2020 Report on Angel Investing In Canada

Published Ju ly 2020

ANNUAL REPORT ON ANGEL INVESTING IN CANADA A Decade of Deals

With funding from the Government of Canada

Data Partner

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

LEAD AUTHOR Colin Mason is Professor of Entrepreneurship, Adam Smith Business School, University of Glasgow, Glasgow G12 8QQ, Scotland, UK. He was also the lead author of the 2010, 2011, 2015, 2016, 2017 and 2018 Angel Investment Activity reports.

COMMITTEE OBSERVERS Warren Clarke Innovation, Science and Economic Development Canada Manasi Joshi Innovation, Science and Economic Development Canada

PROJECT STEERING COMMITTEE

DATA PARTNER NACO worked with Hockeystick as its data partner to collect data.

Dr. Kenneth A. Grant Chair, Department of Entrepreneurship & Strategy Ted Rogers School of Management, Ryerson University Mary Moran CEO at Calgary Economic Development Derrick Hunter President & CEO at Bluesky Equities Ltd. Claudia Krywiak President & CEO at Ontario Centres of Excellence Joelle Foster CEO at North Forge Technology Exchange Mary Long-Irwin Executive Director at Northern Ontario Angels Pieter Dorsman Angel Forum and E-Fund Nancy Lala Chair of Maple Leaf Angels Sara Mohajerani Investment Analyst at Bluesky Equities Ltd.

The views expressed in this report are not necessarily those of Innovation, Science and Economic Development Canada or of the Government of Canada.

Brion Hendry CPA, CA Partner at BDO Canada LLP

This report was made possible with financial contributions from:

A DECADE OF DEALS: AN ANNUAL REPORT ON ANGEL INVESTMENT ACTIVITY IN CANADA This report is the 10th annual report conducted by the National Angel Capital Organization. By highlighting both the investment activity of angel groups in 2019 and year-on-year investment trends, this report provides unique insights into angel investment trends in Canada. This evidence-based analysis emphasizes the importance of angel investing to Canada’s innovation economy. ACKNOWLEDGEMENTS We wish to express appreciation to the members of the Project Steering Committee for their advice, direction, time and feedback during the formative drafts of the report. Special thanks go to the angel groups managers, members, partners and volun- teers who annually dedicate significant time and energy to this initiative.

Preface

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

Charting the Next Decade PREFACE

This year, after ten years of tracking investment data, NACO members have surpassed the $1 bil- lion threshold, with $163.9 million invested in 2019. As a result, this Annual Report on Angel Investing Activity in Canada signifies a new milestone, and a new journey upon which to embark.

With this report, Canadians now have evidence on a decade of angel investment activity. This data tells not only a story of the importance of angel investors in supporting entrepreneurs, but also the impact of early-stage investment on the wider innovation ecosystem.

A Decade of Deals 2010-2019 CUMULATIVE INVESTMENT

TOTAL $1,016,351,374

Quebec Est. Population 8,164,361

Atlantic Canada Est. Population 2,333,000

$185,849,375

$146,614,093

$7,875,635

$133,410,000

Western Canada Est. Population 12,053,678

Northern Ontario Est. Population 780,140

Southern Ontario Est. Population 12,775,222

$542,602,271

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

For almost twenty years, NACO has pioneered ear- ly-stage investing in Canada. Our national network includes over 4,000 angel investors, more than 40 regional angel groups, and 45 innovation hubs. This past year marked a period of transition, op- portunity, and development for NACO and its com- munity of leaders in the movement of increasing access to capital for entrepreneurs. In mid-2019, our Board of Directors selected Clau- dio Rojas as CEO, to lead NACO and Canada’s community of angel investors through a period of significant change in an exceptionally challenging environment for organized angel activity. Under his leadership, NACO’s membership has emerged as a recognized and essential resource for support- ing entrepreneurial growth in Canada. Over the past year, NACO has hosted national and regional summits, virtual roundtables with over 50 recog- nized leaders and 2,500 participants from across Canada’s innovation economy, launched an initia- tive to enhance the funding continuum and pipe- line to venture capital, and fostered the emergence of a new trend of issues-based investing — with HaloHealth, a network of physician-angels invest- ing in the healthcare industry; and The51, an an- gel collective investing in women-led companies. These are inspiring developments, as they reflect the important role of angel investors in driving in- clusive economic prosperity and social impact. Access to Capital for All Entrepreneurs Despite many areas of progress, other significant areas of opportunity for growth and improvement remain. Most notably, investment activity is un- evenly distributed across regions, provinces, and demographics. As NACO endeavours to bring equity to Canada’s entrepreneurial ecosystem, we recognize that the not-for-profit network of angel groups that has led the mobilization of investment for Canadian entre- preneurs is under-resourced. To increase access to capital for entrepreneurs from underrepresented groups, in 2020, NACO announced a new National Initiative for Women Entrepreneurs, and new pro-

