As the number of new companies created in Canada continues to grow, so does the need for capital to fund them. This is where venture capital comes in. Venture capitalists provide funding for start-ups and early-stage businesses that are developing their products or services before they’re ready for a full-scale launch.
Though it’s not easy to get venture capital funding, it’s still something every entrepreneur should think about early on in their business planning process. This blog post provides a basic overview of venture capital funding in Canada.
What is a venture capital fund?
A venture capital fund is an investment vehicle created to empower entrepreneurs and start-ups. These funds pool money from investors, who then invest it in new businesses, helping them grow.
There are many different venture capital funds, each with its own mechanics and purposes. Some specialize in specific industries, like healthcare or technology. Others focus on particular geographic areas within a country or even the entire world.
Venture capital funds can be organized as limited partnerships (LPs), which means that investors contribute money and receive equity stakes in the fund’s companies. They also have voting rights at annual meetings and sometimes get a share of profits earned through their investments. Other venture capital funds are organized as closed-end funds (CEFs), which means they issue shares regularly to raise additional capital for new investments. However, closed-end funds don’t offer investors voting rights or other benefits (though some offer dividends).
Are venture capital funds and venture capital firms the same thing?
Simply put, venture capital firms create and oversee venture capital funds. While venture capital funds are legal entities, they are separate from venture capital firms. Venture capital firms combine a collection of legal entities that aim to generate substantial returns for their investors.
What sources do venture capital funds draw from?
It can be challenging for early-stage companies to obtain debt financing due to their lack of cash flow and collateral. For these companies, funds are typically generated from the founders themselves, who may also rely on friends and family. They may also turn to financial institutions, pension funds, or the government. However, funds may be required above what can be generated within the founders’ network. That’s where angel investors come into play.
Angel investors are a type of investor. They fund start-ups and other business ventures in exchange for equity or partial ownership. Angel investors may be wealthy individuals or family offices (as opposed to venture capital funds) willing to invest their own money into companies they believe in.
While the term “angel investor” is sometimes used interchangeably with “seed investor,” the two terms do not mean the same thing. A seed investor is someone who provides the first round of funding for a start-up, after which the start-up may seek additional financing from angel investors or venture capital funds.
What types of venture capital funds exist in Canada?
The varying types of Canadian venture capital funds serve to meet the different needs of start-ups. Five types of venture capital funds are:
- Private independent venture funds: These funds are professionally managed through pension funds, insurance companies, and other investors (such as high-net-worth individuals).
- Government-sponsored venture funds: These funds are operated by institutions owned by the Government of Canada; for example, the Business Development Bank of Canada (BDC).
- Corporate-sponsored venture funds: These funds invest in and support start-up companies that can contribute strategically to their corporate sponsors.
- Institutionally operated venture funds: These funds are operated by institutions such as banks and Canadian pension funds.
- Labour-sponsored venture capital corporations: These are a type of mutual fund corporation that is sponsored by a labour union. The corporation invests in venture capital funds focused on small and medium-sized enterprises.
What laws affect the venture capital industry?
The venture capital business comes with benefits and certain legal exemptions for those who engage in it. For instance, because most venture capital funds in Canada are structured as limited partnerships, they are not taxed as separate entities. Instead, they are considered vehicles through which funds flow. An exemption to this tax perk is that if any partners are non-residents of Canada, sums paid to those individuals may still be subject to Canadian withholding tax.
If a venture capital fund seeks to issue securities to raise funds in Canada, it will be bound by federal and provincial securities laws. National Instrument 31-103, a national securities regulatory requirement, applies to all firms trading in or advising on investment funds. It requires that promoters, managers, and principals of the venture capital fund:
- Register as a dealer if they are trading in securities;
- Register as an adviser if they are advising others on the investment or purchase of securities; or
- Register as an investment fund manager if directing the business operations and affairs of the venture capital fund.
Multiple registrations may be needed if the individual engages in more than one of these activities. However, it is often the case that the venture capital fund manager and the fund itself need not register as either advisers or dealers if they do not engage in the above activities of trading and advising on securities. It is always good to consult with a legal professional regarding your potential rights and obligations at law when engaging with venture capital funds.
Contact the Mississauga Lawyers at Bader Law for Corporate Finance Advice on Corporate Finance for Your Start-Up
At Bader Law, our experience allows clients to access new capital while maintaining control of their business and minimizing legal risk. We also work with clients to organize their business, manage information technology and licensing, and effectively address shareholder disputes that may arise. We work diligently to help our clients optimize their business by choosing the best structure and legal composition for their operation. Contact us online or at (289) 652-9092 to schedule a consultation with one of our talented business lawyers.