How Deep Tech Startups in Canada Can Rise Above the Funding Drought

For the Canadian deep tech ecosystem, it’s both the best and worst of times. As the industry begins a new investment cycle, startups need a strong technical differentiation. That is something deep tech startups excel at, upending the traditional enterprise SaaS model of the past ten years. At the same time, capital availability has been at its worst in the past ten years, with startups that have longer commercialization horizons struggling to raise. 

What happened, and how are deep tech startups, especially Canadian founders, supposed to navigate the new normal? 

The Landscape for Deep Tech Startups

First, let’s delve into what prompted the Business Development Bank of Canada (BDC) to play a role in the Canadian Deep Tech space, by launching a $200 million early-stage Deep Tech Venture Fund investing in Canada’s leading deep tech startups. It starts with our values, to be united for entrepreneurs and to be courageously impactful. As Canada’s development bank, our mission is to spur the growth and competitiveness of Canada’s economy, one investment at a time, and to lift the investment ecosystem as a whole towards these goals. We decided to play a leading role in addressing the growing commercialization gap between the lab and the market by creating the fund in 2021. At that time, the WIPO Global Innovation Index ranked Canada 9th in innovation input but 22nd in output. Canada has world-leading R&D but trails other OECD countries in translating that research into market-ready solutions.

Yet we did not forecast how much the tech ecosystem and venture capital landscape would have changed in the post-COVID industry. According to the BDC’s latest VC Landscape 2024 overview, total VC capital invested in Canada dropped from $15.7B in 2021 to $7.1B in 2023, dropping more than 50% in less than two years. 

In addition, startups that received funding several years ago are struggling today for several reasons. First, IT budgets are being cut across enterprises because of inflation and greater market uncertainty. Second, large tech companies such as AWS and Microsoft are providing higher-quality services to enterprises. Large tech companies are less concerned whether a startup has a better chatbot or can train algorithms with less computing – they leverage the fact that they can sell a bundle of services to large companies, allowing them to provide cost savings somewhere else or provide more value-add in other ways. Finally, widely available Large Language Models (LLMs) have reduced the technical moat for many AI startups, precluding many founders from capturing more value from the value chain. 

Advice for Deep Tech Founders

However, despite a tougher fundraising environment, these are ideal conditions for deep tech startups. They have the technical moat that most SaaS-focused startups rarely have. These founders have given up short-term revenue generation in a bid to build a product with leading-edge scientific knowledge. Startups based on innovations in foundational AI models, semiconductors, and advanced materials are well set up to succeed as we begin a new ten-year investment cycle. VC funds are sitting on a large amount of dry powder – funds they have already raised but have not invested yet. Pitchbook estimates that US VC funds have nearly $302.8B in dry powder, the highest ever, whereas Canadian VC investors hold about $10.4 billion in dry powder, according to our most recent VC Landscape Report. CVCA data points to no levelling off in seed investments in Canada, with average deal sizes actually increasing at that stage, reaching their highest level in 2023. Founders that have a compelling business model enjoy rounds that are quickly oversubscribed. 

What does this mean for Canadian startups? I recommend three things: 

1. Strengthen the founding team’s industry expertise: VCs can live with delayed revenue generation if the founding team has credibility. As capital becomes more scarce, VCs are less willing to back founders who do not have the industry expertise to identify the greatest opportunities in an industry’s value chain and the founder’s ability to capture value. That usually translates into deep industry expertise. 

2. Hit the metrics: Deep tech companies that have successfully raised funds were able to demonstrate they can achieve success on a number of critical metrics, especially technical and commercial milestones. Investors want to know not only a team’s ability to achieve technical and commercial milestones but also their ability to deliver on time without the need for additional funds in the near future.  

3. Manage valuation expectations: In a higher interest rate environment, capital has become expensive for every actor in the industry, especially for startups. However, I’ve observed several great companies failing to either raise sufficient capital or take funds from investors with little reserve capital for follow-ons, all to maximize valuation. The best founders were flexible on valuation but required clearer value-add services from funds. In other words, the best founders understand VC funds are not just sources of checks but should also be partners in their success.

Starting a new VC cycle means creating new business models. With capital no longer a commodity, the drive for market share at any cost is no longer a viable pathway to success. Startups adapting to the new reality will have a great chance of succeeding, especially deep tech startups.