grams are underway to bring equitable access to capital for Black people, Indigenous peoples, peo- ple of colour, and other historically underrepresent- ed founders. With these new initiatives, NACO will bring additional support to develop and deliver pro- gramming to unlock capital that is diverse, inclu- sive, and accessible to entrepreneurs in all regions and from all backgrounds. This is only the beginning of our access to equitable opportunities initiatives. Regional Developments. Untapped Potential. In Western Canada, NACO’s expansion with the establishment of a Calgary office recognizes the importance of collaborating with established angel groups to develop regional ecosystems by mobiliz- ing new pools of capital. Alberta, in particular, has all the ingredients to emerge as Canada’s epicen- tre of risk capital and has a history of producing world-class companies in high-growth industries. The recent collapse of the natural resource sector combined with the effects of the COVID-19 pan- demic have created an urgent need to focus on this region’s innovation potential. In Atlantic Canada we see an ecosystem that will benefit from the trend identified in this report of increased interprovincial investment. This develop- ment holds the promise of increased flows of capi- tal between regions, and from urban to non-urban centres. Connectivity with out-of-province inves- tors enables entrepreneurs to access new markets, tap into a wider range of expertise, and reflects the healthy development of a nationally connected ecosystem. As evidenced by the success of Verafin in St. John’s, which completed a $515 million equity and debt recapitalization, local angel capital can be combined with extra-provincial investment to cre- ate jobs and prosperity for all communities. While Central Canada demonstrated robust in- vestments, we see a potentially challenging en- vironment ahead for structured angel activity in Southern Ontario due to a retrenchment in pro- vincial funding for not-for-profit angel initiatives. In the absence of new mechanisms of support, this may result in the reduced mobilization of angel

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

A New Decade. A NewMore Inclusive Economy. We now sit in a very unique moment in time. The COVID-19 pandemic has had devastating im- pacts around the world and on Canadians from coast to coast to coast. But it has also afforded us a unique opportunity to think differently as we build the New Economy. Whether this be around the geographic imbalance demonstrated in sec- tion 3.7 or the gender gaps highlighted in section 2.6, we know there is much work to be done and many opportunities for inclusive prosperity ahead. The past decade of data is a valuable foundation upon which to build more inclusive early-stage in- vestment activity. We knowwe can achieve greater impact through enhanced local, regional and na- tional collaboration. We also need to welcome and learn from those groups who have not meaningfully participated in the high-growth economy. And we look forward to supporting innovative solutions that empower our communities, our people, and our country with strength and resilience. On behalf of NACO, we hope that this report inspires action to support Canada’s entrepreneurs in all communities around the country. We welcome your participation as we carve a new path forward, research new initiatives, work to mobilize an un- precedented wave of investment to lead Canada’s post-crisis economy recovery, and expand the na- tional impact of local angel activity to drive greater levels of inclusive economic prosperity in Canada.

investment for entrepreneurs in the region. Early warning signs of resource constraint, for ex- ample, include the challenges experienced in col- lecting data for this report. This is concerning, as the not-profit organizations that have historical- ly mobilized angel activity in Southern Ontario were already operating in a resource-constrained environment prior to the outbreak of COVID-19. To the extent that the economic climate places in- creased pressure on these organizations, we may see consolidation and reduced capacity-building. In contrast, Québec continues to attract significant provincial support for angel activity, which has contributed to robust investment that is expected to continue. Meanwhile, Northern Ontario Angels continues to attract strong regional support, which has con- tributed to its consistent ranking as one of the top performing angel groups in Canada. As a result, Northern Ontario is a useful benchmark for the po- tential of other regions. Earlier in 2019, NACO partnered with the Govern- ment of Yukon to develop its entrepreneurial econ- omy. Angel investors from across Canada partic- ipated in a series of research sessions to share insights and knowledge on attracting investment activity. National connectivity between emerging and established ecosystems remains a source of untapped potential for Canada’s innovation econo- my. Although historically angels have been inclined to invest close to home, the increased digital activi- ty that occurred in response to the challenges of the COVID-19 pandemic may lead to a new interest in interprovincial investing. These insights along with the evidence shared in this report have informed the development of new programming to provide support and education to our regional groups. Through targeted efforts focused on engaging with historically underrepre- sented groups, the full potential of entrepreneurs in all communities will be activated.

Sandi Gilbert Chair, NACO Board of Directors

Claudio Rojas CEO, NACO

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

Table of Contents

Preface

3. Investment Activity in 2019

38 38 40 43

3.1 Demand For Angel Finance

Executive Summary

3.2 The Financing Funnel

10 11 12 14 16

Introduction

3.3 Investments

Angel Group Characteristics

3.4 Deal Structures

Investment Activity in 2019

3.5 Valuations 44 3.6 Investment Characteristics – Industry Sector 46 3.7 Investment Characteristics – Company Size 49 3.8 Investment Characteristics – Region 51

