This past year was a period of remarkable change in Canada’s private-equity and venture-capital industry. Whether it was overall dollar volumes, cross-border acquisitions or increased risk-taking by pension funds, the private-equity landscape was transformed.

Sheer volume was a large part of the story. Carried along on a global tide of mergers and acquisitions, the value of private-equity buyouts in Canada jumped to $65.5 billion last year, a huge increase of about 250%, according to figures released recently by Canada’s Venture Capital & Private Equity Association. Even leaving aside the pending $46.8-billion takeover of BCE Inc., remaining deals totalled $18.7 billion — about double the value of 2006 transactions.

Although much of the money flowed into Canada from the U.S. and overseas, Canadians were also very active, investing $8 billion at home (about the same as U.S. investment in Canada) and even more abroad — $11.2 billion in 2007, up almost 50% from 2006. Only about $2.9 million, or 15%, came from other foreign sources.

“Canadians are very active investors in the U.S. and internationally,” says Rick Nathan, president of the 1,500-member CVCA and managing director of Kensington Capital Partners Ltd. in Toronto.

Kirk Falconer, director of research and analysis in Ottawa for New York-based Thomson Financial, says that Canadian private-equity firms have become much richer because of a fundraising boom in 2006, allowing them to pursue more global shopping opportunities.

Some players, such as Canada’s major pension funds, have so much capital they can’t confine themselves to the domestic market, Falconer says: “Just the amount of money they’ve raised, they’re going to have to look south.”

Another factor is companies with niche specializations, which look outside Canada for acquisitions. For example, Toronto’s Clairvest Group Inc., which specializes in entertainment and gaming, recently acquired a casino in Chile for $42 million. Another fund, Tricap Restructuring Fund, owned by Brookfield Asset Management Inc. of Toronto, specializes in turnarounds, while Onex Corp., also of Toronto, is an expert at “carve-outs” in which it buys part of a large company and spins it off into a separate business, such as its 2007 acquisition of the health-care imaging business from Eastman Kodak in the U.S.

But, in Nathan’s view, it’s also important that Canadian inves-tors not overlook their own backyard. The strong growth of private investment flowing to Canadian companies — a 20% increase this past year — is being fuelled mostly by U.S. investors. Canada needs strong Canadian investors for strong Canadian companies, he says. Even accounting for Canada’s smaller population and gross domestic product, the Canadian private-equity scene remains much smaller than in the U.S., he says, and U.S. investors are charging into the gap.

“They’re coming,” Nathan says, “because there aren’t Canadian-based firms that are capitalized enough for that deal flow.”

MIGRATE TO THE CAPITAL

That can lead to long-term weakness for the domestic economy, he notes: “The problem is that some of these companies will migrate to where their capital is.”

That’s compounded by a lack of risk-taking. Nathan says Canada’s institutional investment landscape is dominated by pension funds, which are guarding retirement funds. “There’s just a general conservatism here,” he says.

But Jim Leech, CEO and president of the $106-billion Ontario Teachers Pension Plan Board, points out that the pension fund, under former CEO Claude Lamoureux, was the first Canadian pension fund to launch a private-equity program. The OTPPB became a trendsetter in this country, he says, by moving away from a portfolio loaded with “vanilla” government bonds and toward diverse strategies that promised higher returns.

The OTPPB, which is leading the BCE takeover along with U.S. partners Providence Equity Partners and Madison Dearborn Partners, has a total private-equity portfolio of more than $16 billion. The OTPPB also acquired 50% of New Zealand’s Yellow Pages early last year.

Leech acknowledges that stock market volatility caused by the recent credit crunch has dampened the private-equity market. But there are signals the market is adapting. “This is a pause, not a conclusion,” says Leech. “And, frankly, most of us could use a bit of a holiday from the frenetic pace of the past couple of years.”

Some sectors of the market do not appear to be slowing down at all. While megadeals are down sharply, mid-sized deals remain strong in Canada and globally, according to a recent report from Thomson, the CVCA’s research partner. “Buyout firms are concentrating investments in the mid-market,” the report says, “as the ability to finance large-cap buyouts has largely disappeared.”

@page_break@“Our market is really focused on the mid-market,” Nathan adds, noting most deals are in the $50 million-$300 million range. But in his view, that’s nothing new: “That’s always been the vast majority. We dropped [in terms of number of deals], but only to the level of 2006. We don’t have the same froth in the market as we did in the first half of 2007. That is a relief.”

But, he adds: “The private-equity market just has a lot of sustainable value. So, the debt costs a little more. So, you lower the price and put in more equity. So, repricing of the market has occurred.”

Beth Shiferaw, vice president of ONCAP, Onex’s mid-market private-equity division, says leveraged buyout debt-financing markets, in particular, have weakened because of the U.S. subprime mortgage market, which has resulted in a repricing of risk. Buyers of collateralized loan obligations, or CLOs, have also evaporated, severely reducing liquidity for leveraged loans.

According to Thomson data, worldwide private-equity activity has dropped to levels not seen in half a decade, as measured by both deal value and number of deals. The value of deals worldwide in the fourth quarter of 2007 dropped by 43% over the previous quarter.

Still, private-equity firms have deep war chests ready for spending. Thomson’s Falconer says that at the end of 2006, there was uncommitted private capital of about $800 billion worldwide and — in Canada, at least — a lot of that money remains unspent. IE