In the Media

In the Media

Tough times are coming for private tech companies, but Canada can weather the storm


LISA MELCHIOR

CONTRIBUTED TO THE GLOBE AND MAIL

PUBLISHED JUNE 8, 2022

As pandemic-fuelled tech valuations drop down to earth and headlines warn of the “coming storm,” now is precisely when we need to step back and level set. It’s at times like these that, with a little perspective, fundamental value breaks through the fog of frothy markets, and that’s good news for Canada’s tech ecosystem and the broader economy.

As a 25-year veteran of private equity tech investing, I can tell you a few things with near certainty: that the window on aggressive fundraising for private companies has closed; that we can expect near-term write downs of recent high-growth venture and private equity-backed tech deals of 50 per cent or more; and that there will be a culling of the herd when it comes to unprofitable companies with a high cash-burn rate and a flavour-of-the-month value proposition.

I can also tell you that while the current situation has the markings of a typical boom-and-bust cycle, the macro reality is different. We all know that the pandemic supercharged technology adoption, but the underlying fundamentals and trend line remain the same; tech will continue to drive growth as the economy is increasingly digitized.

And as we stare down the barrel of rising interest rates, inflation and weakened growth, the business case becomes more compelling, particularly for certain kinds of technology. In a high-cost, competitive world, the efficiencies that can be gleaned from digitization and software automation will be essential for many organizations.

A tech company that epitomizes the intersection of innovation and fundamental value is Constellation Software (CSU-T), a $40-billion enterprise software provider that most Canadians have probably never heard of. (Full disclosure: I personally own Constellation shares.) I first met chief executive officer and founder Mark Leonard when I was part of the private equity team at OMERS, the Ontario pension fund, which invested in Constellation in 1995, just as the dot-com bubble was heating up.

Early on, Mr. Leonard saw the potential of acquiring and managing a stable of industry-specific, mission-critical software businesses, and when the tech bubble burst in 2000, we doubled down on our investment, providing Constellation with the firepower to grow quickly through down-cycle acquisitions. It was a spectacular investment, not only because of Mr. Leonard’s ability to execute and allocate capital, but because of the simple beauty of what some might deem a boring business.

Enterprise, or business-to-business (B2B), software is the backbone of our modern economy – its systems running everything from credit cards, cars and utilities to corporate payroll, insurance claims and supply chains. While it may not be sexy, its predictable revenue, low capital costs and high profit margins have translated into the best risk-adjusted returns of any tech asset class.

The good news is there is a healthy pipeline of these kinds of companies in Canada. According to Vertu Capital’s proprietary database, of the 40,000 software businesses in the country, we are actively tracking almost 600 enterprise software firms, up from fewer than 70 in 2017. And that pipeline is expected to expand significantly as the exponential growth we have seen in venture capital fundraising in Canada since 2018, not to mention foreign VC investing and bootstrapped startups, translates into solid, cash-flow-generating businesses.

Add in the deep talent pool – according to real estate services group CBRE, Toronto, Montreal and Vancouver are among the top five fastest-growing tech talent cities in North America (Edmonton and Ottawa rank sixth and eighth) – and Canada is well-positioned to weather the current tech storm.

Some of the best, most enduring tech companies were built in a down market. Think Google, PayPal, Salesforce and Shopify. Why? Because scarcity forces discipline and focus, investors become more discerning, and talent becomes easier to find.

So, for founders and CEOs who are building great Canadian tech businesses, my advice is to stick to your knitting. Make sure you have enough capital to support your business for the next 24 to 36 months and focus on profitability. Have a clear and well-articulated five-year plan and execute against it. The companies with strong business models and solid management teams will survive and thrive, and there are plenty of investors out there with the dry powder to support you.

Lisa Melchior is the founder and managing partner of Vertu Capital, a Toronto-based private equity firm specializing in Canadian B2B enterprise software companies.