Non-resident employees: withhold on worldwide income?

ITA regulation 102 requires employers to withhold tax on remuneration paid to non-resident employees who are employed in Canada. This requirement can be avoided by seeking a treaty-based waiver (regulation 102 waiver) or certification as a qualifying non-resident employer. However, often there is not sufficient time to do this before the employment is to begin, or there is a lack of awareness of the rules. Where the employer must withhold tax, should the amount be based on the non-resident employee’s Canadian income or worldwide income? Clarification from the CRA would be appreciated.

Specifically, regulation 102 imposes withholding on “any payment of remuneration . . . made to an employee in his taxation year. . . .” The definition of “remuneration” under regulation 100(1) does not specify that the remuneration is only in respect of Canadian employment. Accordingly, a cross-border non-resident employee who is employed in Canada for 5 percent of his or her workdays could technically be subject to Canadian withholding tax on all worldwide remuneration, in addition to withholding tax in his or her country of residence. Of course, this excess Canadian withholding would be refunded after the employee files a T1 tax return.

Subparagraph 115(1)(a)(i) specifically limits the taxable employment income of a non-resident person earned in Canada to “incomes from the duties of offices and employments performed by the non-resident person in Canada.” Thus, the person is not liable for tax on non-Canadian income. One might extend this argument to withholding and therefore not withhold tax on such income, on the basis that the regulations should be interpreted in the entire context of the scheme and object of the Act. Thus, in practice, the withholding amount is generally calculated in accordance with this principle by multiplying the non-resident employee’s annual remuneration by the number of days worked in Canada divided by the total number of working days that year. Commentators have generally recommended this approach; see, for example, “Regulations 102 and 105 and Cross-Border Compliance Issues” in the Canadian Tax Foundation’s 2013 annual conference report.

The difficulty is that the CRA has not explicitly endorsed this approach, except in narrow circumstances. Guide T4001, the “Employers’ Guide—Payroll Deductions and Remittances,” suggests that non-resident directors who attend meetings in Canada are subject to Canadian income tax and withholding based on the number of working days they spend in Canada in relation to the total days they worked overall. Similarly, in respect of a non-resident employee stock option plan, the CRA suggests calculating an employee’s taxable Canadian income by multiplying the total benefit derived by the proportion of working days spent in Canada over the total number of working days that year (CRA document no. 2012-0440741I7, July 6, 2012).

Employers looking to avoid being assessed penalties for underwithholding would appreciate more general assurance that only Canadian income of non-resident employees is subject to withholding.

The author would like to thank Travis Bertrand, articling student, for his contribution to this article.

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Reprinted from Canadian Tax Focus, May 2019, by permission of the Canadian Tax Foundation.

A-I Captain! Know the legal risks of buying an AI company… or go down with the ship

On February 21, 2019, Blackberry completed its acquisition of Cylance, a privately-held artificial intelligence (AI) and cybersecurity company. Acquisitions of AI companies like Cylance are becoming increasingly common as businesses seek to realize the opportunities in offering much-improved products or services to their customers. Canada, in particular, has become a hotspot for activity in the AI industry.

Acquiring an AI company is not always smooth sailing. There are common risks that buyers must be aware of prior to embarking on an acquisition.

Know where the data comes from

An AI derives its value from data sets used to train the AI. A common phrase in the AI industry is “garbage in, garbage out” – meaning, an AI is only as good as the data that has been used in its training. Canada regulates the commercial use of personal information through the Personal Information Protection and Electronic Documents Act (PIPEDA). PIPEDA requires consent of individuals before a company collects, uses or discloses their personal information during commercial activities.

Where the AI has been trained using personal information or uses this data in the course of its operation, PIPEDA requirements will be triggered. As such, during the due diligence process, the buyer must be wary of the consents the target has received from its customers. Often, these will be included in the standard terms of use on which the target engages its customers.

IP owner-“ship”

As with purchasing any technology company, reviewing intellectual property (IP) ownership will be a key part of the due diligence process. Often the sole value of the AI company will be derived from its IP.

In connection with traditional IP ownership issues, buyers must be cognizant that many companies in the AI space are not actually creating their own free standing AI systems but are instead leveraging those created by established AI providers such as IBM or Google. Purchasers must be sure to differentiate the IP owned by the target (i.e., those possibly created through using the AI created by the provider) from the IP that will remain with the provider post-acquisition. This is largely dependent upon the contractual relationships the target has with its customers and the AI provider.

