Repost from Flow Ventures

by Raymond Luk

This is a great time to be building startups in Canada. Ontario and Quebec have recently announced over a $1 billion in funding for new ventures through matching funds and fund-of-funds. There may be more good news when Ontario tables its budget on March 26.

Here’s a quick summary:

Ontario:

• $250 million Emerging Technologies Fund which will match private investments in IT, cleantech and life sciences startups

Quebec (link to budget):

• $825 million for a fund-of-funds to invest in 15-20 VC funds ($700 million from the government, $125 million from the private sector)
• $125 million for the creation of 3 seed funds ($100 from the government, $25 from the private sector)
• 10-year provincial tax holiday for new ventures that commercialize research from a Quebec university or research centre

So how does this trickle down to startups?

1. If you’re raising your first round it means there will be more seed funding sources and more money in existing funding sources. Private investors may be more willing to invest since the government is matching their dollars 1 to 1 or 2 to 1 in some cases.
2. If you already have investment it means your investors may be more likely to top-up if they are on the receiving end of these funds.
3. If you’re commercializing research, which Canada does a poor job of, you look a lot more attractive to investors. Not paying provincial corporate tax for 10 years has a huge effect on investor returns (assuming you’re planning on profitability).

The best part of these initiatives is that they support the existing investment ecosystem rather than trying to replace it with something government run. We already have the pleasure, privilege and intestinal fortitude to deal with the government for SRED and other subsidies. Best leave investment to experienced managers.

So is there any bad news? Timing will be an issue as nobody can deploy this much money quickly. It’ll be awhile before funds actually trickle down to companies. I personally don’t like any initiative with a geographical limitation. I understand the desire to create jobs in a particular place but technology companies can be spread out. In Canada, where we don’t have the density of markets and talent, an Ontario-only company doesn’t make sense.

But enough complaining. Does this mean that we at Flow are more likely to make investments in the near future? You bet!

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 March 16, 2009

Premier Dalton McGuinty

Government of Ontario

Legislative Building, Queen’s Park

Toronto, Ontario

M7A 1A1

Dear Mr. Premier,

On behalf of Canada’s Venture Capital and Private Equity Association (CVCA), I would like to draw your attention to the critical situation facing Ontario’s venture capital industry.  The current severe economic downturn is further exacerbating an already difficult fund raising and investing environment and risks compromising our collective ability to fund the industries of tomorrow.

Venture capital (VC) firms generally focus on entrepreneurial and fast growing small businesses in the technology arena, including information and communications technology, life sciences and biotechnology, alternative energy and clean tech.  Perhaps the best known Canadian VC success story is Research in Motion, which has fundamentally changed the way we work and communicate while at once creating tens of thousands of jobs and serving as an engine for Canada’s economy.

The CVCA has recently released a study on the economic impacts of venture capital.  This study has been led by the CVCA with the financial support of Ontario, several other provincial governments and the federal government.  This study clearly shows that venture capital in Canada has resulted in the creation of close to 150,000 jobs and an additional 1% to Canada’s GDP.  In addition, according to the Information Technology Association of Canada (ITAC), 700,000 Canadians work in the broader information technology and communications technology sectors.

This record reflects the specialized business-building skills that Canada’s venture capital firms bring to their portfolio companies.  It is also a measure of our long-term focus, astute risk management and strong sense of corporate responsibility and accountability to stakeholders.

While the venture capital industry has been a key driver of Ontario’s prosperity, our members are currently facing significant challenges that we believe require government action.  At a time when our economy urgently needs new success stories like RIM, ATI, Open Text, Cognos and Corel, we believe that it is vital for the government to address the: 

● Current lack of funding available to bridge the gap between research and development and the commercialization of promising technologies;

● Existing obstacles to foreign investment

Each of these challenges is presented below along with a proposed approach to form the basis for a more detailed discussion.

