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THE IMPORTANCE OF LABOUR-SPONSORED FUNDS FOR THE ECONOMY OF METROPOLITAN MONTREAL

REPORT ON

A report of the Board of Trade of Metropolitan Montreal.

BOARD OF TRADE OF METROPOLITAN MONTREAL380 Saint-Antoine St. West, suite 6000Montreal, Quebec H2Y 3X7

Telephone: 514 871-4000Fax: 514 871-1255

[email protected]

May 2013

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TABLE OF CONTENTS

LIST OF TABLES AND GRAPHS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii

A wORD FROM THE PRESIDENT AND CEO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4

Contribution of the labour-sponsored funds to the economy of metropolitan Montreal and Quebec . . . . . . . . . . . .5

The three tax-advantaged funds in Quebec and their mission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

The tax-advantaged funds in Quebec and investment capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

Activities complementary to those of private funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

Impressive leverage for governments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

A significant coattail effect for the investment capital market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

A major impact on metropolitan Montreal’s industrial fabric . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

A metropolis that benefits substantially from these investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

Key sectors that are developing due to these funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11

Economic icons that might not be here otherwise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

A positive effect on their shareholders’ savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

More regular contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

A starting point for contributions to other sources of savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

An interesting rate of return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

A major renewal to come . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

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REPORT ON THE IMPORTANCE OF LABOUR-SPONSORED FUNDS FOR THE ECONOMY OF METROPOLITAN MONTREAL

LIST OF TABLES AND GRAPHSTable 1: Gradual elimination of the federal tax credit for contributions to labour-sponsored funds

Table 2: Highlights on tax-advantaged funds in Quebec

Table 3: Direct investments in the Montreal metropolitan region, by sector

Table 4: Examples of Quebec economic icons that obtained support from the Quebec labour-sponsored funds

Table 5: Annual compounded returns (including the tax credit)

Table 6: Age structure of shareholders of labour-sponsored funds (as at May 31, 2012)

Graph 1: Fields of activity of the tax-advantaged funds in Quebec

Graph 2: Comparison of investment levels of tax-advantaged and private funds depending on the economic context

Graph 3: Disbursements of tax-advantaged funds in Canada, 2005-2012

Graph 4: The multiplier effect of tax-advantaged funds on co-investors in Canadian private technology venture capital funds

Graph 5: Quebec venture capital market: breakdown by investor type (2008-2012 average)

Graph 6: Proportion of pension fund holders who contributed two years in a row

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A wORD FROM THE PRESIDENT AND CEO

The Montreal metropolitan area represents 10% of the Canadian economy and over half the economy of Quebec. It is comprised of a substantial number of young, dyna-mic companies, recognized for their creativity and inno-vation. And yet, the growth of these companies depends on a competitive business environment, and in particular, on access to investment capital at different stages of their life cycle.

In fact, access to a diversified, well-structured supply of capital is one of the key success factors for a modern eco-nomy. This diversified supply renders it possible to respond to the needs of entrepreneurs very early on in the start-up process. This initial capital is followed by a supply of patient capital, which can support businesses in the initial stages of their development. Gradually, as companies become sus-tainable, other sources of both local and foreign capital can be added to support the needs of these growing compa-nies. All institutions and funds that finance businesses form what can be called a financial ecosystem.

Metropolitan Montreal’s financial ecosystem supplies not only local businesses, but also companies throughout Quebec. And yet, this ecosystem was severely weakened 50 years ago when large swaths of the financial services

industry moved to Toronto. It would take courageous and innovative decision-making to make up for these losses. Today, two pillars of our financial ecosystem, the labour-sponsored funds, are under serious threat as a result of a hasty decision made by the federal government. It is important that this decision be rectified.

As investors, the labour-sponsored funds help provide the economy with a dynamic venture and development capital environment that can meet the needs of the Montreal mar-ket and its entrepreneurs. These investments, both direct and through specialized funds, are made throughout the life cycle of companies: from the seed stage to maturity. They directly support the creation and development of innovative businesses and tens of thousands of well-paid jobs every year.

The labour-sponsored funds offer an excellent benefit-cost ratio for governments that grant a tax credit to tax-payers, while freeing up major public funds that can then be invested in infrastructure projects, which Montreal urgently needs.

Because the business community believes it is essential to understand the weight of these organizations in our economy, the Board of Trade of Metropolitan Montreal wanted to publish this report establishing the facts as a basis for discussion.

The report that follows presents the labour-sponsored funds and the positive that their investment activities have on the economic fabric of metropolitan Montreal. It also addresses the important effect of current tax incentives on the savings habits of shareholders of these funds, in a context where too few Quebecers save enough for their retirement.

