For several years, participants within the technology sector have advocated extending the flow-through share program currently available to resource companies by making it open to the innovation sector. Using the erosion of our manufacturing base and also the commodity and energy downturn, the case for implementing flow-through shares to catalyze our underperforming innovation sector is becoming more compelling.
A recent paper by Vijay Jog, authored by the University of Calgary’s School of Public Policy (and taken in FP Comment in Kevin Libin’s column last month 9) found poor investment returns for flow-through investors between 2008C2012. From that, the paper concludes that between the investor losses, the cost to government and also the potential “crowding out” of investment in other sectors, flow-through shares do more damage than good and should be eliminated.
Even though 4 years is too short a period of time to fairly assess investment returns, poor investor returns from flow-through shares shojuld not be a surprise, as it is the risk profile that requires a tax incentive in the first place. My guess is the fact that Silicon Valley investment capital returns are similar: mostly losers with sporadic wins.
Successful innovation calls on several ingredients, including strong education and training, and a culture that supports entrepreneurship. But the greatest challenge for innovators is the difficulty in accessing risk capital. In this sense, early-stage resource and innovation companies are similar in that both require the convergence of discovery, entrepreneurship and risk capital.
Flow-through shares are a successful Canadian financial innovation. Catalyzed by flow-through shares, Canada pioneered public venture capital, and Canada’s capital markets had become the global leader in resource finance. The success in capital formation led to industry leadership and also the growth and development of a world-class support infrastructure of head offices, management talent, equipment and repair providers, consultants, finance professionals and professional advisers.
It may be the greater risk profile that requires a tax incentive within the first place
There are two world-leading clusters that to some large extent owe their success to financial innovations for accessing risk capital: Silicon Valley, with the introduction of non-public investment capital for information technology and telecommunications; and also the Canadian mining and oil and gas industries, using the introduction of public venture capital. A current Bloomberg article reported the Bay area, New York and Boston metropolitan areas take into account two-thirds of U.S. venture capital funding. Add in Los Angeles, which increases to just about three-quarters.
Related
- Kevin Libin: Why ‘flow-through shares’ really are a flopExtending flow-through shares to the technology sector: The whys and also the why-notsA road to economic diversification that Ottawa should consider
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While Jog surmises that poor investor returns imply poor sector performance and misguided government intervention, the evidence indicates the opposite: phenomenal industry success despite poor investor returns. Studies through the Department of Finance in 1994 and 2013 found that flow-through shares in the resource sector led to incremental spending, benefitted local economies and non-taxpaying junior companies, and enabled companies to issue shares at premiums of 18 to 25 per cent, with issuance costs in line with the market for regular junior equity. The cost to the government in foregone revenues averaged $440 million annually between 2007C12, but this cost was just triggered by $880 million of equity investment used by the issuers to buy equipment, pay salaries, etc., which triggered taxable revenue in the hands of the recipients. This also does not account for the spin-off economic benefits from this spending. In fact, a 1997 Department of Natural Resource study discovered that each dollar of flow-through tax credit resulted in $2.60 in exploration spending.
The U.S. government’s 2011 Strategy for American Innovation stated that public support is required to address “market failures” – the 2 principal failures being the funding of basic scientific research as well as commercialization, both places that entrepreneurs find it difficult to raise capital. Canadian commentators are regularly with the federal government to deal with our innovation deficit therefore we can grow stronger Canadian companies instead of lose them to U.S. funding and acquisition. The question is whether flow-through shares would be the right prescription.
Flow-through shares are a tax-assisted, market-based program, in which the market makes the investment decisions. This built-in market discipline makes the program easier to administer and certain makes up about the program’s longevity. Whether it doesn’t work, the price to the government will reduce accordingly, making it a low-risk initiative.
We have the opportunity to marry an established, successful financing tool to the world-class scientists and entrepreneurs to help find solutions to environmental, health and other social challenges while improving our economic competitiveness and creating a cluster to drive high-quality job creation.
Richard Sutin is Senior Partner at Norton Rose Fulbright Canada LLP in Toronto
