Public Accounts Committee on Sept. 29th, 2016

[The Chair, Conservative, Kevin Sorenson]

Good afternoon.

This is meeting number 25 of the Standing Committee on Public Accounts, on Thursday, September 29, 2016.

Today we're conducting a hearing on “Report 1, Venture Capital Action Plan”, from the Spring 2016 Reports of the Auditor General of Canada.

[David Christopherson, NDP, Hamilton Centre, ON]

I have a point of order, Chair, whenever it's appropriate.

[The Chair, Conservative, Kevin Sorenson]

I'll recognize your point of order immediately after I introduce the witnesses.

Appearing before us today we have, from the Office of the Auditor General of Canada, Mr. Michael Ferguson, the Auditor General of Canada; and Richard Domingue, principal.

From the Department of Finance, we welcome Richard Botham, assistant deputy minister of the economic development and corporate finance branch. It's good to see you again.

From the Department of Industry, we have Christopher Padfield, director general, small business branch, of small business, tourism and marketplace services.

From the Business Development Bank of Canada, we have Jérôme Nycz, executive vice president of BDC Capital; and Neal Hill, vice president of market development, BDC Capital.

I understand that we have an opening statement from the assistant deputy minister, Richard Botham. We'll begin with the Auditor General of Canada's opening statement.

Before we begin, I would like to advise everyone that we have with us today a six-member delegation of international auditors currently undergoing training with the Canadian Comprehensive Auditing Foundation. These auditors are from Vietnam, Tanzania, Ghana, and Cameroon. We will have an opportunity to meet with this delegation and our international colleagues at the end of today's meeting.

I can advise our guest auditors that the Canadian Comprehensive Auditing Foundation has also been very generous in sharing advice and helping our committee train for our work early in the 42nd Parliament.

As your chair, I want to alert MPs and witnesses, who will want to be mindful during today's meetings that we have these international auditors here and we would really like it if they all thought we got along all the time. It is good to have them here and we look forward to the opportunity of meeting them after.

With that, I will now turn to the point of order from Mr. Christopherson.

[David Christopherson, NDP, Hamilton Centre, ON]

Thank you, Chair. I will be very brief.

I make this intervention as the longest-serving, continuous member on this committee. I'm referencing the presence, again, of the parliamentary secretary to the treasurer.

I accept that it is her right as a member of Parliament and as an associate member of the committee to sit here. I recognize this seems like a small matter, but it has big implications, as the government ran on a platform of removing the influence of parliamentary secretaries from committees. For the most part, that has happened, and it has been a good thing. I complimented that when we finally got around on PROC to where that was the case, where we got rid of the parliamentary secretary, and I gave the government credit for that. It was a good move.

We are called upon here to get above our partisanship, because we're the premier oversight committee in Parliament. It hearkens back to the old days that the government said they were going to be different when it comes to the parliamentary secretary being here. It cannot do anything but leave the impression that the government is riding shotgun on public accounts. If ever there should be a committee where all of us are not being directed or influenced by the parliamentary secretary, it's here.

I have two more points, Chair.

Number one, I'm not alone, and this is not new. A colleague, the member for Carlton Trail—Eagle Creek, was quoted in the paper recently as saying, “The Liberals promised to remove the influence of ministers and parliamentary secretaries on the committee, and this appears to be a promise broken.”

That was in another committee, and I would make the same argument here, that the government is not honouring the pledge they made to remove the influence of parliamentary secretaries, particularly at the oversight committee, particularly given that our major oversight is Treasury Board.

I'm going to leave it there for now. I won't even mention the picture that the parliamentary secretary refused to get out of when we were trying to take a picture of the committee. We still couldn't have it because you and I wouldn't be in it unless the parliamentary secretary got out of it, and she wouldn't.

I'm asking the government—I've done it nicely, and I've done it now my first time publicly—please, honour your promise. Ask the parliamentary secretary to please not come to these meetings. It's serves all of us best.

Thank you so much, Mr. Chair.

[The Chair, Conservative, Kevin Sorenson]

Thank you very much, Mr. Christopherson.

I would also say that any member of Parliament, if they are an associate member, can attend these committees. The parliamentary secretary is welcome to attend, but her input will be limited in that capacity when there is a full contingent of people here.

It is a point of order. I don't want to dwell on it. We have guests here today. We'll just carry on, but we do welcome all members here for this.

We'll begin with the Auditor General of Canada's opening statement, please.

Welcome.

[Michael Ferguson, Auditor General of Canada, Office of the Auditor General of Canada]

Mr. Chair, thank you for this opportunity to discuss our 2016 spring report on the venture capital action plan.

Joining me at the table is Richard Domingue, the principal responsible for the audit.