We hope this report offers the support needed for funds that make a major contribution to the development and expansion of our economy.

MICHEL LEBLANC

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EXECUTIVE SUMMARYThe purpose of this report by the Board of Trade of Metropolitan Montreal is to establish the facts as a basis of discussion, in order to assess the important contribution of labour-sponsored funds to the Montreal metropolitan area. The report was made possible dues to the collabo-ration of Deloitte, which allowed access to non-public data as part of a study that the firm is currently conducting on Quebec’s three tax-advantaged funds.

When it tabled its 2013 budget, the federal government announced that by 2017, it would gradually cancel the tax credit it grants to shareholders of labour-sponsored funds, and instead would inject an additional $400 million into private venture capital funds.

The tax-advantaged funds, which include the labour- sponsored funds (Fonds de solidarité FTQ and Fondaction CSN) and Capital Régional et Coopératif Desjardins, are active investors throughout the life cycle of companies, in both the traditional and high-tech sectors. Through invest-ment activities that are complementary to those of private funds, businesses in metropolitan Montreal and Quebec have the opportunity to develop and grow.

These tax-advantaged funds make an essential contribu-tion to the economic fabric of metropolitan Montreal over the long term investment horizon, by maintaining a high level of investment during slow economic times, for small and medium enterprises in sectors less well-served by pri-vate funds. With direct investments of close to $2.3 billion in the economy of metropolitan Montreal, in addition to

indirect and real estate investments, the labour-sponsored funds have contributed to the creation and maintenance of over 35,000 jobs.

In addition to offering a benefit-cost ratio and an invest-ment recovery period advantageous to the governments that offer a tax credit to their shareholders, the labour-sponsored funds generate a coattail effect by often being the first to commit to private investment funds. They also contribute to the capitalization of specialized funds and the dynamism of the Quebec and Canadian venture and development capital markets. For the 2004-2012 period, according to the most recent study by Gilles Duruflé, with commitments of $758 million, the tax-advantaged funds drew in co-investors for $1,783 million in these same Canadian private technology venture capital funds. In Quebec, the tax-advantaged funds, including the la-bour-sponsored funds, contributed over $625 million, an average of 29%, to the total investment in the Quebec venture capital market over the past five years.

Finally, access to the tax credit for labour-sponsored fund shareholders has a positive effect on their retirement sa-vings level. Over the past ten years, these shareholders in-creased their RRSP contributions beyond those held in the labour-sponsored funds. The importance of individual sa-vings remains a challenge, as a result of the extraordinary demographic tightening Quebec is currently experien-cing. This phenomena is occurring as the baby boomers near retirement.

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INTRODUCTION

THE 2013 FEDERAL BUDGET DECISION

Within the context of its 2013-2014 budget, Jim Flaherty, Canada’s Minister of Finance, announced the federal govern ment’s intention to cancel its share of the tax credits for contributions to labour-sponsored funds (see Table 1).

TABLE 1Gradual elimination of the federal tax credit for contri-butions to labour-sponsored funds

PeriodVALUe oF

THe TAX CrediT

No change until March 1, 2015 15%

March 2015 to February 2016 10%

March 2016 to March 2017 5%

Effective March 2017 0%

Source: www.lesaffaires.com

The federal government bases its decision, in parti-cular, on a survey by the Organization for Economic Cooperation and Development (OECD)1, in which argu-ments are presented in favour of elimination of the tax credit for contributions to the labour-sponsored funds, as was done in Ontario (gradual elimination of the pro vincial credit was completed in 2012). The survey addresses the notion of the effect of eviction of private funds by the labour- sponsored funds for certain investment projects, the negative impact on the return on these investments, and therefore the lower return of the labour-sponsored funds compared with private funds. Indeed, according to the OECD, the private funds offer a better risk allocation and thus a better overall return.

In addition to the gradual elimination of the tax credit, the OECD also recommends in this survey that the public sector contribute by means of co-investment funds in which the investment decisions are made by the private partners. In line with this recommendation, the federal government undertook to invest an additional $400 million in private venture capital funds over the next seven to ten years.

THE TENOR OF OUR STUDY

Although the OECD survey is recent, it is based none-theless on analyses dating from the early 2000s. Therefore, this report is based on other, more recent data specific to the Quebec context.

This report will show, in the first place, that the contribu-tion of the labour-sponsored funds to the metropolitan Montreal economy is substantial and essential to the eco-nomic expansion of our metropolis. The principal charac-teristics of these funds and their complementarity with strictly “private” funds will be illustrated.

