Federal Tax Credit Sparks Renewed Interest in Labour Sponsored Venture Funds

April 28, 2016

The Liberal government’s decision to reinstate a controversial tax credit for labour-sponsored venture-capital corporations has sparked renewed interest in their funds aimed at promoting the growth of Canadian startups. Still, skepticism remains.

Critics argue many of the labour-sponsored funds have been ineffective and had a poor track record compared to private venture-capital funds. They’ve also been blamed for squeezing out investments in provinces such as Ontario, with too much money chasing too few deals. Ontario eventually eliminated its tax credit in 2012 and its labour-sponsored venture funds have been winding down since.

Others believe the revival of the federal tax credit is an opportunity to fix problems from the past, while providing another source to seed the next generation of Canadian startups.

“We have to make sure these things are set up right going forward,” said Mike Woollatt, chief executive of the Canadian Venture Capital Association, which supports the reinstatement of the tax credit.

Mr. Woollatt points to funds that still exist – such as Saskatchewan’s Golden Opportunities Fund, British Columbia’s GrowthWorks and Quebec’s Fondaction and Solidarity Fund – as industry leaders.

The funds, sponsored by labour unions, make venture-capital investments in small and medium-sized businesses. Tax incentives were launched in Quebec in the early 1980s and then eventually picked up by other provinces and the federal government in the late ’80s and ’90s when access to venture capital for smaller companies was limited.

The former Conservative government decided in 2013 to reduce the credit to 10 per cent for 2015, five per cent for 2016, and then get rid of it altogether as of 2017, arguing the venture-capital market has changed and citing complaints the funds were inefficient.

The Liberals reinstated the 15-per-cent tax credit in last month’s budget for share purchases of provincially registered labour-sponsored venture capital funds, “to facilitate access to venture capital for small and medium-sized businesses and support saving by the middle class.”

Ottawa’s credit applies to eligible investments of up to $5,000, making it worth up to $750. Some provinces that still sell the funds provide a matching credit: In Saskatchewan it’s 20 per cent for a total of 35 per cent; in Quebec it’s 15 per cent for a total of 30 per cent. The funds can be held within a Registered Retirement Savings Plan.

Over the years, the funds have supported dozens of successful homegrown businesses including alternative energy pioneer General Fusion, quantum computing company D-Wave Systems, health sciences company Biochem Pharma and Prairie Plant Systems, once Health Canada’s sole provider of medical marijuana for more than a decade.

Amit Gupta, co-founder and CEO of Saskatoon-based Solido Design Automation, says tax credits are largely to thank for the growth of his technology firm, which makes software for chips that go into devices such as computers and iPads.

“We had pressure to move to Vancouver, Ontario or even Silicon Valley where there are more sources of capital,” said Mr. Gutpa.

One of its main financial backers was the Golden Opportunities Fund.

“What Golden has been able to do for us, and the province’s tech community in general, is invest in companies like us to grow and hire locally and grow successful businesses,” Mr. Gupta said.

While the venture community reports a revived interest in the funds since the tax credit was brought back last month, fund operators don’t expect increased interest from retail investors until next year, given that the bulk of investments happen during RRSP season.

The industry also needs time to adjust. Funds that had put new investments on the back burner, such as GrowthWorks, say they’re just starting to look at potentially selling them again while others, such as the Solidarity Fund are doubling down. The Solidarity Fund announced last week that it would nearly double its investments by 2020 to about $3-billion, driven by the reinstatement of the tax credit.

“[It is] a very strong statement by the fund that we are back and have a plan for sustained growth,” said Mario Tremblay, vice-president for public and corporate affairs for the Solidarity Fund.

Tremblay also argues that the fund’s rate-of-return has been “reasonable,” citing a compound annual return to (excluding the tax credits) to shareholders of 7.3 per cent for three years, 6.1 per cent for five years and 3.8 per cent for 10 years.

Geneviève Morin, chief investment officer at Fondaction, said the restored tax credit stopped the “slow erosion” of investments from retail investors, and has encouraged the fund itself to once again actively seek new investments.

It also put the brakes on the fund’s plans to potentially change its investment policy to cope with the loss in the federal tax credit.

“We would’ve been stuck in a situation where maybe we would’ve needed more liquidity,” Ms. Morin said, which meant competing more directly with other venture capital funds, “instead of being complimentary, which is how we had originally placed ourselves.”

Bryan Watson, a partner at consulting firm Flow Ventures, says the industry is still cautious about the impact of bringing back the tax incentive. In the past, he says the sector was too fragmented and its structure led to the crowding out other funds, which caused a reduction in the pool of venture capital and fewer investments. Then the recession hit, which was a double-whammy for the industry.

“The venture capital community is still recovering from what happened in 2007-08,” Mr. Watson said.

“I would urge caution and a really deep understanding of the historic effects. … Hopefully they will adjust accordingly, to allow the program work better.”

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