Venture capital is a major source of financing for innovative high-growth firms and their entrepreneurial owner managers. Venture capital investment in early stage firms has helped to create and grow many of today's leading global technology companies. Many countries are interested in promoting such an ecosystem, since venture capital is widely recognized to be a key driver of innovation and economic development in advanced economies.

In budget 2012, the Government of Canada announced $400 million to help increase private sector investments in early stage venture capital and to support the creation of large-scale venture capital funds led by the private sector. In this audit, we looked at how the Department of Finance Canada, the Business Development Bank of Canada, and Innovation, Science and Economic Development Canada, formerly Industry Canada, assessed the policy need for the action plan, how they implemented the action plan in order to meet the stated objectives, and how they measured the performance of the action plan.

We found that at the time of the Budget 2012 announcement, the Government of Canada had already identified a number of issues faced by the national venture capital ecosystem and had performed preliminary analysis of the market gap. However, the government had not decided how to allocate the money. The government then held consultations with stakeholders, a process that led to the selection of the fund-of-funds model as the preferred approach to address the challenges of the Canadian venture capital market.

We found that the government initially faced difficulty in convincing private sector investors to participate in the action plan, which contributed to delays in implementation. Among the factors behind their reluctance were low returns, as well as strict international regulatory requirements for certain private sector investors. Further, management fees could amount to approximately $250 million of the total amount of $1.35 billion committed by the federal government and other investors to funds of funds over the lifetime of the action plan.

We found some significant shortcomings in the process to select fund managers. In our opinion, the call for expressions of interest, the review of applications, and the selection of fund managers did not entirely adhere to sound practices and had a negative impact on fairness, openness and transparency.

The audit also looked at how the three entities planned to monitor activities in the short term and measure the success of the action plan against the stated objectives and outcomes in the long term. We found that the action plan activities were properly monitored, but better performance indicators would help to measure the policy outcomes of the action plan initiative and inform future policy decisions. Better public disclosure of the action plan's performance could also benefit the Canadian venture capital market.

Mr. Chair, the Department of Finance Canada and also Innovation, Science and Economic Development Canada have agreed to our three recommendations and have prepared a detailed action plan.

Mr. Chair, this concludes my opening remarks.

We would be pleased to answer any questions the committee may have.

Thank you.

[The Chair, Conservative, Kevin Sorenson]

Thank you very much, sir.

We'll now move to Mr. Botham, please. Again, welcome.

[Richard Botham, Assistant Deputy Minister, Economic Development and Corporate Finance Branch, Department of Finance]

Thank you, Mr. Chair.

Since you've already introduced my colleagues, I won't do that. We certainly represent a team that worked on both the analytical aspects as well as the development, implementation, and ongoing management of the venture capital action plan initiative, or as I'll refer to it, VCAP.

I would like to take a few moments to provide you with a bit of the context for the initiative, some of the process elements that led to the development of the initiative, and some of the preliminary results.

In 2010 and 2011, McKinsey and Company, on behalf of the BDC, and the expert panel reviewing federal support to research and development, which was chaired by Mr. Tom Jenkins, examined the venture capital industry in Canada and found that there was a significant financing gap.

It was largely attributable to key structural challenges facing the venture capital market, including a shortage of experienced managers, subscale fund sizes, and a lack of institutional investment in the asset class. These factors led to persistent low returns, decreased the attractiveness of this asset class, and subsequently limited firms' access to venture capital financing.

The BDC also assessed the forecasted demand from Canadian fund managers looking to raise funds, as well as the forecasted supply of venture capital, and confirmed that there was a significant gap. While the BDC had been supporting the venture capital industry for some time, it was recognized that new approaches would be needed to address the structural challenges in the market.

These analyses led to the announcement in budget 2012 of a commitment of $400 million for venture capital activities, for which the government would conduct further analysis before defining its approach. The government rolled out an extensive consultation process, receiving 75 submissions through an online portal, and hosting meetings with more than 250 industry stakeholders in Toronto, Montreal, Vancouver, Calgary, and Halifax, which included a number of members from Réseau capital and the Canadian Venture Capital and Private Equity Association.

In addition to these domestic perspectives, meetings were also held in Boston and Silicon Valley with a number of top-tier venture capitalists and other participants in the market. The government also conducted analyses on international best practices in Israel, Australia, Europe, and the United States.

