Out of the Yukon gold fields of 1898, miners painstakingly picked and panned $10 million worth of the precious metal. But it wasn’t until two years later that the Yukon served up its greatest treasure, when miners dug out $20 million worth.

They were the lucky ones: many had already left following tales of riches to be had in Nome, Alaska. The lesson of history: Never underestimate opportunities in Canada.

One hundred years later, Canada’s venture capital community was enjoying a cash surfeit. In 2000, Canadian VCs disbursed a record $6.3 billion, according to MacDonald & Associates, a subsidiary of Thomson Financial. The bottoming out of U.S. venture capital in 2001 did not seem to menace Canada, which managed to post its second-best year in history.

Canada wouldn’t hit bottom till 2003, and venture investment is still rebounding today. Capital invested in the first half of 2007 topped C$1 billion, according to Thomson Financial, a 21 percent increase over the same period last year.

That investment pales in comparison to what American startups raised; nearly $4 billion, for example, was invested in California alone in the first quarter of 2007. But prospecting in Canada’s tech hubs—largely located in Ontario, Quebec, and British Columbia (B.C.)—is growing. One reason is that Canadian venture firms, along with Canada’s federal and provincial governments, are more actively marketing innovation opportunities to foreign VCs.

“Canada doesn’t have a technology problem,” says Antoine Paquin, Montreal-based general partner at New York City-based Rho Venture Investments. “It has a channel problem. The issue is getting innovation to market.”

Almost 30 percent of all investment capital in the second quarter came from foreign sources, primarily VCs in the United States, according to Thomson—and that’s at least partly explained by Silicon Valley’s relatively overheated market. Valuations there are spiking—investment per company averaged $9 million in the first quarter, according to the quarterly MoneyTree report, up from an average of $7.4 million in 2006—causing venture firms to look for underserved pockets elsewhere. Mr. Paquin says American VCs had it too good in the U.S. “Now the market is extremely competitive. And because of that you go to less-fished waters.”

With west coast B.C. slipping some, despite cleantech’s steady advance in Vancouver and Victoria, Canada’s traditional financial strongholds of Toronto and Montreal have seen the biggest inflows in recent months. In Toronto, North America’s fourth-largest financial center, the focus is on software, new media, semiconductors and semiconductor equipment, and life sciences.

In Ottawa, the national capital, some startups are leveraging traditional strengths in telecommunications and networking equipment, while others have popped up in software and pharmaceutical IT—as is true in Waterloo, an hour west of Toronto.

In Quebec, the accent is on telecommunications, multimedia, and bioscience; Montreal was the original home, after all, of one-time telecom giant Nortel and is also home to the country’s top medical school, McGill University. At Université de Montréal, researchers are working with microchips in an effort to give the blind sight. But the action extends beyond Montreal. Medtech, for example, is getting a higher profile thanks to Quebec City-based bionic prosthesis developer (and recently TSX-listed) Victhom Human Bionics, the subject of a 2005 Red Herring profile.

On Canada’s west coast, Vancouver and Victoria continue to build on a history of cleantech and IT innovation, solar LED lighting maker Carmanah in Victoria and photo-sharing site Flickr, founded in Vancouver and bought by Yahoo in 2005, being two examples.

Helping Hands

The federal and provincial governments have tried to make things interesting for investors, offering handouts for R&D and an array of other incentives, like B.C.’s 30 percent refundable tax credit on venture investment. Indeed, the Canadian government says it offers investors the overall lowest tax rate among developed countries, and the most preferable R&D tax credits among G7 countries.

But some investors don’t see much difference between Canada and the U.S. on the tax front. Ed Alfke, director of the Okanagan Angel Network in Kelowna, B.C., for instance, calls cross-border investment a “zero-sum game in terms of taxes.” But he does concede that government-financed university research—private universities are virtually unknown in Canada—has developed technologies U.S. investors could fund and commercialize cheaply.

One example is a fire alarm system now sold by Kelowna-based SignaLink, where Mr. Alfke happens to be CEO. Through his cross-border network, ongoing development work is now funded by angels in Seattle, the San Francisco Bay Area, Dallas, Detroit, and Canada.

