By Sandi Gilbert
Putting Investor Dollars to Work for Innovation
For years, the Alberta government has been focused on stimulating innovation and diversifying the economy beyond its strong roots of oil and gas. It has developed robust innovation support systems like Alberta Innovates (AI), the government funded initiative previously known as AITF, where entrepreneurs can develop their ideas into real products and solutions. At this stage of company development, both federal and provincial governments also provide grants and low interest loans that fund research and development, and the human resources needed grow from ideation to commercialization. These AI programs are critical to the growth and development of Alberta’s next generation of innovators, but at some point, these companies look to the capital markets to find equity investment required to recruit and hire talent and take their product or service to market.
Access to capital continues to be a significant issue for Alberta’s non-resource based early stage companies. I call it the funding gap: that place between friends and family, angel investors and venture capital firms. It’s growth capital, the money that comes before traction capital. It’s risky, illiquid and in most cases, the companies seeking the capital are developing complex solutions that resolve issues most of us haven’t even considered. They are literally ahead of the curve and that is a scary place for Alberta’s traditional oil and gas investors to venture.
Enter the Alberta Investor Tax Credit
In January of 2017, The Government of Alberta introduced the Alberta Investor Tax Credit (AITC) to encourage private investment in Alberta innovation. The AITC offers a 30% tax credit for private investment into non-traditional companies that have the potential to diversify the economy, create jobs and spur innovation.
Alberta has long lagged BC, Ontario and Quebec in terms of angel investing and venture capital investments. Although we do have large pools of investment dollars in our province, these dollars tend to be in the hands of oil and gas investors that don’t have the time or inclination to seek out technology companies looking for funding. The AITC, closely modelled after the BC Venture Tax Credit, just might be the stimulus we need to direct some of those dollars to Alberta’s early stage companies that are starved for growth capital.
Why an Investor Tax Credit?
An investor tax credit puts the buying power and investment decision making into the hands of investors, rather than leaving the province to ‘pick the winners.’ De-risking venture investing through an investor tax credit has been a successful model in other jurisdictions including the U.K. The province of BC has long had a Venture Tax Credit and in 2010, a study of 517 recipient companies commissioned by the the Ministry of Small Business, Technology and Economic Development revealed compelling program statistics for over a seven year period:
· For every $1 of provincial tax credit issued, the resulting companies generated $1.98 in provincial taxes.
· Companies in the program generated an average of 2.43 new jobs every year as opposed to a broad control of companies that generated almost no new jobs during the same period. The vast majority of new jobs were full-time positions.
· Average company revenues grew by $572K, based on average revenues of $2.27M
· Just 16% of the companies ceased operations with 2% going public and 7% being acquired.
The study also estimated that tax credits of $256M were leveraged into at least $2.3B of equity investments. On average, companies raised a total of $2.14M of equity within the program, with VCC-backed companies raising larger amounts ($4.61M) than individual investor-backed companies ($810K). Also, the study found that every $1 of equity raised within the program resulted in an additional $3.76 of equity and $1.15 of debt from outside the program, demonstrating the program’s capital leverage.
It is widely believed that this program has contributed to the growth of BC’s innovation eco-system, fostering the growth of technology companies that are creating new skilled employment for the province’s citizens. Sounds like ‘just what the doctor ordered’ for Alberta to diversify and stimulate innovation.
About the AITC
The 30% tax credit is available to Alberta investors who pay personal or corporate taxes in Alberta and invest in small and medium-sized businesses doing research, development or commercialization of new technologies, new products or new processes. It is also applicable to businesses engaged in interactive digital media development, video post-production, digital animation or tourism. These companies are known as Eligible Business Corporations (EBCs). Investors can also receive tax credits for investment into approved Venture Capital Corporations (VCCs) that will in turn invest into eligible Alberta businesses.
The government has allocated $90 million in tax credits over the next three years, available on a first come first served basis, for investment into EBCs and Approved VCCs – capital that is expected to stimulate $500 million in venture investment in the province. Investments made as of April 14, 2016 may be retroactively eligible for the AITC.
Investor Tax Credits
Individual investors will receive a refundable provincial tax credit equal to 40% of its investment in an EBC or VCC that has allocated tax credits remaining at the time of investment. The credit is designated as refundable, meaning the GoA intends to issue a refund cheque if the taxpayer does not have enough tax payable to offset the credit, although the act also mentions a four-year carry forward, indicating that the GoA may have some discretion in issuing a refund. An individual investor can claim up to $60K in tax credits each year of the program.
Corporate investors will receive a non-refundable provincial tax credit equal to 30% of its investment in an EBC or VCC that has allocated tax credits remaining at the time of investment. These credits are non-refundable and have a four-year carryforward. There is no maximum tax credit for corporate investors.