The Investment Environment

Conclusion

1. Introduction

1.1 The Role of Angel Investors in the Entrepreneurial Ecosystem

4. The Investment Environment

4.1 The Investment Climate For Angel Investing In 2019

1.2 Survey Design and Respondent Profile

4.2 Government Initiatives:

1.3 Investment Activity of Angel Groups in 2019: an Overview

What Angel Groups Need

5. Conclusion

1.4 The Impact of the COVID-19 Economic Crisis on Angel Investment Activity

24 26

5.1 Summary

1.5 Summary

5.2 Early Evidence on the Impact of the COVID-19 Pandemic on Canadian Angel Groups

2. Angel Group Characterisitcs

28 28 29 30 31 32 33 34

2.1 Introduction

5.3 Recommendations to Policymakers

2.2 Organizational Structure

2.3 Fee Income

Participating Angel Members

2.4 Age of Group

2.5 Size - Membership Numbers

2.6 Gender of Group Membership

2.7 Women’s Entrepreneur Fund

2.8 Investment Activity by Group

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

Executive Summary

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

Claudio Rojas, CEO of NACO at World Angel Investment Summit in Calgary, Alberta. June 2019.

This is the 10th Annual Report on Angel Investment Activity in Canada, reporting on the investments made by angel groups in 2019. It is based on responses from 30 active angel groups of which 25 had made investments. The groups reported 299 investments that attracted $163.9 million of investment by angel investors. This is an increase in the amount invested compared with 2018 (+18.7%) but a significant decline in the number of investments (-45.3%). This is because there has been a large increase in themean size of investment per company compared with 2018 ($1.5m compared with $282,000 in 2018). This is largely an outcome of one very large and atypical investment. Nevertheless, the rise in the average size of investment is also seen in median value which increased from $120,000 in 2018 to $190,000 in 2019.

Introduction EXECUTIVE SUMMARY

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

The majority (73%) of angel groups are organized in not-for-profit structures, while 23% are for-profit entities. Most groups (71%) charge for membership, with fees ranging from $250 to over $1,000 per year. Most of the groups that of- fer free membership are emerging groups (three years old or less). The proportion of groups that charge a membership fee has risen year-on-year. Just over half of the groups (53%) extend membership to corporate entities (typically professional service firms). More than half of the responding groups (61%) have been established for more than five years of which 32% have been operating for ten years or more. However, new groups continue to be founded, albeit at a lower rate than in previous years. There is considerable diversity in the size of groups, with member- ship ranging from 25 or less to more than 100. The vast majority of groups have more than 50 members: 20% have over 100 members. The significance of larger groups has been increasing over time. Historically angel investors are predominantly men. Women comprised just 17% of the members of Canadian angel groups in 2019, the same proportion as in 2018 and a slight increase on the proportion in 2017, which was 14%. This is a similar proportion to other countries. There is considerable variation among groups in terms of their level of investment activity. Seven groups (36%) made between 1 and 5 investments. At the other extreme, a further 7 groups (36%) each made more than 10 investments (active), with just two of these groups making more than 25 investments (very active). There were fewer very active groups in 2019 than in 2018. Not surprisingly, there is a relationship between group size (number of members) and invest- ment activity, with the largest groups making the most investments.

Angel Group Characteristics EXECUTIVE SUMMARY

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

Investment Activity in 2019 EXECUTIVE SUMMARY

The 14 groups that reported their deal flow information for 2019 received 6,551 approaches for funding. This is lower than in each of the previous three years. Just 9% of businesses were selected for presentation to investors. Angel investors undertook due diligence on 56% of these businesses and invested in 45% of them. Overall, angel groups made investments in just 2.4% of the businesses that applied for funding. The proportion of companies that attracted funding is lower than in 2017 and 2018. Future research will explore this development in more detail. Angel groups made 299 investments in 2019, investing a total of $163.9 million. This is the highest annual amount invested, up 14.8% on the 2018 figure and marginally exceeding the previous record amount in 2017. However, the number of investments was signifi- cantly lower than in the previous three years. Follow-on investments accounted for 45% of total investments, an increase on previous years, and 38% of the total amount invested, marginally down in 2018. Angel investors report using a variety of investment instruments, with none being dominant. The most commonly used instruments are common shares which account for 38% of the total, followed by convertible debentures, accounting for 29% of the total. Preferred shares are used in 19% of investments. Debt instruments are uncommon, used in just 2% of cases. There is considerable variation in valuations. Just over half (53%) of all investments were valued at between $2m and $6m and almost two-thirds (64%) were valued at $6m or less. The median valuation was $5m. New investments had a lower valuation than follow-on investments. The median value of a new investment was $5m with 76% valued at $6m or less (42% at $4m or less). This compares with a median valuation of $9m for follow-on investment. Investment activity measured in terms of number of investments is dominated by the Information and Communication Technologies (ICT) sector (48%) followed by the Life Sciences and Healthcare sector (20%). This dominance of ICT and Life Sciences and Healthcare has been a constant feature over time, although the proportion of

