Why flow-through shares should be extended to spur innovation funding

For many years, participants within the technology sector have advocated extending the flow-through share program currently available to resource companies by looking into making it open to the innovation sector. Using the erosion of our manufacturing base and also the commodity and energy downturn, the situation 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 on February 9) found poor investment returns for flow-through investors between 2008C2012. From that, the paper concludes that between the investor losses, the price to government and also the potential “crowding out” of investment in other sectors, flow-through shares do more harm than good and should be phased out.

Even though 4 years is simply too short a period to fairly assess investment returns, poor investor returns from flow-through shares shojuld not be a surprise, because 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, along with a culture that supports entrepreneurship. However the greatest challenge for innovators is the difficulty in accessing risk capital. In this sense, early-stage resource and innovation information mill similar for the reason that both require convergence of discovery, entrepreneurship and risk capital.

Flow-through shares are a successful Canadian financial innovation. Catalyzed by flow-through shares, Canada pioneered public investment capital, and Canada’s capital markets became 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 service providers, consultants, finance professionals and professional advisers.

It is the higher risk profile that calls for a tax incentive in 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, using the introduction of private venture capital for it and telecommunications; and also the Canadian mining and gas and oil industries, with the introduction of public investment capital. A current Bloomberg article reported that the Bay area, New York and Boston urban centers take into account two-thirds of U.S. venture capital funding. Add in La, and that increases to just about three-quarters.

Related

Kevin Libin: Why ‘flow-through shares’ are a flopExtending flow-through shares towards the technology sector: The whys and also the why-notsA road to economic diversification that Ottawa should consider

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 resulted in 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 towards the government in foregone revenues averaged $440 million annually between 2007C12, but this cost was just triggered by $880 million of equity investment utilized by the issuers to purchase equipment, pay salaries, etc., which triggered taxable revenue at the disposal of the grateful recipients. This doesn’t take into account the spin-off economic advantages of this spending. Actually, a 1997 Department of Natural Resource study discovered that each dollar of flow-through tax credit led to $2.60 in exploration spending.

The U.S. government’s 2011 Technique for American Innovation stated that public support is required to address “market failures” – the two principal failures to be the funding of basic scientific research as well as commercialization, both places that entrepreneurs find it difficult to raise investment capital. Canadian commentators are regularly calling for the government to deal with our innovation deficit therefore we can grow stronger Canadian companies rather than 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, where the market helps make the investment decisions. This built-in market discipline makes the program easier to administer and certain accounts for the program’s longevity. If it doesn’t work, the price to the government will reduce accordingly, making it a low-risk initiative.

We get the chance to marry an established, successful financing tool to the world-class scientists and entrepreneurs to help find methods to environmental, health and other social challenges while improving our economic competitiveness and creating a cluster they are driving high-quality job creation.

Richard Sutin is Senior Partner at Norton Rose Fulbright Canada LLP in Toronto