It is then essential to analyze the potential impact of the gradual cancellation of the federal tax credit on the in-dustrial fabric of metropolitan Montreal and the different economic sectors that would be affected by an eventual shortfall of investments from the labour-sponsored funds.

Finally, we will discuss the positive impact of the provincial and federal tax credits currently in place on the savings level of the shareholders of the labour-sponsored funds.

1 OECD, OECD Economic Surveys, Canada (Policy Briefs), June 2012.

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CONTRIBUTION OF THE LABOUR-SPONSORED FUNDS TO THE ECONOMY OF METROPOLITAN MONTREAL AND QUEBEC

Since the establishment of the Fonds de solidarité de la Fédération des travailleurs et travailleuses du Québec (FSFTQ), in 1983, and then of Fondaction CSN of the Confédération des syndicats nationaux (CSN) in 1996, the labour-sponsored funds have made sustained invest-ments in the companies and the economy of metropolitan Montreal and Quebec as a whole.

The three tax-advantaged funds in Quebec and their mission

In Quebec, the government combines three funds under the heading of tax-advantaged funds: the two labour-sponsored funds, Fonds FTQ and Fondaction CSN, and Capital Régional et Coopératif Desjardins (CRCD).

The tax-advantaged funds share the core values of their mission: support for businesses located in every region of Quebec, which contributes directly to the creation of qua-lity jobs. The CRCD fund also seeks to support the expan-sion of resource-based regions and cooperatives. The three funds are subject to the government requirement to invest (at least 60% of their average net assets for the previous year) in businesses with economic impacts in Quebec.

Moreover, Deloitte’s more recent analyses of the tax-advantaged funds reveal important facts about these investments.

However, the contributions of the shareholders of tax-ad-vantaged funds benefit from different tax treatment than other investments. A 15% tax credit is granted by each of the provincial and federal governments for the sharehol-ders of the FSFTQ and Fondaction CSN (an additional 10% from the Quebec government from June 1, 2009 until Fondaction CSN has achieved a capitalization of $1.25 bil-lion). The CRCD shareholders obtain a 50% credit from the Quebec government, because they do not benefit from the RRSP deduction and the investments in the fund are sub-ject to additional constraints (minimum of 35% in resource-based regions and in cooperatives). Only the FSFTQ and Fondaction CSN are affected by the federal government’s decision announced in the 2013-2014 budget.

It is important to mention the rationale of these tax credits. They were established to generate capital contributions by individuals wishing to save for their retirement, while supporting the expansion and growth of Quebec com-panies when the venture and development capital mar-ket was still underdeveloped in Quebec. The credits also enabled the funds to achieve capitalization levels rapidly that allow them the necessary leeway to meet the needs of businesses in many sectors. Since the tax-advantaged funds offer patient capital through their investment, strict redemption rules apply to the shareholders who have in-vested in these funds. In exchange, the tax credit contri-butes to an interesting return for the shareholders.

TABLE 2 : Highlights on tax-advantaged funds in Quebec

• 69% of the transactions occur in the regions

• 70% of the transactions are for less than $1 million

• 52.4% of the transactions in the start-up phase in Quebec are made by the tax-advantaged funds

• 87.3% of the venture capital transactions in the traditional sectors are made by the tax-advantaged funds

Source: Data from FSFTQ, Fondaction CSN and CRCD, Deloitte analysis

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The tax-advantaged funds in Quebec and investment capital

There is no doubt that the tax-advantaged funds play an important role as investors in the businesses of Greater Montreal and other regions of Quebec.

Access to venture capital is crucial for businesses in the seed and start-up phases, both in the technology and tra-ditional sectors. The venture capital market is dynamic in Quebec, reaching 0.083% of the GDP in 2009, compared to 0.019% for Ontario and 0.033% For Canada2. When its venture capital market is compared as a percentage of GDP with that of other OECD member countries, Quebec ranks third, behind Israel and the United States.

Moreover, development capital is just as important to support the early growth, expansion and maturity phases of businesses.

The tax-advantaged funds are active throughout the in-vestment chain, from the seed stage to maturity, in the tra-ditional and technology sectors (see Graph 1). Contrary to the assertions of some observers, Deloitte’s analyses show that the tax-advantaged funds play a role complementary to the strictly private investment funds active in Quebec.

Activities complementary to those of private funds

Businesses seeking investment capital in Quebec have re-course to several sources of financing: government assis-tance programs, tax-advantaged funds and private funds. The government and the tax-advantaged funds invest both directly in projects and businesses, and indirectly in specialized private funds. In both cases, the tax-advan-taged funds respond to certain deficiencies of the invest-ment capital market.