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

investments in the Life Sciences and Healthcare sector has dropped significantly in the past three years. Because the size of investments varies among sectors, the distribution of investments by amount is somewhat different. The ICT sector accounts for only 35% of the amount invested. Angel groups predominantly invest in small businesses with growth potential, mostly those with 1–5 or 6–10 employees at the time of the investment, accounting for 42% and 18% respectively of invest- ments in 2019. This concentration of investments in small compa- nies is consistent over time. However, in contrast to previous years almost one-quarter of the investments made in 2019 were in large businesses with more than 50 employees. Over half (52%) of all new investments were in businesses with 1-5 employees (and 74% with 10 or fewer employees), with just a handful of investments in busi- nesses with more than 25 employees. Follow-on investments were concentrated in larger businesses, with 43% of such investments in businesses with more than 50 employees. Angel investment activity continues to be distributed unevenly across Canada. Central Canada (Ontario and Quebec) accounted for 86% of investments compared with 13% in Western Canada and 1% in At- lantic Canada. In terms of amount invested, Central Canada accounts for 94% of the total. There are also regional differences in the propor- tion of new and follow-on investments. In Central Canada, 62% of in- vestment dollars were new, compared with 64% in Western Canada, and 96% in Atlantic Canada. When calculated on a per capita basis, an uneven distribution of investment persists across regions. Angel investors made 14% of their investments in companies located in the same city as the angel group and a further 52% were in the same province. There is a steady decline in within-province invest- ments year-on-year and a large increase in inter-provincial invest- ments which accounted for 30% of total investments in 2019 com- pared to 13% in 2018. International investments continue to be fairly insignificant (4%).

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

Julie Angus, CEO and Co-founder of Open Ocean Robotics, awarded NACO Startup of the Year 2019.

The Investment Environment EXECUTIVE SUMMARY

Group managers were asked to rate the climate in Canada for angel investing on a scale of 1 (very poor) to 10 (excellent) (Figure 26). (Responses related to the pre-COVID-19 context). Scores range from 3 to 8. The median score is 7.0, the same as in the previous four years. The mean score is 6.4 which is lower than in the previous three years. This reflects fewer groups giving scores of 8 and above compared with previous years. Groups based in Western Canada have the highest median score (7), slightly higher than that of Central Canada (6). Consistent with the previous year’s groups in Atlantic Canada which gave a much lower rating for the investment climate (4). Bigger groups – those with 25-49 members and those with 50 or more members – gave higher scores, with medians of 8 and 7 respectively, compared with 3.5 by the smallest groups (fewer than 25 members). The score given by the smallest groups (3.5) is considerably lower than in 2018. Group managers were invited to add written comments to elaborate on the scores that they gave and comment on specific aspects of the investment environment. A variety of issues were raised but with no single theme dominating. Moreover, many of the issues that were raised were particular concerns of specific groups, in many cases related to their size and location, particularly those groups that are located outside of the major cities. The most frequently mentioned theme was “investor fatigue” re- lated to the extended length of time for the return of capital, which could be seven to ten years or longer. Some groups raised a broad- er concern about a lack of new investors and hence new capital.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

NACO World Angel Investment Summit in Toronto, Ontario. September 2018.

Second, were concerns about the quality of deal flow. Third, several groups raised the broader concern about their lack of resources – and hence personnel – which hindered their ability to recruit new angel investors, provide services to members and support their due diligence process and the post-investment management of their portfolios. The point was made that there are costs associated with running a professionally managed angel group; however, most angel groups are not financially self-sufficient in their current structure and therefore have to rely on volunteers who only have a limited amount of bandwidth to deliver many of the services. Some groups had experienced difficulties as a result of cuts in provincial government programs. The lack of resources to provide formal support for the due diligence process was a particular concern of several groups. Angel group leaders suggested that in view of the critical role that angel investment plays in supporting early-stage high risk ventures, that governments should increase their financial support for not-for- profit angel groups. Beyond providing funding to contribute to support- ing incremental project costs, participants also commonly supported the idea of tax incentives to stimulate more angel investment in recognition of its illiquid and high-risk nature. Respondents in Atlan- tic Canada emphasized that any tax incentives should be regional rather than provincial, with a view to encouraging investment into communities across the region.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

This report is being published at a time when the Canadian economy, along with the rest of the global economy, is starting to emerge from months of lockdown in response to the COVID-19 pandemic. Once again, this highl ights the critical role of angels in financing activity at the star t of the entrepreneurial pipeline. Entrepreneurs who start and scale-up innovative companies will play a key role in Canada’s economic recovery. It is entrepreneurs who will develop solutions to the problems that COVID-19 has created for government, businesses, and Canadians in all communities, to enable them to adjust to the ‘new normal’. It is therefore vital that angel investors continue to invest. However, responses from angel groups suggested that there was evidence of a decline in angel investing, angel investors were focusing on supporting their existing portfolios and scaling back on new investments and focusing any new invest- ments on COVID-19 related opportunities. There was also a concern by some groups that they may not have the resources to continue. These developments are expected to have a significant impact on Canada’s entrepreneurial ecosystem. To support entrepreneurs, government actions could include an increase in financial resources to support the incremental project costs of mobilizing angel activ- ity; matching funds for companies supported by angel investors; tax incentives to encourage community-based investing; a secu- rities regime exemption to increase participation in the economic recovery; enhanced access to emergency programs and measures, and; fast-tracked approval of funding for government business support programs.