Individual investors may be entitled to further tax benefits by holding their shares in a registered account (RRSP, TFSA) as companies that qualify as EBCs may be eligible registered account investments. The EBC in this instance, would engage a trustee to administrate registered accounts for purchasers of the securities, providing potential tax benefits on future capital gains on the disposition of the shares. The benefits, if any, of holding the shares in a registered account will vary depending on the individual investor’s circumstances and it is recommended that investors consult with their legal and tax professionals for clarity on the benefits.
And finally, investments into EBCs have a five-year hold, so they cannot be sold or transferred within that period. Investors receiving the AITC through investment into a VCC may sell or transfer their shares (subject to the VCCs restrictions) as the VCC has the obligation to hold the shares for a five-year period.
An Example $200,000 Investment
Eligible Business Corporations
Companies qualifying for the AITC must meet certain eligibility criteria and engage in certain business activities as described above. The government has developed an on-line application process for companies to apply to be EBC and once approved, can offer their allocated investor tax credits to qualified investors. The program is not limited to private companies. The securities can be issued under a prospectus or a private placement. It is important to note that it is not limited to investment from accredited investors and corporations. A company can use other exemptions including the Offering Memorandum exemption to reach out to a broader investor base. A lifetime maximum of $5M of capital raised by an EBC will be eligible for the AITC, translating into $1.5M in tax credits for its investors.
Generally speaking, certain to some restrictions, securities eligible for the AITC will include, equity shares, warrants, options, SAFEs, convertible debentures (with restrictions) and limited partnership units, so the EBC has lots of flexibility in structuring the investment based on the stage of company and its capital requirements. Capital raised under the AITC cannot be used to invest outside of the province, lend to third parties, invest in real estate, acquire non-related company securities, repay debt obligations, redeem its shares or pay dividends.
EBC investments from VCCs must be arm’s length and the total investment from one or more VCCs is limited to $10 million of capital in a two-year period. One interesting and controversial restrictions states that any company that has received capital directly or indirectly from Alberta Enterprise Corporation (AEC), the GoA’s venture investing agency, will not qualify as an EBC. AEC invests in Alberta-focused venture capital funds that finance early stage, technology start-ups. Most funds operating in the province have received investment from AEC which flows through to their investee companies. Many of these funds have a co-invest strategy with angels and other high net worth individuals. If a company accepts investment from a fund that has investment from AEC, the syndicating angel investors would not be eligible to receive the tax credit putting that company at a disadvantage for additional investment. Angels may consider not investing alongside these funds and looking to place their capital with companies that can provide the 30% credit.
We understand the government has received input from the venture capital and angel investing community on this restriction, so we may see some changes as the program matures.
Venture Capital Corporations
It is expected that several new venture funds will be created as a result of the program. Newly formed VCCs that are approved for the AITC program can offer their investors the tax credit when raising capital for their fund and in turn, invest the capital into companies that meet the eligibility criteria. Once again, certain restrictions and rules apply, such as the requirement to maintain an investment protection account which contains 30% of all amounts of equity capital raised by the VCC. Funds from the protection account are withdrawn as the VCC makes its investments into eligible businesses. If the fund does not make eligible investments, the government can recover the tax credits issued through the VCC.
The VCC is required to make timely investments. 40% of equity capital raised during any fiscal year must be invested by the end of the second fiscal year, and 80% must be invested by the end of the third fiscal year. There are certain restrictions on the investments a VCCs makes, notably arm’s length, with no investment made into EBCs that are closely related to the VCC (large common shareholders etc).
Investing in an approved VCC may be more appealing to investors wishing to distribute their risk over multiple EBC investments rather than directly investing into one or two eligible companies. By investing in a VCC, investors will rely on the fund’s management to access the dealflow, vet the companies and provide mentorship and other resources to increase their chances of success.
The AITC program isn’t a new idea. BC, Nova Scotia, New Brunswick, Manitoba and a number of global jurisdictions have similar investor tax credit programs that are stimulating venture capital funding and adding jobs to their economies. Those of us in Alberta’s technology sector have long been lobbying for this de-risking of venture investment and it is our belief that this program has the potential to bring net new investment to Alberta’s innovative companies. Time will tell, but we remain encouraged by the potential we see in Alberta’s young companies and welcome the additional flow of capital.
The AITC is a first-come, first-served program, so we encourage companies to become registered EBCs if you intend to raise capital this year. This article does not refer to all of the criteria for the AITC program. You can reach out to us at AITC@seedups.ca for more information about the program and how to apply. Learn more at the GoA’s information page at https://www.alberta.ca/alberta-investor-tax-credit.aspx