GRAPH 1Fields of activity of the tax-advantaged funds in Quebec

1

Expansion Maturity

Technology sectors

Traditional sectors

Venture capital Development capital

Early Growth Seed Start-up

Definition of development capital (source: Réseau Capital) “Capital invested in a business which generally has a viable product, a developed market, significant customers, and sustained revenue growth, which has reached its breakeven point and is generating not only profits but positive cash flows. The financing is often intended to increase production capacity and the sales force, develop new products, new services or new markets, finance acquisitions and/or increase the working capital.”

Definition of venture capital (source: Réseau Capital) “Capital invested in a business during the first stages. This investment is generally high or very high risk.”

Source: Deloitte

2 According to OECD, cited in the Deloitte survey on tax-advantaged funds.

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A major difference between strictly private funds and tax-advantaged funds is the investment horizon. The life cycle of private funds is close to ten years and their investment horizon is around five years, but tax-advantaged funds make long-term investments in partner businesses. The perspective of a long-term partner is certainly desirable for entrepreneurs, for whom years can elapse between the seed money and obtaining returns on investment that meet the investors’ expectations.

Furthermore, while many specialized funds target specific sectors (for example, information technology, clean techs, biopharmaceuticals), tax-advantaged funds invest both in the technology sectors and in the traditional sectors, such as manufacturing and retail. For example, the FSFTQ has made a $75-million commitment to Fonds Valorisation Bois, in partnership with the Quebec government, which is contri-buting $95 million, in order to acquire minority positions in forest sector companies that show strong potential3.

The scale of the companies and the transactions is another factor that we must consider. The costs of a $1-milion in-vestment transaction are essentially the same as those of a $10-million agreement. By their presence outside the ma-jor centres (such as Montreal), the tax-advantaged funds meet the demand for financing of smaller-scale projects. We should remember that 70% of the transactions of tax-advantaged funds are for less than $1 million.

Here is another fundamental difference between private funds and tax-advantaged funds. Since tax-advantaged funds have a long-term investment outlook, collect funds from their shareholders annually and must invest 60% of these funds in Quebec, they ensure the availability of in-vestment capital even during an economic slowdown (see Graph 2). Their countercyclical investments can be made alone or in partnership. In fact, the tax –advantaged funds increased their investments and supported successful com-panies at risk due to credit tightening during the last econo-mic crisis. In one known example, the FSFTQ allied with the Quebec government under the RENFORT program.

In addition, the investment activities of tax-advantaged funds in Quebec are completely complementary with those of private funds. Tax-advantaged funds were crea-ted not to compete with private funds, but to meet com-panies’ distinct and fundamental needs.

GRAPH 2Comparison of investment levels of tax-advantaged and private funds depending on the economic context

© Deloitte & Touche s.r.l. et ses sociétés affiliées

$-

$50

$100

$150

$200

$250

$-

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

2007 2008 2009 2010 2011

Investment capital Tax-advantaged funds Loans issued by the banks

13 Rapport préliminaire - Étude sur les fonds fiscalisés

En effet, alors que les investissements en capital de risque et capital développement diminuent lorsque la conjoncture économique présente des perspectives négatives, les fonds fiscalisés, du fait de leurs collectes de fonds annuelles, ne sont affectés que dans une moindre mesure par les turbulences du marché.

Sources: Thomson Reuters; Réseau Capital; Annual reports and financial statements of FSTQ, CRCD and Fondaction; Deloitte; BDC & TD analysis – Debt Market Observations and M&A Trends, September 2012.

Les fonds fiscalisés, de par leur mission de développement économique et leur particularité de fonds patients, permettent aux entreprises de bénéficier d’un appui constant. De plus, ils viennent parfois à pallier au manque de disponibilité des

instruments de financement traditionnels, lorsque les joueurs se retirent temporairement du marché.

En période d’expansion, les banques deviennent plus agressives et cherchent à augmenter leur part de marché; à l’inverse, elles tendent à se retirer en période de ralentissement. Les fonds de capital investissement tendent à réagir de manière similaire. Dans ce contexte, la capacité des fonds fiscalisés à lever des fonds assure une stabilité d’investissement, année après année.

Outre la couverture des carences de marché, les fonds fiscalisés assurent un flux contracyclique de capitaux dans l’économie québécoise

Funds invested in investment capital and by tax-advantaged funds (Quebec) and issuance of loans by chartered banks (Canada) (in millions and billions of $, 2007-2011)

Amou

nts

inve

sted

in fu

nds

Mill

ions

of $

Loans issued by the banks

Billions of $

TCAC 2007-2009 : -46%

TCAC 2007-2009 : +48

Investment capital

Fonds fiscalisés

Depression period

TCAC 2007-2009 : -38%

Banks

Source: Deloitte survey on tax-advantaged funds

3 Sources: Ministère des Finances, Budget 2012-2013, Gouvernement du Québec; Fonds de solidarité FTQ, Rapport de gestion intermédiaire au 30 novembre 2012.

