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A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
September 9th, 2005

By Brent Holliday
Greenstone Venture Partners


A House Of Cards


“And now the end has come,

You're feeling really dumb,

But you deserve it,

You had no choice.

It falls apart,

In little pieces on the floor…” – Odds, It Falls Apart

Tongues are wagging across Canada in the venture capital business.  In fact, the tongues have never had more to wag about…

Exhibit A - An earthquake hit the LSIFs (labour-sponsored investment funds) in Ontario on August 29th, when Greg Sorbara, finance minister of Ontario, sent out a quiet press release that said that there would be no more provincial tax credit after February 2006.  The aftershocks are still being felt in Quebec, Manitoba and BC, where great gobs of early stage capital rely on the provincial and federal tax credit equally to offer to investors (15% each for a total of 30%).  No one saw this coming and no one knows what happens next, but it is safe to say some in the business are in complete shock.

Exhibit B – MDS Capital, the nation’s largest biotech investor by a country mile, released its top staff and instructed a new President to re-structure and sell the investment company with cash and assets of roughly $1B as soon as possible. 

This one-two punch happened within three days of one another, leaving the venture capital industry out of breath.  The change in the scenery will be dramatic, especially if the Ontario move is the first domino in the end of tax-assisted venture capital among the other provinces.  The key to that set of dominoes is the Federal government’s response.  Will they pull the tax credit for all provinces as well? 

There is a mess in Manitoba that raised an ugly stench for LSIFs.  The Crocus fund’s management company is facing lawsuits and jail time for fraudulently reporting the asset value of their companies and for ridiculous expenses amassed by overpaid investment managers.  This embarrassment for the industry was just leaving the page of the business sections when the new news hit.  The Crocus mess didn’t figure into Ontario’s decision, but the timing is amazing.

More importantly, for the first time in a long time, LSIFs did not raise their total allotments in the winter of 2005, including BC’s Working Opportunity Fund.  Consolidation was happening across Ontario where too many small funds had raised too little money to play the VC game effectively.  All of this is further ammunition that the tax credits have run their course of usefulness.  And Ontario was the first to pull the trigger while others had been merely musing about how to end the dependency on tax-assisted investment.

In Quebec, they are re-evaluating the original LSIF programs and looking at new ways to stimulate investment at the early stage. In some ways, insiders tell me, this is where the Feds will watch for guidance on their portion of the tax credit for LSIFs.  If Quebec screams for it to remain, the political card of appeasing Quebec in a minority government might mean that the federal portion remains and Ontario investors get 15% tax credit, while BC remains at 30%.  If Quebec is looking at other stimulative measures for investment capital and they don’t raise hell, the Feds may pull the plug completely.

Let’s say for a minute, that the federal tax credit is gone.  Then assume that BC decides it is not footing the tax credit by itself and stops its multiple programs of LSIF credits, VCC (venture capital company) fund credits and ECP (equity capital program) credits for angels.  What would happen here?

Well, Growthworks would still have lots of money and assets and would have to go to the institutions (pension funds etc.) to try and raise more money based largely on track record, just like the rest of us in the VC community.  Smaller VCC funds raised in the past few years would have less resources, a shorter, unrealized (haven’t exited the invested companies) track record and be in a worse position to raise money from similar sources.  However, the angel community would likely be unaffected.  The angel market is booming now in BC and more and more companies are getting funded at later and later stages and at larger amounts by angels.  The ECP program has something to do with that, but the reality is that the BC economy is on a roll and everyone from the cranberry farmer to the dentist to the commodity (mining, lumber, oil & gas) executive is looking to place risk capital.  Examples of successes for angels like Flickr, ID Biomedical and Schemasoft are the cocktail party talk of the town.  Even without the tax credit, the angel market is healthy and will be for the near future.

But the fallout would be felt at the later stage, where the venture industry is needed.  The down side of a tax credit wipeout and a subsequent struggle to raise money by the affected parties means tougher times for local companies to get the larger (>$3-5M) rounds together.  This would be bad for the entrepreneurs.  Hopefully the frothy US venture industry would pick up some of the slack, but early stage VC is a local business and the “touch” aspect of investing and growing a technology company is important.  Losing the LSIF component would be a huge blow to the industry if it happened in an instant.

The amplification of problems in the life sciences sector would be if MDS Capital moves to the US and pays less attention to the Canadian market.  This would further dampen the later stage for this sector, even though money travels further for research stage life sciences companies than it does for pre-revenue IT companies.  By the way, the largest part of MDS Capital’s pool of money and assets comes from its tax-assisted LSIFs based in Ontario.  And a lot of tax assisted dollars fund biotech coast to coast.

These are nervous days for the LSIFs, without a doubt.  But the complete removal of tax assisted venture capital in Canada overnight is unlikely.  It is more likely that Mr. Sorbara and the crew in Ontario have started a period of introspection for the venture industry.  As I have said in this space before, the technology formation and commercialization business in Canada is in adolescence compared to our brothers down south.  The feds and provinces now have to sit and think how best to grow and support a knowledge based economy in Canada as it takes the next step.  It will be interesting times for the next few months and years.

In the meantime, while tongues wag among the VCs, entrepreneurs need to look at all sources of investment dollars in their plans for growth. If the current status quo in Canada gets shifted and dollars dry up for some period, the smart companies will have a back-up plan.

What Do You Think? Talk Back To Brent Holliday


Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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