Regulatory landscape

The Canadian government has been committed to providing significant monetary support to the AI industry. In the 2017 Federal Budget, the Government committed $125 million to develop the Canadian AI industry through the ‘Pan-Canadian Artificial Intelligence Strategy’.

However, despite this financial contribution, Canada has not created a comprehensive AI policy framework. There are many common legal questions that arise with AI: who owns the copyright of a painting created by an AI? Who is responsible when an AI driven car causes injury? The legislative framework to answer these questions is remains sparse.

The Canadian government will be expected to fill in the regulatory landscape affecting the AI industry in the coming decade as it attempts to navigate these stormy waters. The changing of regulations governing any given industry will cause associated risks to those companies operating in the field. Fortunately, the government’s stated dedication to becoming a world-leader in AI indicates that these changes will mostly be positive for the industry. However, when making investments in AI companies, buyers should be aware of the legislative and regulatory tenor regarding the AI industry as a whole.

The author would like to thank William Chalmers, articling student, for his contribution to this article.

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Electronic documents and signatures: a legal overview

In our increasingly digitized world, it is important to know the rules regarding electronic documents and signatures. Each Canadian province and territory has adopted its own electronic commerce legislation, which are very similar to one another and largely permissive in regards to the use of electronic documents and signatures. Alberta’s e-commerce legislation is called the Electronic Transactions Act (the ETA). Section 10 states that information or a record to which the ETA applies must not be denied legal effect or enforceability solely by reason that it is in electronic form.

The “functional equivalency rules” of the ETA provide the criteria for the use of electronic documents and signatures.

Writing rule

A legal requirement that information or a record be in writing is satisfied if the information or record is in electronic form and accessible for future reference.

Production, retention and examination rules

  • A legal requirement that a person provide information or a record (1) in writing to another person is satisfied if it is provided in electronic form and is retainable and later accessible by the other person, or (2) in a specified non-electronic form to another person is satisfied if it is provided in electronic form and is (i) organized in at least substantially the same manner as the non-electronic form and (ii) retainable and later accessible by the other person.
  • A legal requirement that a person provide, retain, or examine an original record is satisfied by doing so electronically if (1) the integrity of the information contained in the record is reliably assured and (2) where the legal requirement is to provide an original record, the electronic record is retainable and later accessible by the recipient.
  • A legal requirement to retain a record that is originally created, sent or received in writing or electronically is satisfied by the retention of an electronic record if (1) the electronic record is retained in the same format as the original record or in a form that accurately represents the information in the original record, (2) the information in the electronic record is later accessible by any person with the requisite authority, and (3) where the original record was in electronic form and was sent or received, any information identifying its origin, destination, and date and time it was sent or received, is also retained.

Electronic signature rules

A legal requirement that a record be signed is satisfied by an electronic signature only if in light of all the circumstances (1) the electronic signature is reliable to identify the person, and (2) the association of the electronic signature with the relevant record is reliable for the purpose for which the record was created.

The ETA also includes a number of rules regarding the formation of electronic contracts, the time at which electronic records and information will be considered sent or received, and several other matters.

Exceptions and Special Considerations

The functional equivalency rules above do not apply equally to all situations. Section 7 states that the ETA does not apply to wills, powers of attorney, negotiable instruments, records creating or transferring an interest in land, guarantees under the Guarantees Acknowledgement Act and a number of other documents. This list of exceptions is similar for nearly every province but is notably absent from New Brunswick’s legislation. Sections 19 through 24 of the ETA provide additional requirements for when the recipient is a public body. The Alberta Rules of Court allow for the use electronic methods for service except with “commencement documents”, such as statements of claim, originating applications, and so on (see Part 11, Division 3).

As for federal legislation, Part 2 of the Personal Information Protection and Electronic Documents Act and Sections 31.1 through 31.5 of the Canada Evidence Act provide special rules for electronic documents. Finally, while courts have commented on Canadian e-commerce legislation rather sparingly, the Alberta Court of Queen’s Bench in 2015 interpreted Section 8 of the ETA – which says that nothing in this legislation requires a person to use, provide or accept information or a record in electronic form without the person’s consent – to mean that consent, either explicit or inferred, is necessary in order to provide or accept information or a record in electronic form. On this basis, the court found that because the two parties in the case had signed an agreement with very clear notice provisions that did not contemplate the use of email, the court could not infer consent for the use of this type of communication. Thus, the defendant’s use of email for notice of termination of the contract was deficient.