Access to Funding

Given the current economic environment, fundraising in our sector reached new lows in 2008.  The ability of funds to raise new capital impacts their capacity as financial intermediaries to make investments into promising companies.  Because of the increasing difficulties in fundraising, between 2003 and 2008, venture capital investment in Ontario dropped to $99 million in Q 4, 2008, down precipitously from $177 million in Q 3, 2008 and from $217 million in Q 4, 2007.

The lack of capital available to venture capital investors reflects the broader market volatility and the new market realities.  Institutional investors such as pension funds have incurred considerable losses in their public equity portfolios, which in turn has resulted in a corresponding lower allocation to venture capital and private equity.  Additionally, individual investors are increasingly reticent to invest in publicly-traded vehicles such as Labour-Sponsored Venture Capital Corporations, for a variety of reasons, including the gradual withdrawal of tax incentives for investing in the asset class.

Simply, the lack of capital is putting Ontario’s innovation at risk.  Without funding, there is an increasing and very real risk that Ontario will not be able to fully capitalize on and benefit from its multi-billion dollar investment in research and development.

We note that the federal government has already taken significant steps towards improving SMEs’ access to credit.  However, the fastest-growing, most export intensive Canadian SMEs are disproportionately backed by equity infusions from venture capital funds.  The current economic environment is depriving venture capital funds of their ability to raise capital, thereby robbing our most promising SMEs of the opportunity to grow.

A practical commercialization support program will ensure that more of Ontario’s enterprising companies are able to realize their full potential, which will help to strengthen Ontario’s competitiveness in the global, knowledge-based economy of the 21^st century.  The CVCA recommends the following initiatives: 

• Setting up a federal $300-million, third-party managed fund of funds similar to the fund recently-established by Ontario to help fuel the growth of vibrant, leading-edge companies;
• Doubling the size of the Ontario venture fund through a direct injection of $200 million in government funding;
• Improving the federal Scientific Research and Experimental Development program (SR&ED) so that for every $1 of approved claims,$1.50 is returned to the company, thereby stimulating its growth and development; Ontario’s support on this score would be welcome;
• Enabling greater use of government procurement/offsets to encourage domestic as well as foreign multinational investment in domestic venture capital funds; and
• Creating an incentive for large Ontario corporations to invest in domestic VC funds, where an investment in a VC fund would receive the same tax treatment that is currently available for in-house research and development.

 These measures would benefit Ontario’s technology firms as well as its venture capital funds in both the short and medium term and would improve our collective ability to achieve the longer-term innovation and productivity goals that are necessary to maintain the province’s competitiveness in the global economy.

Removing Remaining Obstacles to Foreign Investment

Foreign venture capital investment has historically been an important contributor to the success of emerging Canadian companies.   However, at the end of the fourth quarter of 2008, foreign venture capital investment in Canada fell 56% in 2008 relative to 2007, the lowest level in five years.  Moreover, this trend appears to be accelerating.

We encourage the government to examine ways to improve Ontario’s and Canada’s investment appeal.  The CVCA shares the analysis of the situation put forth by the recently-released federal Advisory Panel on Canada’s System of International Taxation, namely that the current Section 116 process “may negatively affect Canada’s ability to access foreign capital, particularly by private companies.” (p.91). The Advisory Panel’s Recommendation 7.4 that deals with this matter is, regrettably, insufficient to deal with the problems encountered by our members and by the foreign investors with whom they deal.

Canada currently defines taxable Canadian property to include shares of a private corporation resident in Canada.  At the same time, Canada’s tax treaties cede taxing jurisdiction to the country where the non-resident vendor is resident, provided the shares do not derive their value principally from real property.  Based on the large number of tax treaties Canada has concluded, it appears that Canada is prepared to exempt from taxation all gains realized by non-residents, other than the gains from the disposition of real property.

In light of this treaty policy, we believe that Canada should adopt a broader exemption in its domestic law to exempt gains realized by non-residents other than those arising from the disposition of real property.

