The Ontario government is axing its 15-per-cent tax credit for labour-sponsored funds, dealing a severe blow to the recovering sector.
Fund executives were stunned by the move, predicting that this jeopardizes the future of the LSF business in Ontario, its largest market. It's the latest setback for the asset class in Canada. In June, Winnipeg's Crocus Investment Fund became the subject of a criminal probe by the RCMP.
"It's going to be very difficult to see the space attract new investments from the public," said David McBain, president and chief executive officer of Skylon Advisors Inc., the manager of about $200-million in LSF assets.
"You will essentially be facing net redemptions . . . all the investments you have put in place will have to be liquidated at some point. It will be very difficult for managers to do anything but wind it down."
Ontario's LSF tax credit plan was put in place in 1991 in the midst of a recession to help spark investments in entrepreneurial companies, especially those in high-tech and biotech fields.
For a $5,000 investment, Ontario residents received a 30-per-cent combined provincial and federal tax credit providing they owned the fund for eight years.
But Finance Minister Greg Sorbara said yesterday that Ontario's venture capital (VC) market is now in much better shape and investors no longer need the incentive. The 15-per-cent credit will be eliminated no earlier than the end of the 2005 tax year. There are 46 LSFs in the province with a total of $3-billion in assets under management.
Indeed, the investment climate for venture capital is improving. Last year, about $1.8-billion was invested across the country, up slightly from $1.7-billion in 2003. About $960-million was invested nationwide in the first six months of this year. Ontario is the country's largest VC market, gobbling up close to half of all investment dollars.
LSFs are a key source of funding in Ontario with about 40 per cent of VC investment in the province coming from the asset class.
Robin Louis, president of Canada's Venture Capital and Private Equity Association, doubts private and U.S.-based venture capitalists will move quickly to take up the slack in Ontario.
"If the tax credit goes away, that amount will diminish very quickly . . . I think their [LSFs'] participation in new investments is going to dry up very quickly. It's going to be harder to put together substantial-sized financings and that will be bad for everybody."
Several fund executives said they will ask Ontario to rethink the end of the tax credit plan. Les Lyall, senior vice-president of GrowthWorks Capital Ltd., manager of $350-million in LSF assets in the province, pledged to fight the "fundamentally flawed" decision.
Meanwhile, a "disappointed" David Ferguson, managing general partner of $1-billion VenGrowth Capital Partners Inc., will push Ontario for a long transition period.
But Gary Selke, president and chief financial officer of Front Street Capital, described the ruling as "wonderful." Front Street's $80-million in LSFs rely only on the 15-per-cent federal tax credit, claiming the provincial credit forces fund managers to limit their flexibility and invest only in Ontario.
"This is a wakeup call for funds with subpar performance," he said. "Financial advisers will be forced to look at the investment merits of the offering, not just the tax credit."
David Gamble, a spokesman for the Department of Finance, said the federal government is "monitoring developments" in Ontario but that no changes have been made at the federal level.
© 2007 The Globe and Mail. All rights reserved.
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