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Outcry Over Section 116 Clearance Certificates: Legitimate Barrier for Foreign Investment Firms or Convenient Scapegoat?
| Guest post by: Jon Hansen |
Article Overview: New York, October 12, 2009 – Just 17 venture capital funds raised $1.6 billion in the third quarter of 2009, according to Thomson Reuters and the National Venture Capital Association (NVCA). This level represents the smallest number of venture funds raising money in a single quarter since the third quarter of 1994 when 17 funds were also raised and the lowest level of dollars committed since the first quarter of 2003 when $938 million was raised.
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Outcry Over Section 116 Clearance Certificates: Legitimate Barrier for Foreign Investment Firms or Convenient Scapegoat?
New York, October 12, 2009 – Just 17 venture capital funds raised
$1.6 billion in the third quarter of 2009, according to Thomson Reuters
and the National Venture Capital Association (NVCA). This level
represents the smallest number of venture funds raising money in a
single quarter since the third quarter of 1994 when 17 funds were also
raised and the lowest level of dollars committed since the first
quarter of 2003 when $938 million was raised.
Source: Thomson Reuters and National Venture Capital Association News Release (October 12th, 2009)
In preparing for the December 14th PI Window on Business Segment
titled "Foreign and Domestic Venture Capital Investment: Opportunity
Versus Choice" in which I will be interviewing U.S. high tech
entrepreneur and investment expert Brad Feld regarding the key factors
that influence VC investment decisions, I re-read my research material.
This of course included reviewing the CATA video in which the
association's president John Reid interviews lawyer and Chair of the
law firm Fraser Milner Casgrain LLP’s TechnologyGroup, Thomas A.
Houston.
What was interesting about the video, which CATA has made available
for download, is that upon initial viewing Houston cites a number of
interesting statistics including the fact that the Q3 capital
investment level was at a 14 year low, with the Province of Ontario
experiencing an 87 percent drop compared to the same period a year
earlier.
Houston went on to state that foreign investments in Canada were off
the previous year's pace by 24 percent and, according to a report by
Deloitte's, Canada is ranked as one of the most unfavorable countries
in terms of "welcoming" foreign investors.
While there are several reasons for the drop, which we will get into
momentarily, the video and corresponding CATA press release assigned
the blame for the decline exclusively on the Sector 116 clearance
certificate requirements. Specifically, that the "Section 116"
clearance certificate" is required for every investor in a US venture
fund." The fact that many funds have "dozens or even hundreds of
investors," according to the CATA release means that a "single stock
deal can literally require hundreds of applications and hundreds of
signatures."
Referencing one such case in which a US venture capital firm
required "almost 900 signatures" in connection with a single
transaction, it is not a stretch to imagine that out of touch
bureaucratic process is the single most important obstacle to Canadian
firms receiving much needed capital from US-based investors. But is
this really the case or, are there other factors that have been
overlooked in terms of the admittedly sharp decline in foreign
investment such as the continuing fallout from what the National
Venture Capital Association (NVCA) referred to as the "wake of the past
year's financial crisis?"
After all, and as cited in the opening paragraph from today's post,
the Reuters/NVCA October 12th News Release indicated that "venture
capital fund raising activity" in the U.S. "registered the second
consecutive quarterly decline in the third quarter of 2009." This
according to statistics represents the "smallest number of venture
funds raising money in a single quarter since the third quarter of
1994." Correct me if I am wrong, but I do not believe that the US has
a Section 116 clearance certificate requirement.
I am of course not suggesting that the clearance certificate issue
is not a contributing factor in what is a significantly larger issue.
Having to fill out the required tax forms to collect our company's fees
for speaking engagements in the States or face the mandatory
withholding tax is not something that I enjoy doing. But putting the
aggravation aside, it has not deterred me from continuing to accept
invitations to speak in the US. This is where the creditability of the
CATA message is somewhat diminished.
As is often the case, we tend to over-simplify a complex issue by
picking a convenient target that can be readily if not accurately hung
in effigy. We heard this in my interview with Stockwell Day regarding
the Buy American policy which as it turns out had less to do with
actual economic reasons and more to do with Congresses concerns
surrounding public opinion during the dark days of the financial crisis.
The over simplification viewpoint is further fueled by the fact that
neither CATA nor Mr. Houston took the time to explain why the Section
116 clearance certificate was incorporated into the tax act in the
first place. Nor did they bother to explain what if any consequence in
terms of the broader picture a "simple amendment of the tax act" would
have from a big picture perspective. Even if the desired amendment
was in fact made to the Canadian Tax Act, there is no guarantee that
the floodgates of foreign capital investment would suddenly open in a
wave of needed funding. Once again, refer to the Reuters/NVCA News
Release.
While Reid makes reference in the video to the availability of
corresponding white papers and other documentation supporting their
position, one would think that even a general estimate of the dollar
amount of lost investment as a result of Section116 would have been
provided instead of the "900 signature" example. If I am not mistaken,
the reference to the firm having had to obtain 900 signatures would
seem to suggest that despite the "onerous" condition they still went
ahead with the investment.
This is one of the main reasons why I am very much looking forward
to Monday's interview with the US-based Feld, whose 20 years as an
early stage investor and entrepreneur will likely shed the needed (and
balanced) light on this issue.
As is likely the case with anyone who has been following this story,
I am more interested in the questions that haven't been asked and
answered versus what is understandably the somewhat biased views of an
association whose membership is in a sector that is desperate for cash.
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