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ILP, SLFI, HST – tax acronyms every fund should know

When we structure private equity funds, whether through a mutual fund trust, limited partnership or certain other entities, considerable time is spent on the income tax issues. We examine the deductibility of the management fees. We consider strategies for delivering the carried interest to employees in a tax-efficient way. We take steps to keep the flow-through nature of the mutual fund trust and prevent it from being a SIFT trust. We draft detailed securities tax disclosure dealing with allocation and distribution of earnings to unitholders, the resulting impact on adjusted cost base and the tax consequences of redemption of units, among other issues.

What we often don’t do, however, is consider the GST/HST implications. At first glance, this makes sense, as the only sales private equity funds usually make are sales of trust or partnership units (or shares of a corporation). The fund’s income is generally derived from interest or dividends. All of these are exempt from GST/HST, as supplies of financial instruments and services (respectively). Accordingly, much less thought is given as to whether one needs to register, file returns and collect and remit any GST/HST.

However, because the supplies of financial instruments or services are exempt from GST/HST, this also means that input tax credits cannot be claimed to get a refund of GST/HST expenditures. These expenditures include the GST/HST paid on legal fees, filing fees, and accounting and administrative costs, among certain other day-to-day costs. This means that GST/HST is a real cost to private equity funds and other financial institutions, such as banks, credit unions and insurance companies (as opposed to a cash flow issue for most businesses, where GST/HST is paid and then refunded). Accordingly, when real costs are involved, there is naturally an impetus to go where they are lowest – making purchases in Alberta, where GST applies at a rate of 5%, makes much more sense than the Ontario HST rate of 13%.

For this reason, the “selected listed financial institution” or “SLFI” rules were introduced in 1997. Starting in 2010, certain “investment plans”, such as mutual fund trusts and unit trusts (among certain other investment entities), were also included in the SLFI regime. The SLFI rules, while nightmarishly complex, essentially impose HST based on where the particular entity’s offices, operations, unitholders or beneficiaries are located, depending on the type of entity (as opposed to where the actual expenditure is made, as under the regular calculation of “net tax” under the Excise Tax Act). A complex array of regulations needs to be consulted in order to determine the HST payable. Further, various provincial percentages and numerous elections need to be considered (particularly by more complex structures). The compliance burden is serious and the costs potentially significant.

In order to be an “SLFI”, an entity needs to be both a “financial institution”, such as a bank or mutual fund trust, and a “prescribed financial institution”: a financial institution that has a permanent establishment in more than one province (including an HST province). Permanent establishment for “investment plans”, such as mutual fund trusts, is defined to include any place where unitholders have a residence or where the fund is qualified to sell or distribute units pursuant to provincial securities laws. Accordingly, the SLFI rules apply quite broadly and likely capture the majority of private equity funds. The consequences can be significant.

To use a very simplified example, suppose 90% of the unitholders of a mutual fund trust are resident in Ontario and the remaining 10% in Alberta. The trust has made all of its GST/HST exigible purchases in Alberta in a particular taxation year and paid 5% GST. However, as the trust would qualify as an SLFI under the tests above, it would owe an additional 8% as HST on 90% of those purchases (plus interest and penalties). Further, unless the SLFI registers for GST/HST and elects to file returns annually, it will have to file GST/HST returns on a monthly basis (as well as a special annual return). Failing to file these returns will yield a penalty of $100 per failure, as well as additional penalties and interest on any amounts owing under any such returns. In certain circumstances, other penalties will apply as well. Multiply this by numerous entities and several years and you have a serious expense.

Additionally, beginning in January 2019, “investment limited partnerships” or “ILPs” will also be included in the definition of “investment plans”. The SLFI rules will apply to them in much the same manner as they apply to mutual fund trusts, unit trusts and certain other entities. ILPs were introduced in late 2017 and are defined as limited partnerships with the primary purpose of investing in property consisting primarily of financial instruments, if such partnerships are controlled by financial institutions or are otherwise represented as collective investment vehicles. The initial impact of introducing ILPs was to make management and administrative services GST/HST exigible, when provided by a general partner to a partnership. Now, starting in January 2019, ILPs will have the additional compliance requirements of the SLFI rules. This means that they will both have to file GST/HST returns and calculate their HST owing pursuant to the special SLFI method mentioned above.

