Labour Sponsored Venture Capital Corporation encyclopedia topics

History

The idea behind LSVCCs was first proposed in the Canadian province of Quebec in 1982. The province was in the midst of a recession and the lack of capital in small and mid-sized companies had caused numerous bankruptcies.

In response, the Quebec Federation of Labour proposed a "Solidarity Fund" at a provincial economic summit conference in 1982 to help the provincial labour movement create a locally-controlled healthy and sustainable economy. The intention was to lure venture capital to smaller Quebec firms.

This new type of fund slowly began to spread across the rest of Canada during the 1980s. But it wasn't until the late 1990s that LSVCCs became truly noteworthy outside Quebec, thanks in equal part to generous tax breaks from federal and provincial governments and attractive returns. So far in the 2000s, returns have been less impressive, due in part to the bursting of the Technology Bubble. Unfavorable Government rule changes regarding LSVCCs have also been an important reason for this turn.

Labour-sponsored venture capital corporations, as the name suggests, must be sponsored by a labour unions. This sponsor is able to appoint members to the fund's board of directors.

Companies Invested Upon

LSVCC funds invest primarily in small and medium-sized private companies who require funding in order to sustain and increase growth. The emergence of the LSVCC industry stems from the idea that the growth of these firms will stimulate the Canadian economy and create jobs.

The money investors put into these firms is a form of venture capital. These firms are just starting out and generally aren't listed on a stock exchange such as the Toronto Stock Exchange or the Canadian Venture Exchange. LSVCCs offer an asset class that is normally not accessible through conventional investment vehicles. These companies have potential for substantial growth and high returns down the line if they succeed and are generally chosen precisely for that growth potential.

In an LSVCC, as in any mutual fund, investors' money is distributed among a number of businesses. However, because the companies invested in by LSVCCs may be new and are likely small, many don't have much of a track record and can be very risky investments by themselves. Ideally, an LSVCC can reduce that risk by diversifying their portfolio of assets.

These small to mid-sized companies are interested in receiving financing from LSVCC fund companies because they are in a high growth cycle and are looking to further support the expansion of their business. These companies are often too small or too young to secure conventional bank financing. The LSVCC fund companies are also able to provide sought-after strategic guidance and operational support.

Tax Credits

In order to encourage Canadian retail investors to invest in LSVCCs, the federal government and some provincial governments offer tax credits. Currently, the federal government offers investors in LSVCCs a 15% tax credit on a maximum investment amount of $5,000 per year - worth up to $750. Some provinces offer further 15% tax credit on top of that. Together that can add up to $1,500 in tax breaks. In total, a $5,000 investment would cost $3,500 when you take the tax credit into account.

An additional 5% tax credit is available to Ontario investors who purchase certain Research-Oriented LSVCC - a kind of specialty LSVCC dealing mostly in research-oriented small companies.

The Ontario government has recently announced plans to gradually discontinue its 15% tax credit. It will remain in place through the 2008 tax year, and will then be phased out over the subsequent three years.

It should be noted that if an investor chooses to buy an LSVCC in their RRSP, they would obtain the LSVCC tax credits as well as the tax deduction they receive each time they contribute to their RRSP.

Realizing Gains on LSVCC Investments

Gains made in the value of LSVCCs occur in one of three ways:

Exiting from an investment in a company via an initial public offering.

Selling the investment in a company to a larger company (often in the same industry) by way of mergers and acquisitions.

Capital appreciation in currently held investments in a company.

LSVCC fund companies tend to use their investment in a company to buy an equity stake. They will also negotiate to have members of their portfolio management team hold positions on the board of directors of companies they invest in. This allows them to have some say in future decisions that that company makes in regards to company strategy and execution.

The reason LSVCC funds have holding periods is due to the time it takes for these small companies to meet the criteria necessary for one of the above-mentioned options. It is important to realize that even though the holding period is an extended period of time, the LSVCC fund company doesn't wish to retain any investment indefinitely. The primary objective of LSVCC fund managers is to obtain a superior rate of return through an eventual and timely disposition of each investment.

Common Characteristics

Holding Period

In order to retain the tax credit an investor has to hold on to the shares for a set time period, often eight years. If shares are sold before this time, the amount received in tax credits must be repaid to the government in what's termed Tax Credit Clawback.

Liquidity

Because of the nature of the holding period (often eight years), LSVCC shares usually can't be redeemed without paying penalty charges until the holding period is complete. Because of this decreased liquidity as compared with other investment instruments, LSVCCs are best for investors with longer time horizons who are able to hold their shares for the full holding period.

Valuation

LSVCCs don't generally invest in publicly traded firms and that can make it more difficult to assess their value. With a stock that's publicly traded, the price that is quoted when the market closes is influenced by the opinions of investors, analysts and other market participants who have studied the company issuing the stock. Whereas LSVCC funds invest in private companies whose worth tends to be more difficult to assess and to determine.

Risk

LSVCC fund companies are able to diversify their portfolio by investing in a relatively large number of firms thus decreasing overall risk. But this only holds to a certain degree. The companies have little track record and most are not publicly traded. Some will fail; others will stagnate. It’s the few that thrive that ideally provide the profit that makes up for the other losses.