Inovia Report Signals Canadian Software Sector Returning to Normalcy

The Canadian software sector is experiencing a return to normalcy in venture capital funding, as reported by Inovia Capital. Despite the challenges faced over the past two years, the Montreal-based VC firm found that capital deployment in Canada in 2023 has rebounded to levels seen before 2021, with venture funding at $1.0 billion USD and growth funding at $2.5 billion USD.

This resurgence in Canadian VC funding is noteworthy considering the obstacles posed by rising interest rates, diminished deal volumes, and declining valuations. The report also highlights a positive trend in Software as a Service (SaaS) free cash flow margins, which have increased by 10 percent since the pre-2021 VC boom. With historically low valuations, the software sector appears poised for an injection of capital.

Additionally, the report sheds light on the growing influence of emerging managers in the Canadian software market. The number of early-stage funds with investors who have raised three or fewer funds has quadrupled since 2013, underscoring the increasing prominence of these players in shaping the landscape of the industry.

Looking ahead, the report anticipates a shift in investment dynamics, transitioning from predominantly Canadian-led investments to a surge in international interest in domestic companies. Notably, 60 percent of the top 20 growth companies since 2019 had a Canadian leader or co-leader involved in rounds of $50 million or more.

The report from Inovia also emphasizes the distinct contributions each Canadian region makes to the software sector. Ontario continues to dominate funding and is recognized as a hub for the Canadian operations of major tech giants like Google and Meta. Nevertheless, Western Canada (25 percent) and Québec (23 percent) collectively account for 48 percent of total funding since 2019, approaching Ontario's market share of 55 percent.

In terms of talent and capital growth across regions, Vancouver and Calgary have experienced the fastest talent pool expansion in the country, with growth rates of 69 percent and 61 percent, respectively, since 2017. Waterloo follows closely with a 52 percent increase. Importantly, all eight of the top Canadian markets have witnessed workforce growth in the double digits. This highlights a widespread and sustained trend of talent development across the country.

Although Montréal didn't secure a position in the top 10 largest tech markets in North America, it witnessed a robust 43 percent growth in its tech workforce. In Québec, an estimated 30,000 jobs, or 17.4 percent, are now related to AI.

In the realm of AI, 2023 experienced a fivefold increase in investments in generative AI startups globally, with Canadian companies like Cohere, CentML, and Spellbook Canada making noteworthy contributions. Canada boasts nearly 700 AI startups, ranking fourth globally in generative AI companies per capita. Notably, success with generative AI technology has largely been concentrated in established companies integrating AI tools, though exceptions like ChatGPT exist.

According to insights from Inovia's report, companies with well-organized information and data hygiene will gain a competitive edge in implementing AI tools. While large language models are considered beneficial for advancing data-driven jobs, they are seen as enhancing rather than replacing such roles.

The report highlights the ascendancy of FinTech, with companies like Wealthsimple and Neo emerging as dominant players in terms of VC funding, totaling $5.7 billion since 2019. FinTech, digital health, and the "future of work" verticals collectively accounted for over half of total VC funding during this period. Digital health and travel & hospitality sectors have doubled their funding since 2019.

Anticipating a surge in mergers and acquisitions, the report points to over 50 acquisitions by Inovia's portfolio companies in 2023. Public software acquirers, including Constellation Software and OpenText, experienced double-digit stock price surges from January to December 2023. Inovia foresees Canadian software companies strategically leveraging mergers and acquisitions in the coming year, ushering in a phase of rebundling after the preceding decade focused on unbundling software. Lalancette of Inovia notes that this wave of M&A in 2023 is a rising tide that will create opportunities across all sectors.