Thumbs down on vencap credit

The federal Liberal government’s promise to reinstate the federal labour-sponsored venture-capital corporation (LSVCC) tax credit program may be misguided from a policy perspective, and is unlikely to reignite widespread interest in LSVCC funds, say several economists and financial services industry insiders.

“Their performance was terrible,” says Dan Hallett, vice president and principal of HighView Financial Group of Oakville, Ont., who at one time recommended LSVCC funds to some of his clients during these funds’ heyday 15 years ago. “I don’t think there’s any other way to characterize it.”

Says Lindsay Tedds, associate professor in the school of public administration at the University of Victoria: “[LSVCCs’] rate of return [as a group] has been well below even that of safe assets. Is that the kind of vehicle we should be encouraging people to invest in?”

Ottawa has indicated that it intends to bring back the 15% federal tax credit for investments into LSVCC funds. The move reverses a decision made by the preceding Conservative government two years ago to phase out the tax credit, suggesting the program had been ineffective in stimulating the vencap industry.

LSVCC funds, sponsored by labour unions, are set up to invest in small- and medium-sized businesses. Investments made into an LSVCC fund are locked in for a given period – typically, eight years. Before the tax credit was phased out, the federal government offered a 15% tax credit on investments of up to $5,000 a year. Some provinces still offer a corresponding provincial credit, although Ontario, notably, eliminated its LSVCC credit completely in 2012.

LSVCC funds, which originated in Quebec in the 1980s, became popular across Canada in the 1990s, with investors attracted by the generous tax credits and healthy portfolio returns. However, the bottom fell out of the vencap market in the 2000s, and the funds were plagued by dismal returns and accusations of poor governance and high costs. In the mid-2000s, a scandal at Winnipeg-based Crocus Investment Fund, involving allegations of overinflated valuations of its holdings, led to the shuttering of that fund and souring of interest in the vencap industry overall.

One of the biggest issues with LSVCC funds, Hallett suggests, was that investors tended to underestimate their inherent risk. Then, “as tax credit support started getting pulled,” he says, “liquidity became the biggest risk” when new investment dried up.

However, the LSVCC concept remains popular in the province in which it started – most notably in the form of the Fonds de Solidarité FTQ, which held $11 billion in assets under management as of May 2015. This regional success is something the federal Liberals noted in their election campaign literature as an argument in favour of reinstating of the LSVCC tax credit.

Indeed, Rick Robertson, associate professor with the Richard Ivey School of Business at the University of Western Ontario in London, Ont., suggests that the calculus of election campaigning had more to do with the Liberal decision than did the arithmetic of tax policy.

“I find it hard to believe that [re-instating the LSVCC tax credit] was considered to be wonderful tax policy,” says Robertson. “It was a political decision.”

However, the vencap industry group believes that reinstating the federal LSVCC tax credit would be a positive development for the industry, which had been hurt by the federal credit being phased out.

“The tax credits really helped push us forward,” says Mike Woollatt, CEO of the Canadian Venture Capital and Private Equity Association in Toronto, “and when they went away, there was a noticeable gap.”

Woollatt says that the LSVCC programs at the provincial level (outside Quebec) were flawed, which undermined their success. He believes changes to how the programs are structured, including increasing the size of the firms in which LSVCC funds are allowed to invest and providing more flexibility to fund portfolio managers in the time limits under which they are required to invest, would go a long way toward making a federal LSVCC program successful.

Woollatt believes that Ottawa will introduce legislation to bring back the LSVCC tax credit in either the fiscal update in December or in the 2016 federal budget. He adds that the LSVCC industry in Quebec had been hurt by the federal tax credit’s removal, and the Liberals have committed to reinstating the tax credit.