Let's not declare victory just yet

“There’ll be laughin’ and singin’ and music swingin’, And dancin’ in the streets”
— Martha and The Vandellas

The thing about this new world is that there are often no secrets in Ottawa, even at Budget time, provided you listen carefully to what people are saying. Federal Finance Minister Jim Flaherty made good on his musings over the past few weeks, and once again announced that Section 116 of the Tax Act would be (had been) revised to make it easier for U.S. venture capital firms to invest in Canadian early stage tech and biotech companies.

For the past several years, a series of CVCA Presidents (Smith and Nathan), CVCA’s ED Richard Remillard, not to mention lawyers such as Boston’s Steve Hurwitz and Star Accountant / Advisor John Ruffolo, have knocked on every useful political door in Ottawa, Montreal and Toronto to make a simple point: it is insane to have 700 individual limited partners in a large U.S. V.C. fund fill out tax forms on a Canadian deal that requires them to pay no tax in any event.

The lobbying was so successful that when the CVCA would go to Ottawa to talk about our the CVCA’s Commercialization Support Program, officials and politicians would reply: yea, and of course we’ve heard about Section 116. “That must be really hurting the industry.”

Well, sort of.

In 2007, Venture Capital investments amounted to $2.1 billion, of which 41% came from US VC funds. In 2009, VC invested in Canada amounted to $1.0 billion, of which around 20% came from US VC funds.

So, in 2007, almost half of Canada’s VC money came from the U.S., despite the “wall” created by Section 116. Obviously, some U.S. VCs refused to do business up here as a result of the hassle. And that may well have reduced the amount of capital drawn by Canadian Entrepreneurs that year.

According to one American panelist at the Southeast Venture Conference last week in Virginia, up to two-thirds of existing U.S. venture capital funds won’t be in business in five years. Similar predictions have been made by U.S. limited partners in one 2009 Pension Industry magazine. The factors? Combination of allocation reductions, generational change, and poor returns in some quarters. The wizards at peHub have a particular name for a subset of those firms: they call them “Ghost Ships”. Website is still up and running, but no new investments are being made.

In a ’round about way, the point I’m trying to make is that making cross-border investing easier is an important opportunity for Canadian entrepreneurs, but most U.S. VC funds that we’ve met (over the past 8 months of weekly trips south) aren’t looking for Seed or Series A stage deals in Canada.

Frankly, many U.S. V.C. firms aren’t even looking for very early stage deals in their own geographic backyards. The last 48 months has taught them to look at “later stage deals”, whatever that might mean to an individual firm. It is definitely not a trend which is going to save Canada’s early stage tech sector.

So, the hard working people that ensured that Section 116 was mentioned in yesterday’s budget should be justfiably pleased with the success.

However, the underlying reasons why the industry is in crisis still exist today. Let’s not declare victory just yet.

MRM