The Canadian Retail Venture Funds Association today drew attention to gloomy state of the venture capital (VC) investment industry in Canada, and especially in Ontario.

According to data released last week by the Canadian Venture Capital Association, VC investment in Canada declined 31% to $302 million from the Q2 period of 2007 where investments stood at $436 million.

Quebec was the hardest hit province experiencing a VC investment decline of more than half in Q2 2008 from Q2 2007. Ontario saw a slight increase in venture capital investment over Q2 2007.

Yet this slight upturn in Ontario does not reflect the true picture as the number of new financings and early stage investment has declined substantially, says the Canadian Retail Venture Funds Association (RVFA).

The sign of a healthy venture capital market is reflected in the growth of first-time and early-stage financing, the RVFA says, noting this is not the case in Ontario, where first-time and early-stage investments have been declining.

Only $48 million in early stage capital was raised in Q2 2008 in Ontario, compared to $65 million in Q1 2008 for a grand total of $112 million for the first half of 2008 — less than half of the total $242 million raised in 2007.

The Q2 2008 numbers indicate “an inhospitable VC environment in Ontario, which is leading investors to other jurisdictions,” says Canadian Retail Venture Funds Association president, Les Lyall.

Lyall blames much of the decline in VC investment in in the province over the past few years on the Ontario government’s 2005 decision to wind down the labour-sponsored investment fund (LSIF) program.

“If the program were reconstituted, you would see an upward trend in retail fund activity and increased VC investment in Ontario and across Canada,” says Lyall. “Investors can see the end and have written off labour-sponsored and retail funds in favour of more traditional investments,” he adds.

The 2011 wind down date has forced many investors to pull out of the LSIF program, precipitating a rapid decline in the activity of labour-sponsored and retail funds, the RVFA says. Activity in these funds has hit historically low levels, with only $57 million invested in Q1 2008 compared to the $113 million invested in Q1 2007.

In light of these numbers, the RVFA is calling on the Ontario government to reconsider its 2005 decision to wind-down the LSIF program.

The RVFA represents over 60 individual funds, such as the Canadian Medical Discoveries Fund, which supplies capital to VC investors to invest in innovative emerging enterprises.

The CVCA Q2 figures are based on statistical reports from Thomson-Reuters.