Budget stock option changes raise ire

If you know Vancouver’s Jim Fletcher, he gets into the detail of topics and isn’t afraid of speaking his mind. For that, and other reasons, he’s very popular in these quarters. When Jim’s not a partner at Chrysalix Energy Venture Capital, he serves as Chair of Vision Critical Communications Inc., a Wellington Financial Fund III portfolio company.

An announcement in the recent federal budget has caught his eye, and it may well negatively affect every high quality private tech company that’s on the list of near term initial public offerings. As if Canada’s VC community didn’t have enough to worry about! The only way the existing domestic industry has a chance of surviving is if it gets some public exits, and this new budget rule appears to be causing some of Canada’s brightest tech stars to reconsider their plans to go public. Even if things are only delayed a year, that has a meaningful impact on IRRs, which is one of the key metrics that pension funds apply when considering an investment in XYZ venture capital fund.

Jim wrote an op-ed piece in the Vancouver Sun, which you can read here:

But a little-noticed provision in Budget 2010 overwhelms the benefits of eliminating Section 116 taxes. Budget 2010 proposes to instantaneously tax any employee who exercises stock options — at the moment of exercise — and to require the employer to “withhold” the associated taxes, even though the employer has no direct funds to withhold or pay such taxes — all of which are being levied on “deemed” — but unrealized — income. There is no cash being received anywhere in the process of exercising options, but a whopping tax bill is being levied on the “nothing.”

This comes as definitely bad news for several leading Canadian underwriters and investors, who may have been planning for a big tech IPO later this year. The big loser may actually be the TSX, as some companies may now wait to go public until they attract the attention of the NASDAQ, instead of doing the two-step IPO approach that worked for Ottawa’s Dragonwave, for example. This is also from Jim’s op-ed:

As an illustration of the dire consequences of the proposed new changes in stock option taxation, we have had to halt the IPO process for a very successful Canadian technology company. Under the proposed new rules, if all 300-plus employees exercised all of their vested options at once, post-IPO, the company would have an immediate withholding tax liability of about $20 million. This is a new, open-ended and completely uncontrollable contingent liability. If we happened to get “irrationally exuberant” technology markets again, the liability could be multiples of $20 million.

Hopefully the Canadian Venture Capital & Private Equity Association will pick up the cause, and Minister Flaherty will fix this before the budget becomes law.

MRM
(disclosure – although I am a Director of the CVCA, these views are my own)