Budget capital gains changes are a tipping point for Canadian startups: survey

The results of a new survey highlight tax changes and other challenges faced by Canadian startups — and the need for policies that foster innovation and growth.

From massive investments in AI to additional funding for the SR&ED program to changes to the capital gains tax, the recently tabled federal budget touched on many issues of interest for the innovation community. And, to put it mildly, the budget elicited strong reactions. The capital gains tax has become a particular flashpoint for entrepreneurs and investors, with many expressing concern that increasing the inclusion rate on capital gains will make it even harder to grow a business in Canada.

Those sentiments are starkly reflected in the results of a survey of startups conducted by MaRS, Invest Ottawa and Communitech. Of the more than 150 founders who responded, only a fraction feel that Canada is the best place to grow a business. As one respondent wrote, “Canada for incubation; U.S. for commercial deployment.” Nearly 80 percent of founders reported that the Budget 2024 announcement has left them with a “less favourable” or “much less favourable” view of Canada as a place to grow a tech company.

“The results of the survey are clear: Entrepreneurs want to see change, and the budget’s capital gains tax sparked the most frustration,” says Alison Nankivell, CEO of MaRS Discovery District. “Moreover, the data also point to other important areas that need to be addressed to bolster entrepreneurs and their businesses against the challenging economic conditions stifling their growth.” Among founders’ top concerns: access to a seamless flow of capital and government procurement, housing affordability and attracting top talent. “We need to tackle these underlying issues collectively with public and private sectors,” says Nankivell.

Here are some of the survey’s key findings:

Canadian entrepreneurs are feeling pessimistic

The stats are sobering: Almost a third of all companies don’t make it past the five-year mark. And most founders agree that these proposed changes present additional challenges. Only 5.3 percent of respondents view Canada as the best place to grow a technology company. Founders flagged a number of substantial advantages for growth in the U.S., such as more customers, smart capital with deep pockets, executives who know how to scale and a welcoming business environment. “After 11 years of very hard work, I’m done with being treated like I’m greedy, instead of a creator of high-paying jobs,” wrote one founder. Another commented that they plan to build their next company outside of Canada.

This highlights the urgent need for Canada to enhance its appeal, not just in terms of R&D investment but also as a prime location for commercialization, says Chris Albinson, the CEO of Communitech. “Providing our entrepreneurs with the necessary resources and a supportive environment is essential for maintaining Canada’s position as a global leader in innovation,” he says.

For many, capital gains tax is the final straw

Changes to the capital gains tax drew the most ire. “The current tax change will definitely suck the entrepreneurial and innovative spirit of Canada dry and push more talent to the United States,” one respondent wrote. “I know many Canadian founders and engineers who left to start their companies in the United States. The United States rewards entrepreneurship, with the first $10 million tax-free.” Close to 60 percent of founders said they felt the new capital gains tax will deter innovation and investment, and 23 percent believe it will harm job creation and talent recruitment.

In response to these concerns, Sonya Shorey, the interim CEO of Invest Ottawa, stresses the importance of proactive engagement with policy-makers. “It’s crucial that we sculpt a supportive framework that promotes sustainable growth across all sectors of innovation,” she says.

To grow a startup it takes a village (and robust policies)

Given the complexity of growing an idea into a thriving business, there are many policy levers that could help nurture a sustainable innovation ecosystem and enhance Canada’s global competitiveness. In  addition to tax policy there are other critical considerations, such as available capital, the cost of living and overall productivity. Many founders emphasized a desire for policy reforms in a wide range of areas. Notably, half of respondents identified talent-related supports, such as housing affordability, as vital to innovation, while nearly 47 percent called for stronger tax incentives to support commercialization. Moreover, 40 percent of respondents want the government to stimulate demand through public-sector  procurement.

Finding the right levers to help entrepreneurs

Drawing from this feedback, MaRS, Invest Ottawa and Communitech met with federal policy-makers this week to discuss strategies that might sharpen Canada’s competitive edge. “We need policy enhancements that align more closely with the needs of our entrepreneurs and the broader economic goals of the country,” says Nankivell. “Our ongoing commitment is to advocate for policies that address  the urgent need to create an environment where entrepreneurs are empowered to transform ideas into successful, scalable companies in Canada. We need policies that ensure capital is a booster for entrepreneurial success, rather than a barrier.”

The recommendations include:

• Aligning Canadian capital gains policies with the U.S. Qualified Small Business Stock (QSBS) approach to foster a more favourable investment climate.
• Introducing tax credits to incentivize investments in Canadian innovation, enhancing the sector’s financial support network.
• Extending favourable capital gains tax rates to all employees with stock options, broadening the benefits and incentives for tech industry workers.

As MaRS, Communitech and Invest Ottawa continue to push for meaningful policy revisions, they are collectively focused on tackling some of the systemic problems facing entrepreneurs and the broader economy. Strengthening Canada’s innovation ecosystem could be a tremendous boon in addressing the country’s long-standing productivity problem. (Last week, Canada’s economic output per capita dipped even lower.)

“The fundamental goal is to enhance Canada’s stature as a global leader in transformative technology, and to establish this country as a springboard for the next generation of innovators,” says Nankivell.

For the full survey results click here.