The SLFI rules are often overlooked and as a result, can catch an unsuspecting fund by surprise. Failing to comply with the SLFI rules can result in considerable HST payabl, interest and penalties, as well as the reputational risk of neglecting tax obligations. Accordingly, the next time you are structuring a private equity fund, it is advised that you consult with tax lawyer with respect to whether the SLFI rules apply.

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There’s snow business like snow business: considerations for your off-season acquisition

Eastern Canada’s ski season has officially come to a close. However, there is more reason than ever to keep an eye on the moguls.  While activities on the slopes may have ceased, market activity is often at its peak during the off-season (pun intended). For example, in April 2017, Aspen Skiing Co purchased Intrawest – the company that owned the Blue Mountain and Mont Tremblant ski resorts – for $1.5 billion US.  In August of the year prior, Vail Resorts similarly agreed to purchase Whistler Blackcomb for $1.4 billion.

For buyers considering such an investment this off-season, the following considerations should be kept in mind:

  • Climate-related risks: As discussed in a previous post, climate change is a reality we cannot ignore. Investors need to remain alive to the potential negative impact that climate change can have on the value of a business. A ski hill’s ability to adapt to a changing climate in the long-run will undoubtedly impact its future financial viability. A buyer would be remiss to neglect assessment of the hill’s prospects for the long-term attraction of customers in a world where snow and cold temperatures are poised to become increasingly rare commodities.
  • Business model and climate-related risks: Buyers should also look beyond climate change regulatory risk assessments and delve into the business model of the ski hill itself. Buyers should inquire into corporate governance matters and risk management practices used to mitigate future climate-related risk and should consider how such assessment has impacted the business’ financial planning. The buyer should ask whether the ski hill has the resilience necessary to adapt to the effects of climate change. For instance, can the site offer warm weather activities like hiking trails, waterparks, or mountain biking? Does the site have the space needed to accommodate more snow-producing equipment should the winter months continue to shorten and warm? Buyers would be well-served to understand exactly how the company has accounted for climate-related issues in its financial planning process.
  • Environmental considerations: If plans of expansion are on the horizon, it is critical that a buyer ensure necessary environmental approvals will be forthcoming. Given that ski hills are often home to a host of flora and fauna, buyers should conduct considerable due diligence to ensure their expansion plans will not run afoul of environmental rules or guidelines. Last year, a preeminent Alberta ski hill was fined $2.1 million for taking down endangered trees without a permit, which serves as a cautionary tale for future ski hill investors. The rise of environmental activism also means that failure to abide by environmental regulations can result in significant reputational damage, ultimately impacting earning potential.
  • Regulatory risks: Ski hills also come with their own set of regulatory risks. Buyers should ensure that adequate operational logs and records for equipment have been obtained, and that any reporting requirements have been complied with pursuant to applicable technical standards and safety legislation. Furthermore, the buyer may wish to request copies of equipment warranties, licences, and staff training certifications.

When it comes to purchasing a ski hill, conducting a thorough due diligence analysis is crucial. Climate-related risks, environmental issues, and regulatory requirements are only a few in a flurry of considerations. Be sure to use your off-season wisely.

The author would like to thank Elana Friedman and Meaghan Farrell, articling students, for their contribution to this article.

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Building the health systems of tomorrow: dealmaking and the future of the life sciences sector

EY has recently published a year-in-review report for deal making in the global life sciences industry.  The publication features some interesting statistics about deal activity in the past year, and makes predictions about which trends will carry forward into the 2019 and beyond.

The total value of life sciences deals in 2018 was US $198 billion, which was less than anticipated given that the companies in this space have “total firepower” (i.e., a measure of a company’s capacity to engage in M&A) of over US $1 trillion. According to the results of an executive survey, respondents suggested that high valuations and geopolitical uncertainties were leading reasons for not engaging in deals.  Nevertheless, the same executives believe that 2019 will see more life science deal activity than its predecessor, particularly in the small to medium deal range.  Product-focused innovation and portfolio optimization were cited as key deal drivers.