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Impressive leverage for governments

While the provincial and federal tax credits to which the shareholders of the labour-sponsored funds have access are 15% each (total of 30% for FSFTQ and 30% +10 [Quebec government top-up] for Fondaction CSN), the maximum annual amount of share purchases for the purposes of the tax credits is $5,000.

The federal government estimates the tax cost of its tax credit at $160 million (for Canada as a whole)4. The provin-cial government values the cost of this tax credit at $146 million for 20125.

However, the tax and incidental tax impacts of the tax credits are largely to the advantage of the governments that offer them to the shareholders of labour-sponsored funds. Indeed, in the case of Fondaction CSN, the IREC assesses the benefit-cost ratio of the tax credit at 2.05 for the provincial government and 1.26 for the federal govern-ment6. In other words, for each $1 cost of the tax incen-tive represented by the 15% tax credit, the Government of Canada collects $1.26 in tax and incidental tax revenues.

In the case of Fonds de solidarité FTQ, a SECOR study on the economic impact of The FSFTQ’s investments7 refers more to the recovery period of the tax costs for the pro-vincial and federal governments. In 2009, the recovery pe-riod, including the incidental tax cost, was 2.2 years for the Quebec government and 4.7 years for the federal govern-ment. It is important to consider the impact of the reces-sion that began in 2008 on the duration of this recovery period. The analysis then estimates a recovery period for a “normal” year of corporate earnings at 2.1 and 3.8 years for the provincial and federal governments, respectively.

In other words, when all the tax benefits granted to FSFTQ shareholders are considered, the provincial government will have recovered all the amounts after 2.1 years, and the federal government will have recovered all its costs after 3.8 years for a year of operation in an economic growth period.

In addition to a benefit-cost ratio and a recovery period that are clearly to the advantage of the governments that offer the tax credits for shareholders of labour-sponsored funds, these funds often play a key role in the capitaliza-tion of private and specialized funds.

A significant coattail effect for the invest-ment capital market

The OECD recommends that public funds be invested in funds for which the decisions are made by private players. However, the tax-advantaged funds “generate a major coattail effect when they invest in private funds; they en-sure an often initial capital investment in specialized funds which, by leverage, allow mobilization of additional capital and thus complete the fundraising”8.

The most recent study by Gilles Duruflé on the venture capital market shows the key role of the tax-advantaged funds.

In this study it is presented that for the 2005-2012 period, the tax-advantaged funds disbursed $1.474 billion on the Canadian venture capital market.

GRAPH 3Disbursements of tax-advantaged funds in Canada, 2005-2012

26.3%

73.7%

26.3%

73.7%

Direct investments

Capitalization of Canadian private funds

Source: Gilles Duruflé, 2013

4 Department of Finance Canada http://www.budget.gc.ca/2013/doc/plan/anx2-fra.html.5 Ministère des Finances du Québec, Dépenses fiscales, 2012 edition, p. A-46.6 Oscar Calderon, Nouvelle méthodologie pour le calcul des retombées de Fondaction, IREC, July 2012.7 SECOR, Analyse de l’impact économique des investissements du Fonds de solidarité des travailleurs du Québec, July 2010.8 Deloitte analysis, within the context of its Étude sur les fonds fiscalisés, 2013.

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Moreover, since 2004, the direct and indirect commitments by the tax-advantaged funds (two out of three of which are labour-sponsored funds) have played a critical role in achieving the capitalization of 27 Canadian private-inde-pendent funds. These commitments represented 30% of the total fundraising by the private funds. These 27 funds alone raised 45% of the private capital of Canadian funds over the 2004-2012 period9.

For the 2004-2012 period, as shown in Graph 4, the tax-advantaged funds generate an impressive coattail effect when they commit to private funds. Indeed with $758 million in commitments, the tax-advantaged funds drew in co-investors for $1,783 million in these same Canadian private technology venture capital funds.

In Quebec at present, the tax-advantaged funds, including the labour-sponsored funds, have contributed a total of more than $625 million, an average of 29%, to the Quebec venture capital market over the past five years10.

