If the Canadian venture capital industry wants to survive, it needs to start producing returns.

Understanding what's wrong with venture capital in Canada isn't a simple task. We first need to understand the role of VC generally, what is happening in the industry overall, and how this applies in the Canadian context.

VC exists to deliver superior returns to investors looking for investments that are not correlated with public stock markets. Venture capitalists make big bets on high growth technology-based companies. They are willing to tolerate (and some would say create) casualties (investments with no return) in search of those few investments that will deliver massive returns (think Apple, Microsoft, or, more recently, Google).

So while these VCs are funding innovation and creating jobs, at the end of the day they are in it for the returns. Period.

The problem is that, for a long time now, VC returns have been very low. Meanwhile, fund sizes have gotten a lot bigger. Since VCs take 2 per cent of the fund size each year as a management fee, they can still make a great living, even if their fund's performance is poor. For this reason, the interests of the VC are not always the same as those of their investors. And investors are not being compensated for the risk they are taking.

In Canada, industry returns are even worse than they are in the U.S. In its 2009 report on emerging Canadian Software companies, Price Waterhouse Coopers reports that “the median Canadian VC has shown a cumulative-since-inception return of 0 per cent.” This is for a 10-year period that includes the end of the last bubble in 2000). Two years from now, those returns will be negative.

Why is this? And what can we do about it? I don't have the answers but I have made some observations in over 10 years of raising venture capital in Canada:

1. There is a lack of really "big" opportunities. VC is not a game of averages. It is a game of extremes. A fund might generate all of its returns on one or two investments. We simply don't have the big fund-making investment opportunities here in Canada. When was the last time a Research In Motion was built here? Our big companies (Cognos, Hummingbird, etc) have been bought up one by one.

2. There is a lack of capital. It's hard to create big stand-alone companies without a lot of capital. It is standard procedure for Canadian startups to go to the U.S. for funding. I have done this five times, not because I did not want Canadian VC, but because there was nowhere to get it. Hopefully, Tandem Expansion Fund will fill some of this gap and keep more of our companies here.

3. Private investors are not participating. A large portion of Canada's risk capital comes from government sources. Without this public support, we would have no industry at all. Alberta, Quebec, and Ontario have all made big commitments to this asset class. We need to generate returns to get private investors back.

4. We are not the United States. One of the best and worst aspects of Canada's technology industry is its proximity to the U.S. While we have access to a huge market and big capital pools, we simply can't operate in the same way as a market that is ten times our size. While Canada cannot ignore the U.S., it needs to build more strength at home. This means making sure there is enough capital available at each stage, that more of our companies go public on the TSXand stay there, that Canadian customers embrace our startups and their offerings, and that talent stays in the country.

All of this is interrelated. More Canadian capital will allow more of our companies to grow here, go public here, and produce experienced entrepreneurs and executives that will keep the startup cycle going and growing.