Steve Hnatiuk of Yaletown Partners in Vancouver says his firm, and by extension its American investor partners, has been able to take advantage of Canadian tax breaks and cleantech R&D funding from federal programs like the C$550-million Sustainable Development Technology Canada fund.

Government tax breaks for union- and pension-backed funds, which traditionally have helped spearhead funding for small startups, dried up in 2005. In Quebec, however, they are still going strong. The Quebec labor federation’s Fonds de Solidarité FTQ and the province’s public-sector pension fund, the Caisse de Dépôt et Placement du Québec, recently teamed up to attract more foreign investment. Solidarité manages C$7.2 billion in assets, the Caisse C$237 billion—sizeable war chests that have helped persuade U.S. venture firms to open Montreal offices and help seed local startups. Examples include VantagePoint Venture Partners, based in San Bruno, California, and New York City; ProQuest Investments, based in San Diego, California, and Princeton, New Jersey; and New York City-based Rho Venture Investments.

Yet while Quebec enjoys higher capital inflows than Ontario, VCs in the capital say Montreal still lacks things like management experience, slowing its growth as a venture center. “The number of new, successful, high-technology global companies born in Montreal is...well, small to nil,” says Andrew Waitman, managing partner of Celtic House, Ottawa’s biggest venture firm. By his definition, “new” means companies started in 1997 or since.

British Columbia’s Clean Investments

Like nearby Pacific Northwest states Washington and Oregon, B.C. is vying to become a cleantech center. And since the founding of fuel-cell developer Ballard Power Systems in 1979, the province has staked claims in an array of green technologies besides fuel cells, running from solar power to wastewater systems. In fact, B.C. leads Canada in attracting cleantech investment, raising US$50 million last year, US$18.2 million of that going to micro fuel-cell developer Angstrom Power in a round led by Canada’s Ventures West.

“What we have here in B.C. is a long history in energy-related markets and that is colliding with long-term energy entrepreneurship and producing a lot of interesting startups,” says Yaletown’s Mr. Hnatiuk.

But B.C. also has seen growth in bioscience and IT. In 2005, biopharma raised more than US$300 million in public and private investment, putting it ahead of all other sectors for investment dollars, according to the provincial government. A lot of innovation in biotech and other areas springs out of the University of Victoria in the provincial capital on Vancouver Island and the University of British Columbia, in Vancouver on the B.C. mainland.

Clusters of startups in everything from medical management software to semiconductor and networking equipment have also grown up over the last two decades. Early this year, D-Wave Systems of Burnaby, just outside Vancouver, claimed it created the first applicable quantum computer. Burnaby, home to Simon Fraser University, is a happening place; Redwood City, California-based Electronic Arts’ largest development center is located there. Most recently, Microsoft announced in July that it would open a software center in Vancouver. “Frankly, we are drinking from a fire hose in IT here,” says Mr. Hnatiuk.

Yaletown’s portfolio includes almost a half-dozen data analysis or CRM software startups. One of them, 10-year-old GenoLogics, a bioscience informatics platform developer debuting a new software analysis product this year, has backing from OVP Venture Partners, based in Seattle and Portland, Oregon. Managing Partner Charles Waite says OVP looks at hundreds of B.C. startups but relies on local investors to help in the assessment process. “I wouldn’t do a deal without them,” Mr. Waite says. “There are cultural differences and we need someone on the ground.”

And that leads him to another observation. Despite the province’s wealth of technological expertise, managers capable of building companies are in short supply, Mr. Waite says. “Vancouver is seven to 10 years behind Seattle, and Seattle is seven to 10 years behind San Jose,” he says. “In San Jose, you have CEOs with experience leading four to five companies; in Seattle, they have experience leading two to three; in Vancouver, they’re starting with their first.”

The other issue is Vancouver’s relatively small size (2006 estimate: 587,000 in the city itself; 2 million in the metro area) and lack of capital, especially the early-stage variety. Mr. Hnatiuk blames that partly on Canadians’ low-key attitude. “Our Canadian business culture is not to blow our own horn,” he says. “There has been a decades-long building of industries here but what we need is more capital, which is why we are very intensely looking to build good relationships with partners south of the border.”