As with any consultation, while there are differing opinions, consensus formed around some of the following overarching themes, which informed the design features of the venture capital action plan:

The new approach should be private sector-led and market-based, focused on demonstrating superior returns to investors. Although welcome, the funding announced in budget 2012 would be insufficient on its own to create a sustainable industry, and would need to lever significant resources from the private sector. Institutional investors left the venture capital asset class due to poor returns and the absence of large funds that fit their investment mandates, and they would likely only return if incented to do so in a different kind of structure. Venture capital in Canada was shifting away from early-stage investments towards later-stage companies where it was perceived that risk was lower. The funding in budget 2012 should be deployed to increase the number of private sector-led funding sources for venture capital funding managers. Investment should focus where Canada has existing strengths, such as information technology, life sciences, and clean technology. Finally, some funding should be deployed quickly into the market, given the immediate capital needs of innovative companies.

In early 2013, the VCAP was launched. It included a commitment by the government of up to $350 million to create four new private sector-led funds of funds with private sector investors and interested provinces. It also included $50 million for investment in four existing high-performing venture capital funds as a means to quickly flow capital to the market.

Selection processes were designed to allow the government to leverage the knowledge, expertise, and capital of private sector partners. A private sector expert panel was named to lead a competitive selection process for the general partners to manage the funds of funds, and for the general partners of the high-performing funds.

The panel established the information requirements for applications, defined the selection criteria and evaluation methodology using industry benchmarks, and shortlisted candidates for in-person interviews prior to making final recommendations to the Minister of Finance. In the case of the selection process for the funds of funds, recommended candidates made presentations to and were vetted by initial lead investors. Fund managers were selected by all lead investors, including governments.

While the funds of funds have sectoral priorities—information and communication technologies, life sciences, and clean technology—these importantly reflected investor interests, fund managers' experience, and dominant market opportunities.

During the design of the VCAP, the government considered various venture capital models from international jurisdictions, including those that had incentives to leverage private sector investment. While a variety of incentive models have been used across the world in different jurisdictions, including those that allow the private sector partners to purchase the public sector position, the government chose a different incentive structure.

In addition to the incentive structure, a number of other elements were negotiated by all lead investors, private and public. Negotiated elements enshrined in partnership agreements include the selection of the fund managers and the compensation arrangements for fund managers, including management fees.

The VCAP has already been successful in achieving many of the intended outcomes. It has secured the expertise of four talented funds-of-funds managers, including HarbourVest, a U.S.-based leading global manager which has opened an office in Toronto, and Kensington Capital Partners, which has established a new office in western Canada. These new office locations are important, because venture capital tends to be heavily involved in its local market.

Although fundraising started early, investors wanted to commit only once fund managers had been identified and vetted. The VCAP attracted a spectrum of diverse private sector investors, many of whom were new or returning to the asset class after a long absence. Fund managers were successful in attracting sufficient interest from investors based in Canada. A critical mass of domestic investors is an important signal of confidence in the domestic market to foreign investors, and it helps VC fund managers tap a broader pool of investment.

The government's investments in the fund-of-funds model leveraged significant private sector investment, both at the fund-of-funds level and at the underlying funds level.

The four funds of funds have surpassed their target sizes and have raised a total of more than $1.35 billion in new venture capital financing, including more than $900 million from the private sector. Each fund met its fundraising target in less than 18 months, which compares very favourably with industry standards.

Yesterday, the Minister of Innovation, Science, and Economic Development released VCAP data demonstrating that, as of March 31, 2016, the VCAP funds of funds had committed $693 million of their total capital to funds and companies. This includes $555 million to 17 Canadian funds focused on different stages of company development and industry sectors. These 17 funds have gone on to raise a total of almost $2.5 billion for investments in entrepreneurs at the underlying funds level. In fact, 126 innovative, high-potential Canadian companies across various sectors all over the country have already received more than $420 million in financing.

You will have seen the Auditor General's report and the government's responses, so I won't reiterate those findings. Together, Innovation, Science and Economic Development, BDC, and Finance Canada have developed an action plan, which you have also seen, to respond to the recommendations of the Auditor General and follow through on those commitments. Should the government develop a new initiative similar to the Venture Capital Action Plan, we would certainly consider the Auditor General's findings and recommendations as part of our analysis and development.

I am pleased to note that the performance measurement framework has been updated and that VCAP data is available online on ISED's website. These address the Auditor General's recommendation on increased metrics and reporting.

I hope this information assists you in your understanding of the VCAP. We thank the Auditor General and his team for the report. We will act on these recommendations according to our commitments in the action plan.

We would be happy to respond to any questions from the committee. Thank you.

[The Chair, Conservative, Kevin Sorenson]

Thank you very much to our guests.

We will now move into the first round of questioning.

From the government side we have Ms. Mendès, please.

[Alexandra Mendes, Liberal, Brossard—Saint-Lambert, QC]

Thank you all for your presentations and for your presence here today.

My first question is for Mr. Ferguson.

In point 5 of your presentation, you say that the government faced difficulty in convincing private sector investors to participate in the plan. You mention returns and management, among other things.