Conclusion EXECUTIVE SUMMARY

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

1. Introduction

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

1.1 The Role of Angel Investors in the Entrepreneurial Ecosystem INTRODUCTION

Angel investors are a key driver in the entrepre- neurial ecosystem, investing at the start of the entrepreneurial pipeline in new and emerging companies. Alongside their capital, angel inves- tors draw upon their experience as entrepreneurs, business managers and business professionals to contribute their knowledge and expertise, networks and psychological and emotional support to their investee businesses. Angel investors help to build client relationships, leveraging their established business networks, all of which contributes to the ability of entrepreneurs to more rapidly scale their operations. Indeed, this non-financial support can be as significant as the capital that they invest. Angel investors are the main source of seed stage capital, investing relatively small amounts in com- panies at their start-up and early growth stages. As such, they play a complementary role to that of the venture capital industry. This has two dimensions. First, angel investors are often the first investors in businesses that go on to raise larger amounts from venture capital funds and participate in innovation and commercialization programs to scale-up their operations. This fund- ing model has been seen as being analogous to a relay race: “angel investment runs the critical first leg of the relay race, passing the baton to venture capital only after a company has begun to find its stride. Venture capitalists focus on expan- sion and later stages of development, when their contribution ismost effective.” 1 Prominent Canadian entrepreneurial successes that have followed this funding pattern include Shopify inOttawa, Solium in Calgary, Skip The Dishes in Saskatoon, Blackber-

ry in Kitchener-Waterloo, Verafin in St John’s, and Enthusiast Gaming in Toronto. Second, angels invest in startups that, while sustainable from an investment perspective, may not be engaged in leading edge innovation and hence do not offer the prospects of sufficiently rapid growth to attract investment from venture capital funds. Nevertheless, in many cases, these angel-backed businesses may provide attractive growth oppor- tunities for larger companies through strategic acquisitions, partnerships, and other arrangements. However, angel investing often occurs under the radar and therefore is not identified and captured by data gathering organizations. The consequence is that the critical role of angel investors in the en- trepreneurial ecosystem is not given the attention that their significance warrants. Angel investors are largely an invisible population, mostly investing informally, resulting in uncertainty about the size of the angel investor population. Estimates of the number of angel investors in Canada vary between 20,000 and 50,000. 2 However, over the past two decades many angels have recognized the benefits of investing together. This has led to the emer- gence of angel groups in which individual angel investors frequently invest together in the same businesses. There is no standardmodel, but typically angel groups will have a manager (either one of the members or a hired professional) to coordi- nate the investment process, undertake the initial screening of investment opportunities and coordi- nate investor engagement, but with the individual members of the group making their own decisions whether or not to invest in specific businesses.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

Some angel groups have also established sidecar funds that invest alongside the group. This gives members greater opportunity for diversification by enabling them to invest in deals that they do not invest in on an individual basis. It is also a vehicle to attract investors who do not want the respon- sibility of making their own investment decisions. Sidecar funds also enable entrepreneurs to raise larger amounts. 3 This is a very important trend, as angel funds allow capital to be pooled, larger deals to be funded, increases the sophistication of due diligence, and brings efficiency to portfolio management. These developments may attract increased investment from a broader range of community participants. The emergence and expansion in the number of angel groups reflects the need for greater financial resources to make larger investments, including follow-on investments, as venture capi- tal funds have shifted their focus to larger invest- ments. This has been the driver for many angels to band together to create the ‘pooled resources’ needed to make both sizable initial investments and follow-on investments. By having the ability to ‘follow their capital’ it also reduces their vulnera- bility – as early investors – to dilution should their investee businesses need to raise further finance from venture capital funds. An additional driver of angel group expansion is the opportunity for individual angels to spread their investments more widely and thereby achieve greater diversification (which, in turn, minimizes the risk of poor returns 4 ), and to access group skills and knowledge to evaluate investment opportunities andprovidemoreeffectivepost-investment support. Angel groups also offer the attraction of superior deal flow and the opportunity to learn from more experienced investors. Moreover, angel groups have been able to develop efficient routines

