'When I place myself in the mindset of that 25-to-30-year-old Canadian go-getter . . . I would advise that person to go to the United States'

Guest post: In a special edition of the newsletter, Rob Hunter, prolific Canadian tech entrepreneur and investor, goes deep on the Liberals' ill-fated capital gains hike.

From time to time, we enjoy running Op-Eds here at the newsletter to provide a little variety for our thousands of readers.

On the backs of a disastrous Liberal pre-election budget, and as a B.A. in Poli Sci (a degree that has yet to prove that it is worth the paper it’s printed on), it’s perhaps also of particular value to know when it’s the right time to make a call to the bullpen for an actual expert.

Rob Hunter is certainly such an expert. As an award-winning business professor with a litany of successful start-ups and businesses to his name, I was happy to be able to turn to him to make cents of a seemingly senseless capital gains hike.

I hope you enjoy his insights into another Liberal wrong we’ll work to right in the months ahead.

-Alex

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From an entrepreneurial and start-up perspective, the first thing it's important to realize here is that the early-stage funding ecosystem in Canada versus the U.S. is very, very different. To put it another way: If I'm trying to start a company in Canada it is very time-consuming to go attract capital from Canadian investors. There are not a lot of investors, of those that there are, they happen to be very risk averse, and take many, many, many meetings to invest their comparatively smaller amount of money at worse terms, at lower valuations, than those investors in the United States.

I think there's a bit of a snowball effect in play where there have not been a ton of giant Canadian exits. (Editor’s note: for financial luddites like me: an ‘exit’ occurs when an investor sells part or all of his or her ownership. In a healthy or growing company, an investor may exit to gain a return on investment.) You have Shopify, you have others, but at least relative to the U.S., and affording for a per-capita adjustment, where it's something like 10x the funding is done on a per-capita basis in the U.S. than it is in Canada. It's monstrously larger down there, and so if there are no exits then there’s not capital flowing through to individual founders and early employees to then go invest in other companies, so we start this conversation sort of accepting that is already much more advantageous for an early-stage founder to go and raise capital in California than it is in Canada.

So, if I’m placing myself specifically in the world of a 25-to-30-year-old, probably single, probably childless young technology-minded person, and my options are to stay in Canada or go to the United States to start my company, let’s say I stay in Canada.

In Canada, where it will take me forever to raise my round (and even if I do raise my round it will be on bad terms and at a lower valuation). Now, let’s say it doesn’t work out. If it doesn’t work out, not only have I been subject to higher living costs, I’ve been paid less under a weakened funding ecosystem, and if I end up taking a job at a Canadian tech company, of which there are many good ones, I’m still making substantially less than my counterparts to the south. And this is all without even taking into account capital gains hikes yet.

My other option is to go to the U.S., and go seek funding down there, and while a lot can be said about capital gains rates in California, and a lot can be said about cost of living in certain areas, the upside is undeniably better for that founder trying to make their company happen in the U.S., but also, the downside is better as well.

For the sake of argument, let’s say for this hypothetical young founder south of the border, it goes well. One can access more capital, at better terms, in a quicker amount of time, from better investors – and have a good shot at succeeding. But even if it ultimately doesn't work out, there is more of an ecosystem down there to go and find a job.

What’s critical here is that failure in Canada means five, ten, fifteen years of career progression gone. That’s five, ten, fifteen years of savings that were desperately needed to go towards the potential of purchasing a home (and now, well outside of most major markets). In America, depending on where you live, depending on your circumstances, you could already afford that home, and with most entrepreneurs and young men and women in start-ups, they’ve been able to roll right into a $200,000 job if plans change.

The capital gains hike here in Canada is one more grain of sand on the camel’s back. We were already at a huge disadvantage, and now it’s even more disadvantageous, so when I place myself in the mindset of that 25-to-30-year-old Canadian go-getter, who really wants to do something with his life, who really wants to create jobs and generational wealth, I would advise that person to go to the United States to raise capital, and to stay there.

In fact, if I had sold my company at a time when this new Liberal capital gains change was involved, it would have cost me north of $250,000 in extra taxes.

That’s money I wouldn’t have been able to invest in other companies. Those are my charitable givings; it’s long-term savings for my family; it’s my children’s college fund. If I had paid that $250,000 in extra taxes, ostensibly because the Liberals are desperate to create a class war to win back young voters, I would have been forced to decrease spending on every other meaningful venture in my portfolio, and in my life.

With that $250,000, I was able to invest in Canadian venture capital funds, and to go out and acquire portions of Canadian small businesses, so it’s crucial to keep in mind here, and it’s not spin, that when you come for additional capital gains from high-level producers, you’re going to potentially see billions less go towards entrepreneurs, meaningful Canadian businesses, and less money is going to flow through the private sector, at a time we’re desperate to grow private sector jobs made stagnant by government.

In effect, the Liberals have created a death spiral for prosperity here. Less money flowing from angel investors means less money for companies. The less successful companies there are, the fewer investors we create. It’s deeply troubling. It’s as if they’re trying to drive away wealth and prosperity. On that front, at least, they’ve been successful.

Under QSBS (qualified small business shares) in the United States, if you have started a corporation, and if you are that early-stage founder, the first 10 million dollars USD of your earnings from your capital gain is not even taxed federally. Even if you’re in Silicon Valley, and a high-tax state like California, that makes a huge difference. Yes, Canada has a long-term capital gains exception, but the challenges there involve that it’s dramatically smaller, at 1.25 million rather than 10 million. The two just can’t compete. The punishment for success in Canada arrives too soon, and now, at a much larger share.

Coming out of the COVID years, with so many gratuitous and ultimately pointless business closures, I worry greatly about the business owners and the companies who somehow weathered the storm, who made nothing for two-to-three years, who just took on so many years of struggle and toil and risk, who are now being faced with the prospects of even more of that being taken away.

The government’s suggestion that only .13% of the population will be impacted by this is laughable. The vast majority of these targeted gains have not yet been taxed because they have not yet been realized. A tremendous amount of folks are going be impacted by this, and the trickle-down and second-order effects will be massive.

If a family business owner passes away, there’s another tax on the new value of the business. Now the rate is higher for the next generation owning the business. That means less money for jobs, less money for growth, there’s less money to expand the business and continue to be productive for their families and in their communities.

I’m not entirely sure the Liberals had the analytical capabilities, nor the faculties, to have considered the breadth of the damage here, but I’m hopeful that both the right conversations and expertise are now being forced upon them by the adults in the room.

Whether they choose to go down with this ship, and to further harm the finances of millions of Canadians on their way out the door, remains to be seen.

Rob Hunter is an entrepreneur, investor, and business school professor who has seen the highs of an eight-figure exit, and the lows of bankruptcy. He lives in Paris, Ontario with his wife and two kids. For more from Rob, you can follow him on X/Twitter.