Labour Fund Renaissance
You have to hand it to the folks who drowned the Ontario labour-sponsored fund industry a couple of years ago; the Dalton McGuinty announcement that the tax rebate would be phased out signalled the end of the sector. A few cogent arguments, although specious, carried the day with the provincial mandarins. The story went something like this:
– labour-sponsored funds have a lower cost of capital as a result of the 30% tax credit, which is distorting the market and driving up valuations at the expense of the traditional venture capital firms;
– the fee structure is too expensive for retail investors;
– the pacing rules force the labour sponsored firms to put money out, even when there aren’t any quality deals to be had;
– the presence of labour-sponsored funds is crowding out the creation of larger and more robust pension fund-backed venture capital firms; shut these labour guys down and the pension funds will get off the sidelines and pour money into the VC general partners to fill in the gap; and
– the returns to retail investors are horrible (due to high fees, pacing and too many dumb investments).
A couple of year later, what have we learned?
1. Despite the promises, there has been no rush to invest in the tech and biotech VCs on the part of pension funds and/or life insurance companies; only a handful are interested in the space. And the funds of funds groups appear so down on domestic tech that they are investing $ in oil and gas equity funds and calling it “venture capital”. Only EDC and BDC have stepped up as major new players across the country, and that probably had nothing to do with what happened to the Labour guys.
2. The amount of capital available to early stage tech and biotech firms in Canada has shrunk, as several GPs appear to be going out of business and the ones who’ve had success in raising new funds will have a hard time making up for all of the firms that are now either at the end of their life or appear unable to raise new funds (JLA Ventures, Ventures West, MSBI, Propulsion Ventures, Priveq, Tech Capital Partners and Garage Canada all come to mind as examples of GPs that did well in their most recent raises).
3. Labour funds can, in fact, make investors money. About a year ago, I bought a Venturelink fund (they are an investor in our Fund btw). Just checked my monthly RRSP statement, and I’m up about 7.5% before taking the tax deduction into account. And VentureLink just announced that they have crystalized their investment in Stone & Co.; on the heels of their success with Coventree last Fall. And the VenGrowth fellows have had some successes in 2006 as well (Travellers Leasing, Quake, HED, etc.).
Hmmm.
Had I invested that money a year ago in the Yellow Pages Income Fund, for example, I’d be down over 20% (before distributions of about 8%?). But that’s not fair given the proposed tax changes.
Petro-Canada? Down over 12% before dividends; oil is “just” $55/barrel.
Celestica? Down 30%. And we are only in the 10th (?) year of an expanding world economy.
General Electric? Up about 8% (before 2.6% yield). But, that’s only one of the most successful conglomerates in the world.
Wal-Mart? Up about 2% before the small dividend. But they’re just the largest retailer in the world.
Loblaws? Down ~14% before the 1.7% dividend, and they’re the best retailer in Canada.
Barrick? 0% return before a 0.7% dividend, and Gold is at US$612.
There were lots of places for investors to make money last year, but perhaps its time the pounding on the entire Ontario labour sponsored fund industry came to an end. Most brokers would’ve bet their year’s commission that almost every one of the above household names would surpass the return of a labour-sponsor fund.
It might be time for retail advisors and the Ontario Liberals to have another look.
MRM
IT IS A GOOD PROGRAM, BUT IT NEEDS A MAKEOVER BEFORE THE RENAISANCE CAN OCCUR
Now here’s a hot button issue! I’ll get the ball rolling because I know more of you have intelligent things to say about LSIFs. And up front, thanks for the honorable mentions.
It is interesting how at the federal level the government uses concerns about lack of investment in research and innovation to tax income trust distributions while at the provincial it is cutting programs that result in hundreds of millions of dollars being directly invested in the Ontario technology sector. But hey, there is now the $36M provincial research and innovation fund! Not quite enough to replace 35+ % of the Ontario VC industry we are talking about.
First, I just want to highlight the characteristics of LSIFs.
1) They are still eligible for a 15% federal tax credit and are still eligible for a 15%-20% credit until 2008 taxation year in Ontario, up to a maximum investment of $5,000. Savings = up to $1,500. The Ontario credit will be phased out by 2010.
2) They are still eligible for a regular RRSP deduction (and RRIF for non-registered) which could be worth almost 50% of your investment (depending upon your tax bracket). Savings = up to $2,500.
3) Typically 8 year hold period to be eligible for the tax credit.
4) Typically higher management fees then you would see in a public equity mutual fund or institutionally backed venture fund.
So is, let’s call it, Retail Venture Capital dead in Ontario? Not yet… But there are a few important things that need to happen before RVC can be revitalised.
1) Retail investors need to educate themselves;
2) Financial Advisors need to maintain high ethical standards, not breach any conflicts of interest and make sure their clients know what they are getting themselves into;
3) Returns in Canadian VC need to improve across the board – that would also fix the “pension funds and/or life insurance companies” issue referred to above; and
4) The Province’s need to get on the same page.
Here is some interesting info from a study conducted well before the decision to cut the program was made, lest we forget that what we are talking about is important to the welfare of Canadians:
The study, conducted by Don Allen of Regional Data Corp., looked at the files of 185 firms that received funding up to 2001 from labour-sponsored investment funds, comparing growth patterns before and after LSIF-financing.
“This study proves that anyone who thinks government policies don’t create jobs and growth should think twice,” says Dale Patterson, executive director of the association.
“By giving Ontarians tax incentives to invest in labour-sponsored investment funds, Ottawa and Queen’s Park have made a huge impact on our economy, and these incentives are more than paying for themselves.”
Among the findings:
• Ontario’s GDP is $2.3 billion larger than it would have been without LSIFs. At the national level, the positive impact on GDP is $2.6 billion.
• LSIF funding has created 27,000 jobs in Ontario; without LSIFs, the province’s unemployment rate would have been 0.3% higher in 2002.
• The payback to the government in terms of tax revenue has been swift
and substantial. For example, in 2002 alone, the provincial tax revenue attributable to LSIF investments was $357 million – a number that far exceeds the cost of the tax credits.
• LSIF financing has had a catalytic impact on the growth of small- and medium-sized businesses. One-third of LSIF investments have gone to start-up firms – a group that has great difficulty in finding venture capital.
• Export growth from companies receiving LSIF funding has been sensational. Before LSIF financing, these companies exported $515 million and by the year 2002, this total quadrupled to $2 billion.
• 48% of LSIF investors have incomes below $60,000. LSIFs have made
private equity and venture capital investing available to middle-income Ontarians for the first time, giving them an additional, affordable choice for their retirement investments.
The association represents all LSIFs in Ontario. Its member funds have more than 437,000 shareholders and manage $2.9 billion in assets in more than 600 Canadian companies.
Please excuse any dated information.