In the News...

Tracy Tjaden

Canada's venture capital industry leans too heavily on government tax breaks dished out at the whim of politicians.
So says a leading U.S. venture capital expert.

"It's a huge problem," said Paul Kedrosky, a National Post columnist who teaches business at the University of California, San Diego. "You're creating a private equity system predicated on the munificence of governments which is never a good idea - it should be predicated on the greed of investors and not on tax-giveaways."

Well over half of all the venture capital raised in Canada is from small retail investors, lured to the riskier investments by government tax breaks.

There are no such tax incentives south of the border. In the United States nearly all venture capital is raised from large institutional investors and pension funds.

Kedrosky said Canada is shooting itself in the foot because the tax-incentive VC funds here are crowding out investment from larger institutional players not interested tax breaks.

"Reality is, and the research is clear on this, that public money directed toward VC crowds out private money, and we have to ask ourselves is that really where you want to put scarce tax dollars, and the answer is almost certainly not," said the former University of B.C. business professor. "Rather than using them as a tool for seeding venture funds these things actually become the largest source of venture money and that's a dangerous game to play."

Tax-incentive venture capital sources in Canada include labour-sponsored venture capital funds and venture capital corporations.
VCCs and labour funds both offer investors a 30-per-cent tax credit.

The difference is that half of the credit for labour funds comes from the federal government; the other half is covered by the province. For VCCs, the province picks up the entire 30 per cent.

A clawback of both programs would spark panic in local technology circles. The tech industry relies heavily on venture capital and is currently lobbying for both federal and provincial governments to boost tax perks for VC investors.

Just last week BIV reported on efforts by B.C.'s technology sector to push the federal government to match the province's tax incentives for the VCC program.

According to Robin Louis, president of the Canadian Venture Capital Association and Vancouver's Ventures West Management Inc., about 85 per cent of venture capital raised in the U.S. is from institutional investors, pension funds and endowments, and about nine per cent comes from individual high net-worth investors.

A federal government-sponsored program encourages investment in small businesses in the U.S., but it sees the government match investment from the private sector.

In Canada, 60 to 80 per cent of venture capital is raised through tax-incentive programs from individuals, Louis said.
He added that the U.S. system is a good model for Canada, but a hard one to copy because the U.S. VC industry is more mature and Canadian pension funds have historically invested little in VC.

Those funds are much smaller than their U.S. counterparts, which makes it harder to build a well-diversified VC portfolio, he said.
But Kedrosky argues that pension funds and institutional investors on both sides of the border are snubbing Canadian VC funds because the tax-incentives are dragging down returns.

Many claim that because individual investors get a tax break, they don't demand as high a return as institutional investors.
The debate has been simmering for years between private VC funds and their labour-sponsored counterparts in Canada, both of which belong to the CVCA, said Louis.

Without coming down on one side or the other, he agreed it's dicey to build a VC industry that leans heavily on government promises.

"I would be concerned that in the long term at some point a government would decide not to return the tax credits," he said. "If they were shut off at that point it would really be a problem for entrepreneurs trying to raise money."

He also agreed Canadian VC funds might be getting passed over by large U.S. managers because of the tax incentives offered here.
But Charles Cook, chief financial officer of Discovery Capital Corp., said many industries in Canada have grown thanks to tax incentives, including flow-through programs for resource companies that pass tax deductions for new exploration and development through to investors.

Kedrosky and Brent Holliday, a partner with Vancouver's Greenstone Venture Partners Ltd., agree Canada should cap tax incentives and wind them down.

"As long as subsidies are in place, there is very little incentive for institutional investors to get involved," said Kedrosky.
Holliday said to create a substantial, healthy venture capital industry in Canada, the large institutional investors and pension funds have to become players.

tracy@biv.com