Ontario’s Strong Mix

Meanwhile, Ontario surges, then falls behind. According to Thomson Financial, the jump to C$309 million in first quarter investments in the province fell sharply in the second quarter to C$131 million. The year’s largest deal so far was a C$160-million investment by Bethesda, Maryland-based American Capital Strategies in Geosign Technologies, an Internet publishing company based in Guelph, southwest of Toronto.

According to Thomson, U.S. venture investments in Ontario accounted for a major portion of the 82 percent in foreign capital committed to the largest first-quarter transactions.

While last year’s decline in new Canadian-funded startups continues, investors say Ottawa offers a healthy mix of investment opportunities—like six-year-old Epocal, a blood diagnostics technology maker which in April received $31 million in C-round funding led by Dallas-based Highland Capital Management; and younger companies such as enterprise security firm Third Brigade, online payment developer ModaSolutions, and clinical trial data management company TrialStat, all based in Ottawa. If the number of startups is down, Celtic’s Waitman says, “the health of those who have survived and are thriving is very good.”

Then there’s Toronto and Waterloo, home to Research in Motion of Blackberry fame. The University of Waterloo, one of the country’s top IT schools, anchors a community rich with startups focused on a variety of software and telecom areas. Better known examples include Toronto’s Fresco Microchip, which designs silicon tuners for better television reception, and Waterloo-based Semacode, which makes software for mobile phones that can scan and process bar code information.

Life sciences research continues at a furious pace at the University of Toronto and other research hospitals, powering up companies like Affinium Pharmaceuticals, which works on treatments for drug-resistant infections. Co-founded by UT Biochemistry Professor Jack Greenblatt, Affinium just raised C$21 million in an A round led by San Diego-based Forward Ventures.

But VCs agree that since the primary market for bioscience products is in the U.S., startups generally have to export their marketing or other business functions south. With the dwindling of union- and pension-backed funds, “I believe there will be more contraction of Canadian-based fund managers in life sciences,” says Kelly Holman, managing director of Toronto-based life sciences group Genesys Capital Partners, which helped seed Affinium and Epocal. “But I believe there will be more capital flow in life sciences because I think more groups outside Canada see the value of the assets here.”

Quebec’s Hot Market

Quebec has world-class research, a strong tradition of innovation in aerospace, telecom, and multimedia, and a powerful investment engine in the form of labor-backed funds and government tax breaks. So why is its venture sector underserved?

“The technology is already here, we have a specialized work force from, for example, [network provider] Nortel and [Swedish wireless giant] Ericsson, and the cost of doing R&D is almost as cheap as in India [with tax breaks figured in],” says Jacques Bernier, senior vice president for information technologies, telecommunications, and industrial innovations at Montreal’s Solidarité FTQ. “What was missing was a good mix of private capital.”

Mr. Bernier came on three years ago to help the giant investment fund kick start more IT innovation. Implementing his strategy to bring in more foreigners to fund companies at seed and exit stages, Solidarité partnered with more than 18 foreign and domestic funds, persuading eight of them to open branch offices in Montreal. Today, 20 percent of the fund’s C$665 million worth of investments is sunk into IT and life sciences, including Montreal startups like mobile email provider OZ Communications and mobile platform maker BlueStreak Technology. Solidarité has also invested in U.S. companies that are in turn opening offices in Montreal, including New York City-based mobile content distributor Cellfish Media, Los Angeles-based data archiving company Nexsan, and digital video encoding maker Envivio, based in South San Francisco.

Cultural Synergies

For U.S. investors, Canada’s similar culture, innovative spirit, and long trading history with the U.S. make it an appealing partner. Argon Capital, a Redwood City, California-based venture firm with a focus on Western Canada, is betting on just that kind of synergy in building a portfolio based on energy innovation out of oil-rich Alberta and new technology in communications, nanotechnology, and new media coming out of the area’s university centers. Although the low cost of doing business in China and India is alluring, you also can’t beat native English speakers and two-hour flights, say Argon Partners Jason Bross and Dr. Juan-Antonio Carballo. Which may be the new lesson of history: Never underestimate a good commute.

FOR MORE ON CANADA, SEE: Canada's Hottest Startups, Nortel Goes Shopping, Research In Motion Stays in Motion