GRAPH 5Quebec venture capital market: breakdown by investor type (2008-2012 average)

Corporate

Government

Institutional

Tax-advantaged

Private-independent

Foreign

Other

Source: Thomson Reuters

GRAPH 4The multiplier effect of tax-advantaged funds on co-investors in Canadian private technology venture capital funds

2012. 27 fonds privés (2 541 M$) ont béné�ciés d’investissements

$758 million Amounts committed

by the tax-advantaged funds in

private funds

The commitments of the tax-advantaged funds to the private funds have a coattail effect (commitments by co-investors and investors in companies)

$1,783 million Amounts committed by co-investors in these

same funds

Source: Gilles Duruflé, Deloitte analysis

$1 invested in companies by private funds in which the

tax-advantaged funds have committed funds,

generates 2.5$ of additional investments in the financed companies

Source: Deloitte survey on tax-advantaged funds

9 Gilles Duruflé, Investissements directs et indirects en capital de risque par les fonds fiscalisés du Québec, April 2013.10 Thomson Reuters, Québec’s Venture Capital Market in 2012.

10


According to the latest Thomson Reuters report on the venture capital market in Quebec11, 37% of the funds invested in 2012 went to traditional sectors, while life sciences and IT respectively accounted for 28% and 30% of the funds. Of the $409 million invested in Quebec in 2012, 29% went to businesses in the seed and start-up stages and 60% in the development stages. Thus, due to their direct investments and their major contribution to the various venture capital funds, the labour-sponsored funds and CRCD supported companies throughout their life cycle, in both the traditional and technology sectors.

Furthermore, this active participation by the labour-spon-sored funds in the venture and development capital market

contributes to a dynamic Quebec market and to attracting foreign investment to the province. While Quebec’s share of Canada’s GDP is 20%, the province reaped 31.8% of the foreign investments for the past five years in the venture capital market, compared to 68.7% for the rest of Canada12.

Thus, with leverage that is clearly to the advantage of the governments that offer a tax credit to their shareholders, and a major contribution to the dynamism of the invest-ment capital market in Montreal and Quebec, there is no doubt that the labour-sponsored funds are an integral part of the business environment of metropolitan Montreal’s companies and play a crucial role.

A MAjOR IMPACT ON METROPOLITAN MONTREAL’S INDUSTRIAL FABRIC

An eventual withdrawal, even if it is gradual, of the tax credit for shareholders of labour-sponsored funds would result in negative consequences for access to financing by metropolitan Montreal businesses. Some sectors would

be more affected than others, and the argument that pri-vate funds would replace this shortfall is certainly not foun-ded for all sectors.

A metropolis that benefits substantially from these investments

As prescribed in their constituting act, the labour-spon-sored funds must invest at least 60% of their average net assets for the previous year in eligible enterprises in Quebec, without requiring any guarantee. As at May 31, 2012, this proportion was largely respected both by the FSFTQ and by Fondaction CSN13.

A substantial part of these investments is realized in the Montreal metropolitan area. The labour-sponsored funds have directly invested nearly $2.3 billion in the Montreal metropolitan economy. When indirect and real estate in-vestments are taken into account, the investment activities of FSFTQ and Fondaction have contributed to the crea-tion or maintenance of more than $35,000 jobs14.

11 Thomson Reuters, Québec’s Venture Capital Market in 2012.12 Ibid.13 FSFTQ, Financial statements as at November 30, 2012; Fondaction data.14 FSFTQ and Fondaction internal data, as at May 31, 2012.

11


Key sectors that are developing due to these funds

The Quebec government offers a good number of business assistance programs, particularly through Investissement Quebec, which manages a portfolio of $3.4 billion, in addition to the Economic Development Fund valued at $4.2 billion15. All sectors are eligible for the loans and loan guarantees of these financial products, on condi-tion that the majority of their revenues are derived from sales of goods and services to businesses16.

The technology sectors (life sciences, information and communications technologies, clean technologies, etc.) are better served than in the past by specialized venture and development capital funds, and by the Teralys Capital Fund, which invests in these sectors. Fonds de solidarité FTQ contributed $250 million to the initial capitalization of Teralys Capital. The retail sector is much less well ser-ved. Retail businesses are not eligible for the government assistance programs managed by Investissement Quebec.

The labour-sponsored funds have substantial investments in all the major economic sectors: services, technology, manufacturing and commerce.

TABLE 3Direct investments in the Montreal metropolitan region, by sector17

SeCTor iNVeSTMeNTS

Manufacturer $530,631,883

Commerce $164,249,190

Services $1,060,950,601

Technology $348,207,510

Specialized funds $442,648,517

Other sectors $157,503,555

Total $2,261,542,739

Source: Combined FSFTQ and Fondaction CSN data

The labour-sponsored funds have directly invested

nearly $2.3 billion in the businesses and economy of

metropolitan Montreal.

