Do U.S. VCs have visions of Canada gold?

March 10, 2010

Canada is leveling the playing field for VCs that want to do business north of the border, but a sudden influx of U.S. venture capital cash is not likely on the horizon.

Last week the Canadian government announced it will scrap Section 116, a law that withholds 25 percent of the returns from the sale of a Canadian company backed by a U.S. VC firm until each investor proved they were a foreign citizen.  This tedious process sometimes delayed the official sale many months, or years in some cases. There is no U.S. law similarly hampering Canadian VCs.

Dan Primack, the editor of Thomson Reuters’ publication PE Hub, told Reuters TV some U.S. VCs created Delaware corporations — companies registered in the state of Delaware, without having to be based there, to take advantage of more business-friendly tax laws — and kept their portfolio company’s “R & D” in a Canadian city to try to skirt the legislation, but this measure could cost as much as $400,000, a significant chunk of change for most startups.

“A lot of VCs just threw up their hands and said we’re not going to invest in Canada,” said Primack, who interviewed Boston-based investment lawyer and lobbyist Stephen Hurwitz for a PE Hub article.

Primack said he didn’t expect the scrapping of Section 116 would create an immediate influx of U.S. VCs funding Canadian entrepreneurs, but added removing the impediment would likely lead to an increase going forward.

“Whereas last year or the year before that U.S. venture capitalist would have said it’s not something we’re interested in, today they might take that look, because there’s not the tax reason not to,” said Primack.

Canadian VC Mark McQueen, the founder of Wellington Financial, didn’t think the elimination of the law would change much, as most U.S. VC firms are shying away from early stage deals.

“The last 48 months has taught them to look at ‘later stage deals,’ whatever that might mean to an individual firm,” McQueen said in a blog post titled “Let’s not declare victory just yet.” “It’s definitely not a trend which is going to save Canada’s early stage tech sector.”

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