for handling investment enquiries and screening opportunities and standardized investment doc- uments. Angel groups are also attractive to high net worth individuals who want to invest in emerging companies but lack the time, referral sources, investment skills or the ability to add value. Indeed, some angel groups have a core-periphery model comprising an active core group of angels who drive the investment process, with the outer core only being invited to invest, on a ‘take-it or leave-it’ basis, in those deals that the core group has decided to invest in. Angel groups also reduce sources of inefficiency in the angel market; in con- trast to invisibility of most solo angels, the visibility of angel groups enables entrepreneurs to approach them directly. An important outcome of the visibility of angel groups and their organization into industry asso- ciations, such as NACO, is that it is now possible to track developments in angel investment activity, which allows for the compiling of statistics to predict and shape future trends and priorities. Although it is likely that the invisible, unorganized market con- tinues to dominate in numerical terms (number of angels, number of investments), angel groups are now a major source of entrepreneurial finance in terms of the amounts invested, increasingly mak- ing investments of up to $500,000 and beyond that were previously the prerogative of venture capital funds. This report is the 10th annual report conducted by the National Angel Capital Organiza- tion. By highlighting both the investment activity of angel groups in 2019 and year-on-year investment trends this report provides unique insights into angel investment trends in Canada that emphasiz- es the importance of angel investing in supporting Canadian entrepreneurs.

1 Benjamin, G. A. and Margulis, J. B. (2000) Angel Financing: How to Find and Invest in Private Equity. Wiley, New York. 2 Gregson, G (2018) Critical Perspectives on Small and Medium-Sized Enterprise (SME) Funding in Canada, NACO. 3 See Gregson (2018) op. cit (note 3), page 65. 4 Gregson, G, Bock, AJ & Harrison, RT 2017, ‘A review and simulation of business angel investment returns’ Venture Capital: an international journal of entrepreneurial finance, 19 (4), 285-311.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

1.2 Survey Design and Respondent Profile INTRODUCTION

The 2019 survey went out to 55 groups. These groups included current members of NACO, groups whose membership had lapsed, and other groups that have been identified as involved in angel investing but are not members. Groups were initially contacted in December 2019, with multiple follow-ups in early 2020 (prior to the onset of COVID-19). The survey was in two parts: (i) questions on various aspects of the angel group characteristics and (ii) ques- tions on each of the investments that group members made in 2019. The number of responses to each part of the survey was lower in 2019 than in past years. The initial deadline for completion of the survey was January 24, 2020. Follow up calls and emails were made to the groups who had not responded with offers of assistance and encouragement to complete the survey. However, as the data collec- tion process evolved, the need to respond to the challenges generated by the COVID-19 crisis meant that many of these groups were even- tually unable to participate. Responses were received from 30 groups, slightly down compared with the 2018 report (32). Only 25 of the 30 groups that responded had made investments in 2019. And in contrast with previous years, every group that responded in 2019 that had made investments provided detailed information about each of their investments.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

TABLE 1 Profile of Angel Groups: An Overview of Participants

Angel Group Characteristics

All Respondents 2018 (32)

All Respondents 2019 (30)

Groups that Participated in 2018 and 2019 (20)

Median Age (Years)

Mean Age (Years)

7.2

9.1

10.7

Median number of members

Mean number of members

256

394

Table 1 presents a profile of the age and size of the 30 angel groups that participated in the 2019 survey. It highlights the continuing maturity of angel activity in Canada, with the average age increasing from 7 to 8 years old, reflecting the decline in the number of new groups being formed. Group size is also increasing compared with 2018. The average (mean) number of members went up from 256 in

2018 to 394 in 2019. However, the median number of members increased only marginally from 59 to 60 reflecting the skewed nature in the size distribution of angel groups, with a handful of large groups and a considerably greater number of smaller groups. The total membership of the Groups that responded is more than 6,500 individual angels.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

1.3 Investment Activity of Angel Groups in 2019: an Overview INTRODUCTION

These groups invested $163.9m in 299 businesses in 2019 (Table 2). Many of these investments also included other investors who co-invested in the deal, so the overall amounts raised by the businesses in investments in which angel groups participated is much larger. This is an increase in the amounts invested in both 2018 (+18.7%) and 2017 (+4.2%). However, the number of investments is significant- ly down on both 2018 (-45.5%) and 2017 (-37%). This reflects a significant increase in the average size of investment per company compared with 2018. The mean investment more than doubled from $282,167 to $506,987 while the median value (the mid-point between the lowest and highest value of investment) has increased from $120,000 to $169.814. These investment trends are also reflected in an increase in the mean amount invested per group (from $5.1m to $7.2m) (although the median fell from $2.1m to $1.7m) and a decline in the average number of investments made per group, with the median declining from 10.5 to 9 and the mean falling from 19.4 to 11.4. These trends are consistent with the growth in membership of angel groups. These trends are confirmed when the 20 groups that provided information in both 2018 and 2019 are separately examined (Table 2 columns 3 and 4). These groups made fewer investments in 2019 than in 2018 (231 compared to 308, a 25% decline) but increased the total amount invested from $99m to $129m, a 30% increase. This reflects an increase in the mean size of investment from $394,000 to $656,000. There was no change in the median size of investment ($150,000).