15 Investissement Quebec 16 Agriculture, personal services and retail excluded. 17 The Montreal metropolitan area includes Montreal, Laval, Laurentides, Lanaudière, Montérégie.

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Economic icons that might not be here otherwise

The labour-sponsored funds have supported companies recognized in Quebec for their major contribution to the pro-vince’s economy. Here are a few examples.

TABLE 4Examples of Quebec economic icons that obtained support from the Quebec labour-sponsored funds

Renaud-Bray (bookstore chain)

The initial investment by Fonds de solidarité FTQ in 1996 allowed Renaud-Bray to emerge from a delicate financial position (initial investment of $4.7 million). The company today is the biggest French-language bookstore chain in North America. Renaud-Bray has 721 employees.

Robert Transport (road transportation)

The company has benefited from several investments by Fonds de solidarité FTQ over the past 20 years, particularly for expansion projects in Quebec and Ontario. Located in Boucherville, the company employs 2,572 people, including 2,451 in Quebec.

Air Transat (travel wholesaler)

The company, which has 6,175 employees, including 3,678 in Quebec, has benefited from several rounds of financing. The investment by Fonds de solidarité FTQ after the events of September 11, 2001 allowed the company to emerge from a precarious financial position and continue its operations.

Sonaca (aerospace)

The investment by Fonds de solidarité FTQ, at the bottom of the econo-mic cycle, saved 283 jobs at Mirabel. Subsequent reinvestments allowed the plant to expand.

Sail (retail)

Support from Fonds de solidarité FTQ allowed this sporting goods retailer to buy out the Beloeil company and then expand in Quebec and Ontario. It now has 880 employees, including 530 in Quebec and 350 in Ontario.

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Sports Rousseau Pro Hockey Life Sporting Goods Inc., better known as Sports Rousseau, is a sporting goods retailer now present in five provinces. The investment by Fon-daction CSN has supported the company’s growth projects, and it has rapidly become a world reference in the hockey field.

Fresche Solutions Fresche Solutions today is an internationally recognized IT modernization company, which includes several of the world’s leading companies among its partners. Fondaction CSN contributed to returning ownership of the com-pany to Quebec while participating in the establishment of a shareholding workers’ cooperative (CTA).

AV&R Vision & Robotics AV&R Vision & Robotics specializes in complex automation projects requiring a high level of precision. With expertise in artificial vision and parts finishing, the AV&R team has over 600 achievements to its credit and has won many awards. The investment by Fondaction CSN allowed the acquisition of the company by its founding officers.

ENOBIA An example of success in biotechnology. After Fonds de solidarité FTQ has sustained Enobia’s growth for several years. This company attracted a major player in human healthcare, which took it onto the international scene, thus recognizing the high-tech knowhow of Quebec companies and researchers.

DISTECH CONTROLS Control of this company, which manufactures energy-efficient controllers and software, was recently brought back from Singapore to Montreal. It has par-ticularly relied on Fonds de solidarité FTQ and the Montreal-based private fund W2 for its growth, and from now on will grow from Montreal.

ACQUISIO Joining Charles Sirois’ Tandem private fund, Fonds de solidarité FTQ parti-cipated in the startup of this IT company, which offers a recognized platform for interactive media.

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A POSITIVE EFFECT ON THEIR SHAREHOLDERS’ SAVINGSIn Quebec, as in the rest of the world, we are faced with a savings challenge. Citizens active on the job market do not save enough for their retirement and employer plans only cover half of Quebecers18. A study by Claude Castonguay reports that more than 60% of workers cannot maintain their standard of living after retirement19.

More regular contributions

According to Deloitte’s analyses of the tax-advantaged funds, the shareholders of labour-sponsored funds contri-bute more regularly to their retirement funds, particularly due to the deductions at source to which they have ac-cess. Nearly 40% of the shareholders of Fondaction CSN contribute through deductions at source, while this pro-portion is 31% for FSFTQ20. The proportion of sharehol-ders of Fonds de solidarité FTQ who contribute two years in a row to their RRSP is 10% higher on the average than the proportion of all contributors to a registered pension plan21 (see Graph 6).

A starting point for contributions to other sources of savings

One of the reasons why employees hesitate to resort to financial tools for retirement savings is the challenge of financial literacy. Over the past ten years, shareholders of the labour-sponsored funds have multiplied the retirement savings products held in their portfolio, in addition to their RRSP, in the labour-sponsored funds. One of the explana-tions is that the shareholders receive a form of financial education by contributing to the labour-sponsored funds. This allows them to better understand all the immediate tax benefits and future economic benefits of saving for their retirement.

