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.