Canada’s politicians must learn to respect entrepreneurs and their capital
J. Ari Pandes is an associate professor of finance and an associate dean at the University of Calgary’s Haskayne School of Business.
Michael J. Robinson is a professor emeritus in entrepreneurship and innovation at the University of Calgary’s Haskayne School of Business.
A key message often communicated to entrepreneurs is the importance of respecting the capital provided to their companies – the financial and human capital. This message should resonate equally loudly with Canada’s politicians, who sometimes fail to recognize that capital is footloose – financial and human capital flow to higher-return, lower-risk opportunities, wherever they are.
Recognizing this free movement of capital requires policy makers to regulate efficiently and effectively. Unfortunately, this has not been the case over the past decade in Canada. This failure has limited the ability of high-potential Canadian corporations to attract the resources needed to grow in this country.
Private-sector professionals and senior personnel from the Bank of Canada have sounded the alarm about declining Canadian productivity for years. While various explanations have been suggested for this problem, we argue that the inability of Canadian firms to attract the investment needed to support innovation has been a significant factor.
The dramatic decline in the number of publicly traded companies around the globe has been well documented. In the United States, the number of public companies is down by nearly a half from its peak in 1997. Canada has experienced a similar decline after the number of public companies on the Toronto Stock Exchange peaked in 2008.
Many U.S. academics are not concerned about the decline in their public markets as increases in private equity investments have more than filled the financing gap. This has allowed U.S. companies to remain private longer and also provided existing public companies an off-ramp to the private markets. Indeed, U.S. and global private equity markets have grown significantly; data from McKinsey & Co. shows a near doubling of annual private equity investments globally from 2014 to 2023, to US$2.1-trillion.
Unfortunately, the same growth has not been observed in Canada. Alarmingly, the Canadian Venture Capital Association (CVCA) reports that annual private equity investments in Canada fell from $41.2-billion to $9.7-billion from 2014 to 2023 – a decline of more than 75 per cent. Looking at individual provinces, private equity investments declined by 30 per cent in Quebec, by 80 per cent in Ontario and British Columbia, and by 93 per cent in Alberta.
One bright spot has been the growth of Canada’s startup ecosystem. Major Canadian universities and regions across the country have established programs that provide support and mentorship to help founders during the crucial startup development phase for new ventures.
Together with this mentorship support, Canadian founders have also attracted increased financial support. The CVCA reports that venture capital investments increased from $2-billion in 2014 to $7-billion in 2023. Thus, it appears that Canadian entrepreneurs are creating valuable intellectual property and developing scalable business models that are allowing them to attract early-stage financing.
This success is consistent with studies showing that Canada actually performs well at generating new ideas and starting new businesses. This is not surprising, as we are among the top countries in per capita expenditures on postsecondary education and among the countries with the highest proportion of our adult population with postsecondary degrees. We also score very highly on relative rates of entrepreneurship.
As economists have noted, Canada does not have a startup problem, we have a scale-up problem. Our country fails at scaling up new businesses to a size at which they can compete on the world markets. As the above data suggest, one reason is that our later-stage corporations have trouble accessing private or public equity capital.
Another issue is that the high marginal tax rates for employees make it difficult to recruit the talented senior executives needed to help scale growing businesses. The market for talent is global, and successive taxation changes have resulted in Canada falling further and further behind.
Over all, these factors help cause our most promising young companies to either settle with stagnant growth, relocate the business or sell the company – typically to a foreign buyer.
Anyone involved in supporting entrepreneurial ventures can provide anecdotal evidence of Canadian entrepreneurs leaving the country or selling their companies too soon. Suggestive evidence can be gleaned by comparing venture capital (VC) exit data in Canada and the U.S. In 2023, the National Venture Capital Association (NVCA) reported 735 exits of U.S. VC-backed companies, 19 times more than the 38 Canadian VC-backed exits. Notably, more than 5.7 per cent of U.S. exits involved IPOs with an average valuation of more than $1-billion, while Canada had only one IPO (2.7 per cent of exits), valued at $337-million.
In terms of acquisitions, the average value of a U.S. VC-backed exit in 2023 was approximately $300-million, compared with just $12-million in Canada, excluding three major outliers. In 2022, there were no Canadian IPOs of VC-backed companies, and the average size of the 34 exits by acquisitions was a mere $20-million. These figures suggest that Canadian entrepreneurs are exiting their VC-backed ventures earlier and at lower valuations than their U.S. peers.
Recent tax changes have made Canada even less attractive for private investment. Raising the marginal tax rates on income and capital gains means Canadian entrepreneurs will be further inclined to sell their businesses early instead of investing time and effort to grow them into global champions. This not only stifles innovation in key industries of the future, but it also sends the message that success is penalized in Canada, rather than celebrated. With the proposed tax changes by the incoming U.S. administration, the odds of losing even more Canadian entrepreneurs to the U.S. has only increased.
If Canada aims to foster a thriving entrepreneurial ecosystem, politicians must rethink their tax policies to support and reward people who take the risks to build and scale their businesses. First, we should be raising the capital-gains exemption for Canadian-controlled startups to several million dollars, giving entrepreneurs the freedom to build without the fear of punitive taxes. Second, we must re-examine the personal taxation system that makes it so difficult to attract the international talent our scale-ups need.
Currently, all U.S. states have lower marginal tax rates than any Canadian province, and the gap is expected to widen in the near future. Without lower rates here, we risk losing our bright entrepreneurial minds to other jurisdictions, who will take their skills and potential tax revenues with them.
Finally, a more radical suggestion is to allow tax deferrals on capital gains by entrepreneurs and their investors when reinvested into new ventures within the same year. This would not only reward successful entrepreneurs but also increase the pool of capital available for innovation.
Our message to policy makers is similar to the message we give to entrepreneurs: Respect the financial and human capital that drives growth. In an era in which businesses can easily move across jurisdictions, Canada must create an environment where entrepreneurship is celebrated, not penalized.
It’s time for a comprehensive review of our tax and regulatory policies to foster homegrown success and businesses that can compete on the global stage. While these changes may spark debate, they offer a path to sustainable economic growth, which would be a superior approach compared with temporary and targeted government subsidies.