This article is part of our special report on venture capital and family offices.
Derrick Hunter is the second-generation CEO of Calgary-based Bluesky Equities, a diversified, family-owned investment company. The group allocates capital across a number of asset classes, including fundamental equity, private equity, fixed income, hedge funds and real estate. Bluesky is also committed to the venture capital space as an active early-stage investor, with a current portfolio of 80 VC angel investments in B2B companies operating primarily in North America.
Here, Mr. Hunter talks to Canadian Family Offices about his firm’s strategy for investing in early-stage companies, the current state of the market, and why he thinks government policy is on “the wrong path” when it comes to VC.
How much does venture capital contribute to Bluesky’s overall operation?
There’s a perception that we’re a venture fund, because we’ve been doing it as a business unit since 2012. Today, we’re focused on being an all-weather portfolio manager, and venture constitutes one component of our portfolio, but it’s not anywhere close to the majority of our activity.
To our eyes, many of the deals that are getting closed are still being done on terms that never recognized that circumstances have changed.
How do you determine Bluesky’s level of commitment to VC?
We have a dedicated portfolio manager, but we don’t have a quota. It’s not like a typical fund that will raise money it has got to invest within three years. We have a fairly healthy funnel, and we’ll keep investing as long as we see investable companies. When we get exits, we’re happy to recycle the money. However, we’ve found over the last two or three years it’s been quite difficult to find good investments in this space, and we’re not going to force a deal if we don’t like the terms.
What’s your model for assessing VC opportunities?
Our process for venture investing has developed over 15 years, and we’re pretty disciplined.
We get dozens of cold calls every day, but we don’t really look at anything that didn’t come as a warm introduction. I’d describe our sweet spot as the time after they’ve canvassed their friends and family, but pre-Series A.
We invest in companies that are pretty small but generally have a product in market. We have a checklist that we work through. It all boils down to our expectation that the company can grow quickly enough to produce the targeted return profile we have in mind.
Most of the time, they’ll have at least one customer. The valuation post-money might be in the $4 million to $10 million range. At that level, you can think through what has to happen for this company to be worth 10 times more—and today, these are typically tech companies. We write a lot of cheques for companies at that very early stage when there’s much more available torque. When they come back to us and say they’re ready to do the next round at a higher valuation, we always have pro rata rights. We’ll look at potentially writing a larger cheque on the next round and increasing our exposure. But the deal still has to make sense to us at the time.
The taxes … are so massive compared with the United States that we’re not even on the same planet from a competitive standpoint.
Obviously, accurate valuations of these companies are critical.
We’re rigorous about valuation. That’s something that I think the industry, particularly in Canada, has not really been disciplined about. There’s often a VC fund in a syndicate that we co-invest with. The single biggest reason we pass on a deal is that we can’t get our heads around what they’re paying according to the deal terms established by the lead. The deals were definitely rich in 2020, 2021 and 2022, in the era when money was free and interest rates were zero. You couldn’t get any money on cash, so it forced investors to take on more risk to get better returns. That really played a role in elevating prices and valuations in the venture market.
When rates went to five per cent, that eviscerated the venture market because you’ve got alternatives. To our eyes, many of the deals that are getting closed are still being done on terms that never recognized that circumstances have changed. You get deals that require a crazy growth rate or some crazy multiple of revenue, and we’re scratching our heads, asking how this can still be the valuation. If you look at BDC’s numbers in this space, venture investments in Canada are nowhere close to being economically satisfactory. [Editor’s note: BDC’s Canada’s Venture Capital Landscape reports that, as of 2024, Canadian VC’s net 10-year internal rate of return stood at roughly 10 per cent.]
If general partners weren’t overpaying at the front end, their returns would be better. Until the Canadian VC industry does a better job of underwriting, you’re not going to get acceptable returns from a financial point of view. And if you can’t demonstrate acceptable financial returns, given the amount of risk and lack of liquidity and the relatively high taxes owing in this asset class, you can’t expect to attract institutional money or significant private capital.
