Help clients leverage tax credits

For clients who want to invest in venture capital, almost nothing has more growth potential right now than the technology and software development industries.

You may be thinking that an offshore investment is a better bet, because the costs are lower.

But shipping software development to India or China is actually less cost effective when Canadian government stimulus programs (all of which require the work to be done in Canada) are taken into account. Further, by keeping the work inside Canada, you encourage home-grown innovation.

Read: Canada needs more aggressive venture strategy, expert says

If your client invests in seed-stage companies in Canada, they can increase return on investment by leveraging tax dollars—you get up to 45 cents of every dollar you invest into software; and every dollar a startup receives from federal, provincial, or municipal sources lowers requirements for outside capital. For investors providing the outside capital, this is a good thing. Government funds decrease the overall dilution of that startup’s equity, and in doing so increase the ROI for the angel investors who seeded the company.

Read: Private equity in balanced portfolios

Here are two examples:

• A startup needs $200,000 to build a software application, test it, market it and sell it. The founders seek cash from angel investors (e.g., high-net-worth Canadians who often fund seed-stage opportunities). The angel invests the full $200,000 and in return receives a 40% stake in the startup. One year later, after great success, Google buys the startup for $2 million. All things being equal, the angel would receive $800,000, a 400% ROI.

• Now, look at the same investment with government programs fully leveraged. The startup needs $200,000 to build, test, and market a software application, but this time the angel invests $100,000 and receives a 30% stake in the new firm (less cash, less stake). The startup applies to government programs that match angel investments, which in turn generates an additional $50,000. It could then use the $150,000 to apply for both Scientific Research and Experimental Development and Industrial Research Assistance Program monies, which could lead to an additional $50,000 in matching funds. These government programs seek to underwrite the cost of innovation.

  If Google acquires the startup for $2 million, the angel investor actually does much better. How? The startup repays the government funds ($50,000 + $50,000), leaving $1.9 million. Of this amount, the angel would receive 30%, or $570,000. While this is less in absolute funds, it has a much higher ROI, 570%. It is also considerably less risky because the angel investor only had to commit half as much capital. In essence, the investor takes half the risk and gets almost 40% more in ROI.

  By leveraging government programs, venture capitalists can get a higher ROI. (Your taxes are going to help your investment generate more wealth for you, for the startup, and for all of Canada.) So before you decide to invest in a Canadian technology startup, make sure you are getting the most bang for your buck.

Sean Wise is a venture capitalist who teaches entrepreneurship at the Ted Rogers School of Management, Ryerson University. His latest book is called Hot or Not: How to Know if Your Business Idea Will Fly or Fail.

This article was originally published on capitalmagazine.ca.