A major recurrent theme is the ongoing transformation of the industry. The interplay between health and technology has prompted companies in the life sciences to address the challenges to their business models. These challenges, in turn, drive deals as incumbents and newcomers alike jockey to improve their competitive position in the digital, data-driven future of healthcare. EY cites a number of 2018 deals as noteworthy for the purpose of exemplifying this changing landscape.  For example, in 2018, Amazon formed an alliance with Perrigo, an over-the-counter drug manufacturer, and acquired PillPack, a pharmacy:  moves that marked the e-commerce giant’s dramatic entry into the health care market.  Elsewhere, Google has allied itself with Flex, a provider of digital health care solutions, while Google’s parent company Alphabet made a significant investment in Oscar Health, an insurer.  Finally, EY notes that the Chinese technology conglomerate Alibaba has had remarkable successful developing its health care e-commerce business in China.  These technology companies have the deep pockets, a growing consumer base and technological and operational advantages to change the value chain for delivering health services.

To address this transformation, EY expects that incumbent life sciences companies will become increasingly focused on their strategies. Furthermore, these companies are expected to engage in deal-making to execute their strategies and ensure that they are positioned to control the health care ecosystems of the future.  In EY’s words “the imperative is mounting to use M&A to foster growth potential.”  Deal professionals everywhere are advised to pay attention to activity in this industry, as the size and importance of the markets involved will ensure that repercussions are felt far and wide.

The author would like to thank Eric Vice, articling student, for his contribution to this article.

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Cannabis and corporate governance: time for grow ops to grow up?

Since the legalization of recreational cannabis on October 17, 2018, the Canadian cannabis industry has experienced a significant boom. In its 2018 Cannabis Report, Deloitte predicted that legal sales of marijuana are expected to generate up to $4.34 billion in 2019. Moreover, and as previously discussed, Health Canada has introduced draft regulations governing the production and sale of edibles, extracts, and topicals, potentially providing additional growth opportunities for Cannabis companies to partner with the traditional food and beverage industry.

As the industry continues to grow, it is worth asking the question, how do these companies stack up from a governance perspective? One point of reference is the Globe and Mail’s “Board Games” rankings. These annual rankings rate the corporate boards of S&P/TSX composite index companies on a scale of 1-100, based on their corporate governance practices. The rankings are based on an analysis of four sub-categories (namely: board composition, shareholding and compensation, shareholder rights, and disclosure) and the assessment criteria are generally more rigorous than the “mandatory minimum” standards imposed by regulators. In 2018, of the 242 companies examined, three cannabis companies were ranked 226 or lower.

The rankings make sense given how young the legal cannabis industry is in Canada, as the focus for these companies at this early stage will undoubtedly be on growth over governance. However, a short-sighted approach to governance may lead to headaches down the road.

The following factors, identified by the Globe and Mail, will serve as a useful starting point for Cannabis companies seeking to develop their governance structures as they grow:

  • Board composition and diversity
    • increasing the number of independent directors on both the board and board committees; and
    • working to increase diversity in terms of board composition, coupled with the adoption of formal board and executive diversity policies.
  • Director and executive performance
    • conducting self-assessments and peer-review assessments in order to evaluate director performance;
    • providing director education programs to board members;
    • ensuring there is a CEO succession planning process in place;
    • separating the roles of chairman of the board and Chief Executive Officer;
    • establishing guidelines, policies and procedures for share ownership by the board and executives; and
    • providing robust disclosure on the directors of the company, providing tailed director biographies, accurately explained directors’ relationships to the company, and fully disclosed the value of all directors’ shareholdings.
  • Executive compensation
    • prohibiting executives from using financial instruments to hedge or offset their equity exposure; and
    • disclosing how the company ensures executive pay is linked to financial performance relative to the company’s peer group.
  • Shareholder rights
    • adopting shareholder rights processes, such as say-on-pay votes; and
    • adopting policies for clawing back bonuses when wrongdoing has occurred, or requiring CEOs to hold on to shares for a predetermined period after leaving.