How involved do you become with the companies you invest in?
We’re extremely hands-off. We’ve done well over 100 of these early-stage tech investments in the last 13 years, and we don’t have the bench strength to become heavily involved.
You’ve frequently stated that tax policy is not favourable to VC investors in Canada.
If you’re going to encourage somebody to invest in this asset class, private capital should be expecting at least two times the return of the TSX. You’re talking about funds that typically last for 15 to 17 years, they’re extremely illiquid, and they don’t typically pay much in distributions along the way. They’re not really very tax-friendly because you’re paying tax on the nominal return over 15 years, which can include inflationary effects. The taxes, if you have a successful outcome, are so massive compared with the United States that we’re not even on the same planet from a competitive standpoint.
A lot of VC funds are way past their 10-year term, but they’re still alive because the general partners don’t want to sell.
Canadian governments at the federal and provincial level see the problem as lack of available capital and have established policy incentives, including the federal government’s pledge of $750 million to address “early growth-stage funding gaps” and an increase in the Venture and Growth Capital Catalyst Initiative, in which government will invest alongside the private sector.
Government is on the wrong path. We’re saying that it’s OK for the federal government to use MOUs to decide what pipelines to build or what mining projects get built. We’re going to centrally plan the economy. That doesn’t square with encouraging entrepreneurs who need to let markets operate. Another problem with venture funds that have federal and provincial government arms is that they tack on other caveats and treat it as regional and social development. Once you start competing in the venture space with government money that’s got requirements attached to it, you’re impacting the terms of the deals that get done. If we had 10 times the private capital, then this amount of government money probably wouldn’t matter so much. But the biggest investor in Canada’s VC space is the federal government.
If you could influence government policies to encourage the VC market, what would you suggest?
The biggest challenge is taxes, which are way too high and kick in at too low a level. The income that’s left over after paying tax becomes capital, so it’s not surprising that it doesn’t get reinvested. But data around the world is pretty clear that it’s better if your incentives come at the end of the investment, not at the beginning. Some people are lobbying for investment tax credits and flow-through shares. I believe the best outcome would be to eliminate capital gains when you exit an investment. If you can’t eliminate them, do a rollover like they do in U.S. real estate—allow gains to be carried over to the next investment. An entrepreneur who builds a company and sells it gets a million-dollar lifetime capital gains exemption in Canada. In the U.S., it can be 30 times that much. That’s our biggest competitor, and that’s where half our entrepreneurs are going.
What about changes in the VC industry itself?
They need to practise better underwriting, and the general partners who manage funds need to have better alignment. A lot of VC funds are way past their 10-year term, but they’re still alive because the general partners don’t want to sell, because they rarely have a significant amount of capital invested in the funds. These funds usually get structured so they receive two per cent of the AUM and then 20 per cent of any gain over a hurdle, which is usually about eight per cent. If you look at the data from BDC, almost nobody reaches eight per cent. If you’re making all your money on your two per cent rake every year, that’s a big disincentive to sell. As an LP, I may be willing to take a discount from our last mark value. But as a GP, I’m probably not willing to do that. I believe that GPs should write a healthy cheque at the front end. We would never invest in a startup where the founder didn’t have actual money in the deal.
How would you characterize the success of Bluesky’s approach to VC?
Our failure rate hasn’t been as high as we expected. Dealing with very young companies, we expected a 75 per cent failure rate, and we’re between 10 and 20 per cent so far. In terms of returns over the past 14 years, our results are pretty good. We’re doing better than the Canadian industry by a comfortable margin.
Peter Kenter is a Toronto-based writer with a deep and abiding interest in how everything in the world works and how it got that way. He’s written about the economy, investing, financial services, cryptocurrency, pharmaceuticals, mining, energy, cannabis, agriculture, consumer electronics, education, sponsorship marketing, and entertainment. He’s the author of TV North: Everything You Wanted to Know About Canadian Television.
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