The significance of angel investors is underlined when compared with venture capital investment. Venture capital firms invested a “Record Breaking CAD $6.2B in 2019.” However, the vast majority of this was invested in a small number of large mega deals – just 28 investments of over $50m accounted for 55% the total amount invested. Venture capital funds made just 116 investments of $1m or less (the typical investment focus of angel groups), a total investment of just $41m 5 , less than 1%of the $6.2b invested. Moreover, this was a decline from 2018 which saw $80m invested in 210 investments of $1m or less. This is significantly less than the amount invested by angel groups. And it needs to be emphasised that only a minori- ty of angels operate via angel groups, hence the investments reported here represents a significant under estimation of overall angel investment ac- tivity. First, it only includes the visible segment of the angel market; it does not include investments made by angel investors investing on their own and in informal groups that typically go unrecorded 6 . Second, because some groups did not report their investments, it does not cover all of the investment activity in the visible market.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

TABLE 2 Investment Activity by Angel Groups - Overview

Angel Group Characteristics

2018 All Respondents (32)

2019 All Respondents (30)

2018 Groups that

2019 Groups that

Participated in 2018 and 2019 surveys (20)

Groups (n) that made investments

Investments (k) made by group members

583

299

308

231

Median number of investments

10.5

Mean number of investments

19.43

11.96

19.25

13.58

Per angel group median investment amount

$2,055,810

$1,697,914

$2,147,962

$1,965,095

Per angel group mean investment amount

$5,101,259

$7,126,990

$6,184,768

$8,068,229

Groups reporting detailed investment information

n = 27, k = 507

n = 23, k = 284

n = 16, k = 308

n = 16, k = 225

Per company median investment amount

$120,000

$190,000

$150,000

Per company mean investment amount

$282,167

$585,431

$394,248

$658,631

Total Investment amount (all groups)

$142,835,246

$163,920,775

$98,956,285

$129,091,668

5 CVCA (2020) Venture Capital Canadian Market Overview 2019. https://central.cvca.ca/wp-content/uploads/2020/03/CVCA_EN_ Canada_VC_2019_Final.pdf 6 The European Business Angel Network (EBAN) estimates that the visible market – which they define as comprising investments made by angels operating as part of a network which either has a direct relationship with EBAN or reports through a federation, reports through a national venture capital association or which appear on investment databases where start-up investments are reported and specify investors – comprises just 10% of total angel investment. However, other commentators suggest this figure is too low.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

1.4 The Impact of the COVID-19 Economic Crisis on Angel Investment Activity INTRODUCTION

This report highlights the vital role that angel investors play as the dominant investors in start- ups. But it refers to a world that no longer exists. As the OECD observes, the COVID-19 pandemic has triggered the most severe economic reces- sion in nearly a century and is causing enormous damage to people’s health, jobs and well-being. 7 It projects that Canada’s annual output will shrink by 8% if recovery is uninterrupted and by 9.4% in 2020 in the event of a second virus outbreak and related shutdown. The rebound will not be dynamic enough for output to attain pre-COVID-19 levels by the end of 2021 under either scenario. 8 The recovery will be driven to a great extent by high growth, equity-backed startups and scale-ups. The disruptions that economic crises cause to existing markets catalyzes innovation by creating an environment for entrepreneurs to launch new products, services and business models. Many successful companies are created in such times. For example, companies started during the 2008/09 recession include WhatsApp, Slack, Airbnb, Stripe, Uber, Waymo, Pinterest and Git Hub. It is therefore critical that angels continue to invest. However, the early evidence that is emerging from North America and Europe suggest that the COVID-19 economic crisis will result in a decline in both angel and venture capital investment activity in the short and medium term, with potentially sig- nificant adverse impacts on entrepreneurial activity.

Five developments seem likely, the combined effect of which will be to reduce angel investment activi- ty over the next 12-24 months. 9 First, most venture capital firms are expected to focus on their existing portfolios, both to extend the financial runway of those firms that they consider to be worth support- ing and because of concerns about their own ability to raise further finance from their Limited Partners. Moreover, they will also need to spend more time supporting the companies in their portfolios and hence will not have the bandwidth to consider new investments. The implication for angel investors is that the investee companies in their own portfolios that need to raise follow-on funding from venture capital funds to scale-up may not be able to do so. This would require the angels to either support their investee companies for longer or to seek a sub-optimal lower return exit, and hence reducing the financial gain available for recycling back into the entrepreneurial ecosystem. Second, some venture capital firms are reducing their valuations, with terms and conditions that have traditionally favoured entrepreneurs now shifting investment in favour of investors. Other in- vestors have expressed an increased focus on the “flight to safety” with lower risk investments attract- ing more attention. This implies that investments made before the onset of the crisis may see a re- duction in their valuation. Some entrepreneurs will