We see little benefit in providing the exemption only on a bilateral basis.  The benefit of a broader exemption is that it would make Canada a more attractive destination for equity investments by non-residents and, in particular, venture capital and private equity funds.  A broader exemption would also reduce a significant compliance burden that acts as an impediment to foreign direct investment in Canada.  Unfortunately, recently enacted changes regarding the Section 116 clearance certificate process did not address the issue and are unlikely to reduce the number of situations involving arm’s length transactions in which clearance certificates are obtained.  We recommend amending the definition of taxable Canadian property so as not to include the shares of a private corporation resident in Canada other than when such shares derive their value principally from real property in Canada.

This proposed solution would put an end to the onerous Section 116 compliance requirements (except for real property), should not result in any significant tax revenue loss and would mirror the practices of most leading international jurisdictions.

We would strongly urge Ontario to continue to press the federal government to remove the Section 116 obstacles to foreign investment.

Encouraging Angel Investing

Although it is not within the CVCA’s mandate, we recognize the important role that Angel Investors play in our ecosystem.  Although the CVCA has not taken a formal position on the topic, I will note that one half of U.S. State governments have adopted some sort of “Angel Tax Credit” to stimulate the creation of start-ups.

In closing, the strength of our venture capital industry has a direct impact on Canada’s economic health as well as the financial well-being of millions of Ontarians.  At the CVCA, we take this responsibility very seriously. 

We would welcome the opportunity to meet with you to further discuss the opportunities and challenges that are outlined in this letter. I can be reached at 416-607-5150 while the CVCA’s Executive Director, Richard Rémillard, can be contacted at 613-744-8969.

Yours sincerely,

Gregory Smith

President

CVCA

http://www.cvca.ca

cc. Dwight Duncan

      Minister of Finance

     John Wilkinson

     Minister of Research and Innovation

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By Gilles Duruflé

CVCA has just released its comprehensive study on the impact of venture capital in Canada on economy, jobs and innovation.

The report (i) explains what venture capital is and how it adds values, (ii) describes how the Canadian venture capital industry developed compared to the US industry and how it differs from the US, (iii) measures its impact on the Canadian economy in terms of jobs, economic growth, innovation and exports, (iv) through various success stories, illustrates its long term “snowball effect” generating a pool of business angels, entrepreneurs and managerial talent which benefit the next generation of technology start-ups and, finally, (v) underlines the present contraction of the Canadian venture capital industry and its growing gap with the US industry which is a major threat for the Canadian technology and innovation ecosystem.

Here are the major findings

Between 1996 and 2007, Venture Capital investors financed 2,175 technology companies in Canada. 1,740 of those are operating in Canada in 2008. In addition, prior to 1996, it financed 15 companies that are still operating and have sales larger than $ 50 million in 2008.

On average these 1,755 companies have sales of $ 10.5 million and employment of 47 direct jobs. They are a mix of small, medium and large companies.

In aggregate, they generate sales of $ 18.5 billion:

• $ 15.4 billion in ICT,
• $ 1.9 billion in Life Sciences,
• $ 1.0 billion in Other Technologies.

They employ 63,955 people in Canada and 17,760 abroad.

In addition, they generate 83,549 indirect jobs in Canada for a total of 147,504 direct and indirect jobs generated in Canada which represents 1.3% of all private sector employees in Canada. Indirect jobs are jobs generated in other companies through the purchase of goods and services from these companies. They are calculated on the base of industry-weighted employment multipliers provided by Statistics Canada.

The 51,050 direct jobs in Canada in ICT venture capital-backed companies represent 8% of the total sector employment and the 5,069 direct jobs in venture capital-backed Biotechnology companies represent 34% of total employment in that sector (graph 12).

Gross domestic product (GDP) is the measure of total value created in the country during one year. In 2007, the contribution of venture capital-backed companies to the Canadian GDP was    $ 14.5 billion, 0.94% of total GDP: 0.54 % directly through compensation, profits and taxes paid by these companies and 0.40% indirectly through the activity generated in other companies and sectors in Canada due to the goods and services bought by these companies.