Is the very design of the plan not part of the problem?

Do you think that the very fact that the government would create such a venture capital fund was part of the problem?

[Michael Ferguson]

No, the government's policy was simply to set up such a system. It had to determine how best to prepare the system. Our place was not to question the policy, but simply to identify the few issues present during the first stages of this program. The government's participation in this program did not concern us.

[Alexandra Mendes, Liberal, Brossard—Saint-Lambert, QC]

I was not referring to your concerns, but to those of potential investors.

Your role was not to determine if this was a good policy or not, and I understand that well. However, were certain potential investors concerned by the fact that this was a government initiative?

[Richard Domingue, Principal, Office of the Auditor General of Canada]

We noted that in the beginning, these people had a lot of work to do to convince private investors to join the project. As we indicated in the report, the fee structure and the tracking of performance, which was a hindrance for the entrepreneurs, were part of their concerns.

Concerning achieving the full funding of these funds, we noted that for some of them, the funding period ended last March. So it was difficult to convince the businesses. The regulatory framework was also an issue. Under some Basel regulations, this type of asset was indeed not recognized in the calculation of admissible assets. Consequently, the financial sector, particularly the banks, were quite reluctant to join this initiative.

[Alexandra Mendes, Liberal, Brossard—Saint-Lambert, QC]

Thank you.

I am still a bit confused about the reasons.

In point seven in your presentation, Mr. Ferguson, you say that better disclosure of the action plan's performance could benefit the Canadian venture capital market. How would that disclosure be done? What would be your recommendation for better disclosure?

[Michael Ferguson]

Again, this is a program that's dealing with $400 million of federal investment into the program. There need to be ways of being able to determine whether the program is being successful. I think we've heard some indicators that were mentioned just now in the opening statement about some of the things that are coming out of the venture capital fund.

The problem with something like an investment in venture capital is that from a profitability point of view, you don't know whether it's going to be profitable until maybe 15 years from now.

What indicators can be used to identify whether the companies that are actually being invested in.... I think this is one thing that keeps interesting me in this whole conversation. We talk about how much money the government, the provinces, and private sector have committed, and how much money has gotten into the hands of fund-of-funds managers, and how much into the hands of funds managers and again, there was a number about the amount of money that has been committed to companies.

What's interesting is understanding how much money has actually gotten to the companies. What are they doing with it? What are the indicators that they have their ideas and their ideas seem to be leading to commercialization and leading to something that is going to be profitable? I think it's trying to get down a little bit more into that level of detail which is the information that people really need to be able to understand that, okay, yes, this program seems to be on the road not just to creating that ecosystem of venture capitalists, but also creating successful companies.

[Alexandra Mendes, Liberal, Brossard—Saint-Lambert, QC]

That brings me to the question of all the layers of management in this. It was confusing to see that you have the managers, the managers of managers, the layers of intermediaries in all of it. How do you distil that into the ISED website and show where the money is going and how it's becoming a reality in terms of eventual profitability? As far as I understand it, there are at least five levels of disbursement of funds somewhere in here.

[The Chair, Conservative, Kevin Sorenson]

Are you asking Finance or the—

[Alexandra Mendes, Liberal, Brossard—Saint-Lambert, QC]

It could be, and it could be BDC, actually, too. From what I understand there are capital funds to companies but there are Canadian funds focusing on different stages of company development. Then there are 17 funds that go and raise a total of x billion dollars for investments in entrepreneurs at the underlying funds level, and then 126 innovative high potential Canadian companies finally getting some funding.

[The Chair, Conservative, Kevin Sorenson]

Our time is up, so if there's a question, maybe we can come back.

[Alexandra Mendes, Liberal, Brossard—Saint-Lambert, QC]

There isn't really a question. I'm just making a statement, yes.

[The Chair, Conservative, Kevin Sorenson]

Thank you, Ms. Mendès.

We'll now move to the opposition.

Mr. Poilievre, you have seven minutes.

[Pierre Poilievre, Conservative, Carleton, ON]

Help me to understand the management fees. The Auditor General's report indicates that roughly $250 million out of a total $1.35 billion was committed to the fund of funds over the lifetime of the action plan. What does that work out to in percentage terms on an annual basis?

[The Chair, Conservative, Kevin Sorenson]

I think we will go to Finance or BDC.

Go ahead, sir.

[Neal Hill, Vice President, Market Development, BDC Capital, Business Development Bank of Canada (BDC)]

Thanks for the question. I'm Neal Hill with BDC. We're the managers of the program for the government. Venture capital is not an easy—

[Pierre Poilievre, Conservative, Carleton, ON]

The question is what does it work out in percentage terms on an annual basis?