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

fail to secure funding from investors due to elevated levels of risk aversion. This has implications for angels whose investee businesses raise follow-on finance from venture capital funds. It is likely that these investments will take the form of down- rounds which will see a decline in their value, raising the possibility of a re-run of the post-2000 dotcom crash in which many angels saw their investments wiped out by the perceived predatory behaviour of venture capitalists, driving many of them out of the market. Third, there are expected to be fewer opportunities for liquidity events, and those which do occur will be at a lower valuation. This will limit the scale of en- trepreneurial recycling: there will be fewer cashed- out entrepreneurs who become angel investors and the amount they have to invest will be reduced, and angel investors will have fewer and smaller exits which will reduce the capital they have available to re-invest. Fourth, although some angel groups have an- nounced that they are continuing to make new investments the likelihood is that most angels will

seek to preserve their capital to support their ex- isting investee companies rather than making new investments. And finally, the significant uncertainty in financial markets will have a negative impact on the net- worth of many active and potential angel investors. This might be expected to reduce the amount of discretionary capital that they have available to be allocated to angel investing. Angels will continue to invest. However, it is likely that much of their investment will be to support their existing investee businesses rather than in making new investments. And although some angels will continue to consider new investment opportunities, it is likely that there will be less angel investment available at the start of the entrepreneurial pipeline. This would mean increased pressure on startups to get finance, a significant slowdown in the number of startups and scale-ups over for the next 5 years, and a negative impact on Canada’s economic growth.

7 OECD Outlook. The world economy on a tightrope. June 2020. https://www.oecd.org/economic-outlook/ 8 https://www.oecd-ilibrary.org/sites/0d1d1e2e-en/1/3/3/7/index.html?itemId=/content/publication/0d1d1e2e-en&_csp_=b- faa0426ac4b641531f10226ccc9a886&itemIGO=oecd&itemContentType= 9 These are developed in more detail in Mason, C (2020) The Coronavirus Economic Crisis: Its Impact on Venture Capital and High Growth Enterprises, European Union Joint Research Centre JRC120612. http://publications.jrc.ec.europa.eu/repository/handle/ JRC120612

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

1.5 Summary INTRODUCTION

Canadian angel groups increased the amount that they invested in 2019 by 14.7% compared with 2018, but the number of investments was significantly lower. This is because of a substantial increase in the average size of investment. The increase in the aggregate amount invested by angel groups is likely to be associated with an increase in their average size of group membership. The remainder of this report looks in more detail at angel groups and their investments in 2019 and trends in investment activity over time. It is structured as follows: Section 2 presents angel group characteristics. It covers their organizational structure, age, fee structure, number of members, gender composition of their membership, number of investments and amount invested in 2019. Section 3 presents an analysis of the investments made by angel groups in 2019 and compares this with previous years. It starts with an analysis of the financing funnel that tracks how the number of businesses that originally approach the groups diminishes at each stage in the investment process. It then provides information on the sectoral and geographical characteristics of investments, size of investee businesses, details on co-investments and syndicated deals, follow-on investing, deal structures and company. Section 4 assesses the current environment for angel investing in Canada. It provides information on the views of group managers on the investment climate in Canada, the challenges that they currently face and where government support should be focused. Section 5 concludes the report by highlighting the key themes that emerge from the analysis, discusses the early evidence of the impact of the COVID-19 crisis on angel groups in Canada and proposes ways in which governments could further support angel investing at this critical time.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

2. Angel Group Characterisitcs

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

ANGEL GROUP CHARACTERISTICS

2.1 Introduction

This section profiles angel groups in Canada. The evidence confirms the growing maturity of Canada’s angel market, reflected by the growing presence of longer-established groups.

ANGEL GROUP CHARACTERISTICS

2.2 Organizational Structure

Angel groups can potentially organize themselves in a variety of ways. In Canada, the majority of groups - 73% - are structured as not-for-profit entities. A further 23% are for-profit entities (Figure 1). This is similar to previous years.

FIGURE 1 Corporate Legal Structure of Angel Groups (n = 22)

For-Profit Corporation Not-for-Profit Organization Other

Note: Category “other” includes a transitioning not-for-profit entity,

and a General Partner and Limited Partner structure.

23%

73%

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

2.3 Fee Income ANGEL GROUP CHARACTERISTICS

The majority (71%) of angel groups charge their investors membership fees (Figure 2). Membership fees for individuals range from$250 and over per year, with six groups (50%of those that charge membership fees) charging in excess of $1,000. The remaining 29% of groups do not charge fees. These are all emerging groups (less than five years old). The proportion of groups that charge a membership has been rising year-over-year (54% in 2017; 65% in 2018).

FIGURE 2 Angel Group Membership Fees

Free

$1 - $250

$251 - $500

$501 - $750

$751 - $1000

$1000+

Membership Fees

Note: there are 13 groups offering both individual and corporate membership

Just over half of the groups (59%) that responded to the survey extend membership to corporate entities, which may include family offices, investment entities, and professional services firms (e.g., law, accounting). These corporate entities may provide sponsorship and other support to the groups, including offering pro-bono services to businesses that are seeking, or successfully raise capital, with the objective of developing long-term commercial relationships with them. Fees for corporations are typically higher than those for individuals – all are above $750 and 80% are above $1,000. Whereas, only 56% of groups charge individuals more than $500, while only 38% of groups have individual membership fees in excess of $1,000.

ANNUAL REPORT ON ANGEL INVESTING IN CANADA

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