Seven years ago, there was a lot of hand-wringing over Ontario’s heavily service-based economy and the “innovation gap.”
In the flush of promise-making that preceded the 2011 provincial elections, the Ontario Liberal party pledged a tax credit to investors in homegrown tech startups. The details were vague, but the general idea was that investors would receive a 35-per-cent tax credit on eligible startup investments – or something to that effect. It doesn’t matter, because nothing came of the promise and, in 2018, it would appear that closing the innovation gap is no longer de rigueur in Ontario politics.
And that’s a problem for a few reasons. The usual metaphor for a concentrated brew of new ideas, government incentives, talent and capital in a single geographic locale is a “startup ecosystem.” If startup companies are the striving organisms of the ecosystem, then angel investors and the risk capital they provide are its oxygen. It’s well-known that an ecosystem deprived of oxygen cannot thrive.
Incentivizing angel investors with tax breaks is neither a novel idea nor an unusual one. Ontario continues to lag the usual suspects – the United States and Britainhave aggressive tax-relief strategies for seed-stage investors. What’s new is that Ontario now trails Saskatchewan on this front. In April, Saskatchewan introduced the Saskatchewan Technology Start-up Incentive (STSI), which will provide investors with up to a 45 per cent non-refundable tax credit for individual and corporate equity investments (capped at a maximum annual benefit of $140,000 an investor). If you’re a tax-efficient investor in startups, go West. Or go East: all four Atlantic provinces offer similar tax incentives to qualified angel investors with New Brunswick’s the most generous, at a 50-per-cent return on investments up to $250,000. Just don’t stay in Ontario.
If you accept that incentivizing innovation is good public policy – and the data makes it hard to disagree – then initiatives such as the STSI cannot be disdained as mere tax cuts for the rich. Angel investors play a crucial role in the virtuous cycle of innovation. A 2015 PricewaterhouseCoopers study found that nearly 75 per cent of successfully funded startups in Canada obtained their critical first half-million dollars or less from angel investors, family or friends. Moreover, the most sought-after angel investors provide value beyond money, including operational expertise, business acumen and a supportive network.
Canadian venture capitalist firms and foundations were also cited as key funding sources, but to the surprise of no one who has ever tried to start a small-to-medium enterprise in Ontario, banks were not. Fortune may favour the bold, as the Latin proverb goes, but innovation is risky and the big six Canadian banks don’t take risks; they take user fees. So until the banks get bolder, angel investors will remain the main purveyors of risk capital.
The PricewaterhouseCoopers study also found that 44 per cent of Canadian startups turn to U.S. venture capitalists for funding. This is hardly surprising and a sensible route in many cases, but it’s also a bit of a shame. Herein lies the other problem with the laissez-faire approach to private risk capital: While there are precious few incentives for investors who fund risky tech startups, there are excellent incentives for research and development. Indeed, the federally administered Scientific Research and Experimental Development program (SR&ED), which Ontario further sweetens with a tax credit, is considered one of the richest research incentive programs in the world. In other words: We are overachieving at encouraging R&D, but underachieving at extracting much economic benefit from it.
It’s consistent with the general theme of innovation in Canada. An April report by the Council of Canadian Academies (CCA) states plainly that: “Although Canada is a highly innovative country, with a robust research base and thriving communities of technology start-ups, significant barriers … often prevent the translation of innovation into wealth creation. The result is a deficit of technology companies growing to scale in Canada, and a loss of associated economic and social benefits.”
Of course, a shift in Ontario tax policy would remove only one such barrier. But it’s worth noting that in the mining and minerals sector, something akin to a startup ecosystem is flourishing. Indeed, Toronto venture capitalist and Dragons’ Den star Bruce Croxon observed in an interview with Media Planet that “Canada is the most efficient risk capital market in the world for energy and mineral companies. The TSX has proven it can attract huge sums of risk capital.” Undoubtedly the reasons for this success are myriad, but it’s hard to dispute that tax incentives in the mining sector are much more evenly dispersed than those in the tech sector. (For example, on the development and exploration side, companies may claim a 5 per cent Ontario tax credit on top of the 15 per cent federal Mineral Exploration Tax Credit; on the investor side, there are schemes such as flow-through shares.)
The CCA report also quips that “Canada has much to be proud of, with world-class researchers in many domains of knowledge, but the rest of the world is not standing still.” Neither are tax codes (congratulations, Saskatchewan!). Ontario politicians, please take note.
Monika Yazdanian is the director of The Forge, the startup incubator for McMaster University and Hamilton region.