 2024 update was the lack of Series A funding across North America. A major contributor to this is a shift in the investment strategy of multi-stage funds away from new Series A investments and in favor of doubling down on existing portfolio companies at Series B and C.
We saw this firsthand in the Panache portfolio, with 2 out of the 3 Series B rounds announced in Q2 led by existing investors:
Toronto-based Relay (USD $32.2M Series B led by existing investor Bain Capital Ventures)
St. John’s-based CoLab (USD $21M Series B led by existing investor Insight Partners)
(Quebec City-based Qohash raised a $17.4M Series B led by new investor Fonds de solidarité FTQ.)
We continue to see companies with solid-but-not-stellar metrics struggling to raise Series A funding (AI-related companies being the notable exception). As a result, many startups across North America are currently trying to raise smaller Seed extensions / bridges to secure enough funding to push through the current Series A freeze.
Can you spare a Series A..?
For companies caught in the no-mans land between Seed and Series A, making it through the second half of 2024 will be a grind. There isn’t a lot of appetite amongst Seed VCs to bridge companies that aren’t already in their portfolio — particularly when many bring with them the “baggage” of a high 2021 valuation — and most smaller funds simply don’t have the reserves to bridge portfolio companies on their own. Extending runway and focusing on capital efficiency is going to be the name of the game for these founders.
3. Valuations are Rising in Smaller Markets
One of the unique aspects of the Canadian venture landscape is the prevalence of region-specific funds backed by local governments, economic development agencies and other investors focused on regional growth. These regional VCs operate in a manner akin to more traditional VC firms with two key exceptions:
They are geographically constrained and must invest in a specific province or region
Most have strict time-bound requirements for deploying capital
While all VCs have a deployment period specified in their LPA (the period of time when they can invest in new startups — typically 2-4 years), traditional VC firms have a lot of flexibility around this. For example, they can extend their deployment period with the approval of their LPs or they can choose to not invest all of the capital in the fund. Both of these make sense, since financially-driven LPs generally don’t want VCs to make bad investments. But the LPs in regional VCs often have a different motivation: economic development. As a result, many of these firms are required to deploy their capital even when the environment to do so isn’t great (i.e. even when there aren’t a ton of good startups raising money).
Which brings us to Q2.
Coming out of 6 quarters of sluggish activity, many regional VCs (not to mention their LPs) face pressure to deploy capital. Now.
The surge in strong founders coming to market in Q2 finally provided that opportunity for many of them.
The result is an unusual phenomenon: in provinces where regional VCs provide a disproportionate amount of funding, we’re seeing valuations rise for non-competitive deals — in some cases, far beyond what those same companies would justify in Toronto, New York or even San Francisco. This increase is due to regional investors looking to deploy more capital than they might otherwise into companies while still backing into a cap table that will look good to downstream investors (20 - 25% dilution).
For founders, this can seem like winning the lottery: a clean cap table, relatively low dilution and more money out of the gate than they would typically be able to access. But over-capitalization can have long-term negative consequences for startups — especially those with first-time founders. It can lead to over-hiring, lack of focus and operational inefficiencies, behaviors that tend to be more pronounced in ecosystems where founders have fewer experienced mentors or comparison points. (Combine that with easy-to-access tax credits like SR&ED, and you can end up with a Seed-stage company with an effective burn of $200K and very little to show for it.) It can also be a turn off to potential investors whose mandate spans a broader geography.
Assuming that fundraising momentum continues into the fall, I would expect these regional valuation bumps to only last a quarter or two.
(To learn more about regional VCs, see this post on the 9 types of startup investors.)
4. US Funds Are Throwing Their Weight Around
The first half of 2024 has been a unique one from a VC fundraising perspective. While many small-to-midsize funds are struggling to raise, mega funds have been knocking down LPs like they’re going out of style (this is very much a “flight to quality” by institutional LPs).
While these mega funds might not be deploying much at Series A, a number of them are leapfrogging even earlier and throwing their weight around at the Pre-Seed and Seed stages.
And Canada is very much on their radar.
Too soon?
In Q2, multiple US mega funds were extremely aggressive at the early stages in Canada, particularly in Toronto and Vancouver. I’ve heard similar stories from VCs in smaller US markets, like Seattle, Atlanta and Salt Lake City.
This “barbell” strategy makes total sense for larger funds given what’s happening in the market right now: deploy aggressively into credible early-stage, AI-native companies where local competition can’t compete on price, while doubling down on portfolio winners at Series B and C.
Barring any significant shift in the market, I expect this behavior by US mega funds to continue — if not increase — in the back half of the year. (That’s great news for founders, even if it makes my job tougher.)
5. Deals Are Happening Really Fast. Or Not.
Combine all of these points together and deal velocity has increased significantly — at least when it comes to “hot” deals.
What constituted a “hot” deal in Q2?
Credible founding team (repeat founders and/or founders who were previously early employees at a well-known startup)
AI-native proposition (natural incorporation of AI into a core aspect of the value proposition)
Strong market tailwinds (developer tools, AI infrastructure, and future of work were all notably hot amongst investors in Q2)
Early customer validation
Vancouver, Toronto and Montreal all saw early-stage deals that went from initial meeting to signed term sheet in less than two weeks. Think that’s fast? I know of multiple deals that went from first meeting to money wired in a single week.
Alex Norman trying to close deals before the rest of Canada finds out
What about the rest of the market?
The good news is that capital is definitely flowing in Canada. But there’s an noticeable difference in deal velocity for early-stage startups raising outside of hot sectors. Extensions and bridge rounds notwithstanding, most deals where the founder is running a well-planned high-velocity fundraising process are still taking 4-5 weeks (or longer) to get to a term sheet (at least, based on my very unscientific view of the market).
Bottom line: the Canadian startup ecosystem got its swagger back in Q2. Credible, experienced founders are fundraising and most VCs have shaken off the cobwebs. Add to that the entry of US mega funds into the early-stage picture and we’ve got strong signs for a healthy second half of 2024.