The impact of venture capital-backed companies on the Canadian economy is however quite significant: 150,000 jobs (1.3% of all private sector employees) and nearly 1% of GDP. The impact on growth is also important, since venture capital-backed companies which responded to the survey grow more than 5 times faster than the overall economy. Moreover, their impact on innovation (R&D and patents) and exports is very substantial.

There are additional major benefits beyond these economic measures. (i) Successful venture capital-backed companies generate wealth and talent which are reinvested in the next generation of technology start-ups; (ii) they create serial entrepreneurs; (iii) they allow investments by business angels, and (iv) they provide a source of experienced management talent. Alongside business angels, venture capital funds play a critical role in linking these pools of wealth and talent to new start-up companies. This is what we call the “snowball effect” and it is illustrated by the success stories of Q9 Networks, Axcan Pharma, Taleo, Creo and ALI technologies.

But the report makes clear that the picture is not all rosy.  While we know that Canada’s venture capital sector is younger than its American equivalent, the figures in this report demonstrate that venture capital investment in Canada has declined relative to foreign markets. 

In the period from 2003 to the third quarter of 2008, relative to the size of the economy, the investment pace in Canada has been 60% of what it was in the US and the gap is widening.  Between 2003 and the first 3 quarters of 2008:

• Venture capital investment in the US increased by 17%, from 0.18% to 0.21% of GDP
• Venture Capital investment in Canada meanwhile decreased by 35%, from 0.13% to 0.085% of GDP and investment by Canadian funds in Canada from 0.10% to 0.06% of GDP

This decline in investment is strongly related to the decline in fund raising by the industry.

Given the importance of venture capital’s impact on innovation and on the overall economy, the report concludes on a call to all parties – governments, investors, venture capital funds and entrepreneurs – to work together to build a strong, permanent, Canadian venture capital industry.

Link to full report ENGLISH FRENCH

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Original post on 9 February, 2009

http://blog.techcapital.com/2009/02/09/entrepreneurs-persistence-and-impact-on-the-economy/

By Jacqui Murphy

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Posted on 28 January, 2009

By Editor

CVCA – Canada’s Venture Capital and Private Equity Association is disappointed at the absence of measures in the Canadian federal budget to improve access to venture capital for Canada’s most promising growth companies.

“We commend the budget’s inclusion of “shovel-in-the-ground” infrastructure projects and the allocation of new funding for innovation within Canada’s educational institutions, which will help to stimulate the economy and support long-term growth,” said Gregory Smith, President of the CVCA and President of Macquarie Capital Funds Canada Ltd. “Unfortunately, the budget has failed to address the current shortage of venture capital financing, which presents a significant challenge to near-term job creation and to Canada’s future prosperity in the important knowledge-based economy.”

Canada’s venture capital sector fosters emerging companies in the life sciences, high-tech, biotech and clean tech industries. Canadian companies backed by venture capital generate sales of $18.3 billion and directly and indirectly employ almost 148,000 Canadians. But venture capital investment and fundraising levels have been declining for years and are now reaching critical lows. In the fourth quarter of 2008, venture capital investment was down 40% from the same period in 2007.

Further, there are increasingly fewer foreign investors coming into Canada. A key obstacle is that Canada’s international tax system deters foreign investors, thereby putting the country at a disadvantage. The budget notably failed to address Section 116, which has long been acknowledged as detrimental to foreign investment.

For venture capital-backed companies, the diminishing availability of capital means that they do not have the resources to commercialize their innovative technologies and products.

“Helping companies to successfully commercialize Canadian research is essential to job creation and economic renewal and to enhancing Canada’s place within the global, knowledge-based economy,” continued Mr. Smith. “Canada needs to follow the lead of other countries that have recently taken steps to address the critical role played by venture capital. The government has missed an important opportunity to ensure a vibrant venture capital industry and new investment in innovation at a time when our country needs it the most.”

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