GRAPH 6Proportion of pension fund holders who contributed two years in a row

76%

79%

68%

78%

71%

76% 74%

70%

68% 67% 64%

70%

59%

62%

65%

62%

50%

55%

60%

65%

70%

75%

80%

2004 2005 2006 2007 2008 2009 2010 2011

Part des détenteurs (REER) qui ont cotisé deux années de suite

Fonds de Solidarité shareholders All contributors

Source: Fonds de Solidarité survey, Deloitte analysis

Year after years, the proportion of shareholders of tax –advantaged funds who make another contribution is higher than for all RRSP contributors

Source : Fonds de solidarité survey and Deloitte analysis, taken from the Deloitte survey on tax-advantaged funds

18 Deloitte, Étude sur les fonds fiscalisés, 2013.19 Claude Castonguay, Le point sur les pensions, Cirano Report, 2011.20 FSFTQ and Fondaction data. 21 Deloitte analysis

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An interesting rate of return

While some criticize the lower rate of return obtained by the labour-sponsored funds compared to private funds, it is important to consider the different and complementary mission pursued by the labour-sponsored funds. With an objective of creating and maintaining jobs and develo-ping the regional economy, the labour-sponsored funds

respond effectively to a large segment of the demand in the venture and development capital market, while ensu-ring risk management that measures up to their sharehol-ders’ expectations.

Moreover, the returns received by the shareholders on the labour-sponsored funds are completely respectable.

TABLE 5Annual compounded returns (including the tax credit)

5 yeArS 7 yeArS 10 yeArS

FSFTQ n. a. 13.4% 10.0%

Fondaction CSN 17.0% n. a. 6.4%

Source: FSFTQ and Fondaction CSN management reports, November 30, 2012

A major renewal to come

One of the advantages of the labour-sponsored funds we have discussed above is the availability of capital in pe-riods of economic slowdown and credit tightening. This is made possible by the recurring high annual contributions of their shareholders, who recognize the increased advan-tage conferred by the tax credits compared to the other financial products related to retirement savings.

However, the withdrawal of the tax credit by one of the levels of government could affect this capacity of the la-bour-sponsored funds to raise capital at the same level as in previous years. Moreover, when the age distribution of the shareholders of these funds is considered, we can anticipate large capital withdrawals in the years ahead. Of course, the labour-sponsored funds, aware of these

dynamics well before the announcement of withdrawal of the tax credit, accelerated their recruiting efforts among younger workers. However, as in the case of all pension funds, this is still a major challenge as the baby boomers near retirement.

At Fondaction CSN, 54.6% of the shareholders are age 50 or over, while this proportion is 52.8% at Fonds de soli-darité FTQ22.

The importance of individual savings remains a major chal-lenge due to the extraordinary demographic tightening that Quebec is currently experiencing.

TABLE 6 Age structure of shareholders of labour-sponsored funds (as at May 31, 2012)

AGe oF SHAreHoLderS FSFTQ FoNdACTioN CSN

Under 30 years 4.4% 5.8%

30-39 years 16% 16%

40-44 years 11% 10%

45-49 years 15.8% 13.6%

50-54 years 20% 18.8%

55-59 years 18.8% 20.6%

60 years ans over 14% 15.2%

Average age 48.9 years 48.9 years

Total 594,287 shareholders 113,838 shareholders

Sources : FSFTQ and Fondaction CSN data22 Fondaction CSN and FTQ data.

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CONCLUSIONThe labour-sponsored funds make an undeniable contribution to the economy of metropolitan Montreal and Quebec as a whole. Due to their mission and the resulting activities, the funds play a supporting role for companies in sectors and at stages of development often neglected by private funds.

In addition, the labour-sponsored funds make major investments in several specialized funds and are the first investors to commit. They often play a key role in the capitalization of these private firms, which have a mission complementary to theirs.

The facts prove the case: the labour-sponsored funds generate positive leverage for the governments that grant tax credits to their shareholders. Nearly $2.3 billion is currently invested directly in the Montreal metropolitan area and more than 35,000 jobs have been created or maintained, when indirect and real estate investments are included.

Due to these tax credits, the labour-sponsored funds allow access to savings for more than 700,000 shareholders of Fonds de solidarité FTQ and Fondaction CSN. Many of them save more regularly and tend to diversify their sources of retirement savings. This is good news in view of the demographic challenge currently faced by Quebec as a whole.

The economy of Quebec’s metropolis needs these financial tools to prosper.

report on the importance of labour-sponsored funds … · ration of deloitte, ... in the economy of...

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