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Meaningless Paperwork Is Destroying Canada’s VC Industry
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Meaningless paperwork is destroying Canada’s venture capital industry, and if our northern neighbor ever wants significant US venture capital to flow north, they’ll listen when I tell them to eliminate Section 116 certificates immediately. Currently, when a U.S. venture firm sells shares in a private Canadian company, it must file for a Section 116 certificate, which requires the signatures of a fund’s entire limited partner base. It can take up to eight months to receive the certificate, and during that time, 25 percent of a transaction’s gross proceeds are held in escrow. Each U.S. investor must also file Canadian tax returns even though tax is rarely if ever due in Canada. Indeed, Section 116 certificates are not only a major hassle for U.S. investors – they’re also revenue neutral for the Canadian government. The net result of this obstructionist tax law is that many U.S. investors avoid investing in Canadian companies altogether. Firms like mine, which pursue the highest quality Canadian deals, must create an exchangeable share structure in which we invest in a Delaware Corporation that acts as the parent of the Canadian investment. This expensive workaround costs us dearly, and nothing gets me angrier than when I put money in my lawyers’ pockets instead of my companies’ coffers. Think I’m exaggerating? GrandBanks Capital’s latest Canadian deal, a $7.5 million Series B financing, will eventually make us a lot of money – but it already made our lawyers rich. The company and investor counsel legal bills totaled over $300,000. It’s hard for U.S. venture capitalists to justify making Canadian investments when meaningless paperwork wipes out over 4% of our capital. At GrandBanks Capital, we’re not afraid of Canada – in fact; we’ve invested in four excellent Canadian companies that have $120 million in paid in capital. But think of how much more capital U.S. investors would put into Canada if it weren’t so damn expensive. I agree 100% with Stephen Hurwitz, Co-Founder of the North American Venture Capital Summit and a Partner at Choate Hall & Stewart, when he told Canada’s The Globe and Mail newspaper, “Right now the government is presiding over the slow strangulation of this industry.” And although I’ve personally relayed very similar messages to Quebec Premier Jean Charest and Ontario Premier Dalton McGuinty during their trips to Boston, I’m still waiting for them to address the problem that they have created. While my heart goes out to paperwork processing Canadian bureaucrats, my brain tells me that firing them is necessary. For Canada’s venture capital industry to survive and for entrepreneurial innovation to thrive, the Parliament must eliminate Section 116 certificates, and allow us to invest in the creation of GNP behind talented Canadian entrepreneurs and not to further the pocket books of their lawyer cronies.
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November 6th, 2007 at 8:23 am
[...] 2. GrandBanks founder Charley Lax yesterday wrote about how Canadian regulations make it particularly costly to invest in Canadian companies. For example, he said that the company and investor counsel bills for the Xcoto deal came to over $300,000: “It’s hard for U.S. venture capitalists to justify making Canadian investments when meaningless paperwork wipes out over 4% of our capital.” [...]
November 6th, 2007 at 4:56 pm
Charley:
Well, if you told the PM in no uncertain terms that Canadian companies are losing US investment dollars due to the red-tape factor and sky-high legal costs, maybe he knows something we don’t. With the US dollar losing so much value recently, maybe our Maple Leaf neighbors are in the market for some yen?
I cross-posted on your piece to http://blog.innovators-network.org The Innovators Network is a non-profit dedicated to bringing technology to startups, small businesses, non-profits, venture capitalists and intellectual property experts. Please visit us and help grow our community!
Best wishes for continued success,
Anthony Kuhn
Innovators Network
November 7th, 2007 at 8:46 am
Charlie:
You are spot on with your criticism of Sec 116.
Here’s a twist you might like.
As you know, we are a Canadian fund in the sustainable energy space. I’ve been in the VC business for more than 35 years, always working from canada.
There’s another Canadian rule which requires that every Limited Partner of a Canadian limited partnership must be a tax-paying Canadian entity (the pension funds must submit tax returns; then they are exempted from actually paying anything)
So, when we raised Chrysalix II, we had US and other tax-exempts become LPs.
In order to satisfy the above “LP rule” we registered the head office in the US.
Now, however, that US partnership has to abide by the rules of section 116.
So, here we are in Canada, raising foreign capital, hamstrung from INVESTING IN OUR OWN COUNTRY!
This almost unbelievable stupidity is indeed costing Canada a great deal, but the mandarins are obdurate. They really ought to be replaced.
We have had Ministers promise to remove the blockages, but Canadian officials insist on acting as if ignorance is to be rewarded. If this were the worst stupidity they inflict upon us, then maybe you’d have a case.
But, believe me, it isn’t.
Canada is a great place to live, but a dreadful place to work.
You can quote me on that!!!
Best regards
Mike Brown
November 18th, 2009 at 10:01 pm
@Charlie and @Mike Brown: Can someone articulate the rationale for protecting the status quo? Apart from preventing chance who benefits from Section 116 as it stands? I’ve even had lawyers tell me it was bad policy - so that tells me something.
Who are the apparatchiks that are holding on but could remove the blockages? I doubt Charest and/or McGuinty are it.