FINANCE
Finance is the lifeblood of any enterprise, and in our roundtables we heard of the problems that innovative firms face and of some of the constructive measures the public and private sectors are taking to improve Canada's capital markets. The process of bringing new ideas to market presents more difficult problems for financial institutions than financing an ongoing operation. The newness of the product means that the financial institution has to deal with both a higher risk and a higher degree of uncertainty about what the risk is.
It is very difficult to convince a potential investor to risk investing in a small start-up technology company when that investor can earn significant return in purchasing common shares of banks for example as well as a number of others.
We were told "Canada is awash in capital" by Susan Smith of the Royal Bank, but the problem is one of gaps, because our financial institutions find it difficults to finance firms at certain stages of their growth.
[T]here are billions of dollars in uninvested capital in this country. On the other side, there is first-class commercializable science and technology in Canada that is not able to attract that financing. The gap is therefore in attracting the financing to early stage endeavours. Most of funding. . . is attracted to later-stage enterprises where the risks are lower, the due diligence costs are no longer higher, and there is a relatively good supply of investment opportunities in this country.
The real gap in Canada comes in what I call the ability to create. . . and build the kinds of companies which will attract the available capital at earlier stages. I truly believe that we have to develop this capability or we're going to start to lose our science and technology to countries that have a very good capability and commercialization, and who will then sell us the resulting value-added products.
A venture capital firm, specializing in emerging high-technology firms, pointed out:
[V]ery little of that flow of capital is directed towards emerging technology companies. We try everyday to find co-investors to share the risk associated with that kind of investment. Believe me, this is not obvious. With the kind of profile I drew a few moments, who would like to risk large amounts of capital in such an undertaking?
There was some doubt about whether the financial institutions could make an impact on this problem, which meant that some further tax relief would be needed.
Some of the banks have recently announced initiatives to address this start-up sector, but in my opinion it is still too early to tell what impact these will have.
An alternative that the government might want to consider would be some type of preferential capital gains tax rate for this type of investment. Clearly this type of program would have to be under very restrictive parameters to ensure that the cost does not get out of hand. These costs would be somewhat deferred, since the expectation of this type of investment is that liquidity can be achieved somewhere between five and ten years from the date of investment.
The Canada Business Development Bank described to the Committee its new program to fill gaps left by the private sector. This Crown corporation is targeting small and medium high-technology companies with new financing products.
[A] gap exists in the way the markets work and actually matching up the amount of investment. . . and getting it to the businesses. . . [W]hen companies have well established product, well established markets, known technologies and traditional assets, they tend to find their capital and their financing solutions in conventional sources.
The charter banks have very strong networks to provide term loans and operating credits. Generally, the more well versed the company is in its technology, the easier the job is to find its financing.
As companies develop new solutions and have unproven markets with unconventional assets entered into the mix, you see companies trending away from the traditional term lending sources to companies like [the Capital Alliance Ventures Inc.] that are providing higher risk venture capital.
So what emerges is in between. On one hand we have the conventional sources of capital. On the other hand we have higher-risk venture capital. In the middle are a large number of very successful businesses that, for whatever reason, whether it's the stage of the development, the type of assets they have, or perhaps, even the amount of money that they require, don't have a foot solidly in either camp. Our bank is trying to develop a range of development capital that combines both the features of debt financing and equity financing to try and bring the features of both those into the small and medium-sized business market.
Efforts to address these and other financing gaps have led to the creation of venture capital funds. Some funds have focused on financing gaps especially important in science and technology sectors. One such fund was created by a prominent Canadian medical scientist to exploit the world-class research from the Medical Research Council (MRC).
Venture capital investments in life sciences doubled between 1994 and 1995, it looks like they're going to double again.
That's the critical point that's been made by virtually everybody here. That source of capital at the point of transfer fundamental discoveries out into products that are going to have economic benefit has been missing in Canada. My suggestion is to you that. . . through an important linkage of partnership through the MRC and through your provision of the tax inducement for the Canadian Medical Discovery Fund. . .
We heard that there may be deeper institutional and cultural reasons why financing high-tech companies is difficult in Canada.
[O]ur star entrepreneurs do not get the same attention as do their counterparts in the U.S. The consequences of this relative lack of knowledge are twofold.
First, the performance of the Canadian stock markets regarding technology stocks is an indication of the lack of understanding of the Canadian public in general. We must do something to create and stimulate the growth of the Canadian stock market. We cannot much longer afford the luxury of seeing our star companies listed only on NASDAQ to get a fair market value.
Secondly, the Canadian pension funds in general do not invest as much as their American counterparts in the high-technology sectors. There was a time when virtually no vehicles were offered to the pension fund manager to funnel these investments other than the direct approach, which is not practical for large funds like these. But the situation has evolved and the statistics show that Canadian venture capital firms have evolved and managers of those funds are more and more able to perform in the high-tech investment sector.
In closing, I would recommend that the venture capital industry, the government, and the pension fund managers work together to find a scenario in which the available capital can be directed efficiently to nurture the creation and the growth of emerging Canadian high-technology companies.
The Committee was told repeatedly that the R&D tax credit was seen as very necessary for Canadian high-tech industry. However, witnesses were concerned about the administration of the tax credit by Revenue Canada.
[T]he government should continue its participation in the investment tax credit [ITC], for scientific research and experimental development. These tax credits continue to play a very important role for all knowledge-based companies. This is especially true for companies at both ends of the development spectrum, the young Canadian technology company and at the other end the multinational one that does research and development in a number of countries.
The one possible cloud in the horizon for ITCs is the tendency by Revenue Canada to reject larger and larger portions of claims. This is being done through administrative measures, and it means that activities which were eligible for investment tax credits in previous years are no longer considered eligible. This has the impact of increasing uncertainty on the collectability of ITCs and thus reducing their value to the companies.
A number of witnesses pointed out that tax treatment of R&D in Canada is more favourable to that in most competitive countries.
Canada's R&D tax treatment is very attractive by international standards. The study shows that Canada's federal government incentives in combination with the two provinces that we have examined, Quebec and Ontario, give the second most favourable tax treatment in the OECD.