Some of these factors will be easier to address than others. For example, simply enhancing disclosure of directors’ shareholdings and relationships can improve a company’s corporate governance standing with minimal additional effort or expenditure – therefore not distracting management or the board from their focus on growth. Similarly, conducting self and peer-review assessments for board members, separating the role of chairman from the role of CEO, and enhancing the disclosure around executive compensation are all relatively painless ways in which companies can demonstrate to their shareholders that they take governance issues seriously. Moreover, proactively addressing the more manageable deficiencies could buy cannabis companies time to address some of the larger action items, such as adopting shareholder rights processes, down the road.

By strengthening their corporate governance practices, organizations involved in the legal recreational marijuana industry can send a strong signal to their shareholders, to Canadian securities regulators and exchanges, as well as to the more sophisticated investors they will undoubtedly seek to attract that cannabis is a strong and professional budding Canadian industry.

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Fintech is thriving! Global investment more than doubles in 2018

KPMG recently published its “Pulse of Fintech” report on global investment in fintech for H2 2018. Here’s what you need to know:

  • Global investment in fintech companies hit $111.8B in 2018 (with 2,196 deals), more than doubling global fintech investment in 2017. This was partly due to a small number of mega deals.
  • In the Americas, 2018 fintech investment hit $54.5B across 1,245 deals.
    • At $52.5B (up from $24B in 2017), investment in United States fintech companies made up the vast majority, mainly driven by a strong number of $100M plus mega deals.
    • Canada’s fintech market remained steady in 2018, but appears to be poised for growth in light of the changes to the Bank Act that are expected in 2019 and initiatives undertaken by the Canadian governments (including its payments modernization initiative and its consideration of a shift to open banking). Moreover, given Canada’s role as a global leader in artificial intelligence (AI) and machine learning, KPMG expects increasing investor interest related to AI-driven fintech offerings in Canada over time.
    • Investment in Latin America (particularly Brazil) continues to see strong growth, in part due to increasing global investment (including from investors in the US and Canada).
  • In Europe, investment in fintech companies reached $34.2B (536 deals), more than tripling 2017 investment, with the United Kingdom remaining the leader despite Brexit concerns.
  • Asia achieved a new high for fintech funding in 2018, with 372 deals raising a total of $22.7B. While China remained the leader, deals in countries such as India, Australia and the Philippines counted among the top 10.

KPMG’s predictions for 2019 include:

  • Increasing levels of consolidation, particularly in the payments and lending spaces, but also in emerging areas such as blockchain.
  • Bigger deals due to investors’ increasing focus on later-stage fintechs.
  • An increase in open banking, fueled by favourable regulations in Canada, Europe and elsewhere.
  • A dramatic increase in investment in blockchain companies dedicated to building specific products and services.
  • Investments in regtech will rise, as startups strive to help incumbent financial institutions reduce costs associated with complying with stringent regulations.

For more information on the latest developments, contact a member of our FinTech practice.

The author would like to thank Scott Thorner, articling student, for his assistance in preparing this legal update.

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Continued robust VC investment and PE mega-deals take the spotlight in a review of the 2018 VC & PE Canadian market

A recent report released by the Canadian Venture Capital Private Equity Association (CVCA) entitled “VC & PE Canadian Market Overview 2018” (the Report) reviews the current strength of Canadian venture capital (VC) investment and very recent mega-deal trend in Canadian private equity (PE).

Highlights of the Report

  • Total VC investment remains remarkably high: a total of CAD $3.7B in VC over 610 deals was invested in Canadian companies in 2018, representing only a 2% decline from 2017. Comparatively, an average of CAD $2.5B over 506 deals was invested each year between 2014 and 2016.
  • VC sector investments align with past trends: information communication technology (ICT) continued to attract significantly more VC funding compared to the life sciences and Cleantech sectors. In 2018, more than two-thirds (CAD $2.6B over 386 deals) of the total amount of VC invested in Canadian companies went to those in the ICT space.
  • VC investment in later-stage companies continues to increase: the percentage of VC dollars invested in later-stage companies increased by 8% from 2017 to 49% (CAD $1.8B).
  • PE investment remains variable: CAD $22.3B PE invested in 2018 represents a 15% decrease from the CAD $26.4B invested in 2017, but is 62% higher than the CAD $13.8B invested in 2016.
  • Mega-deals power Q4 and year-end totals: two mega-deals (CAD $1B+) in Q4 brought the 2018 year-end tally to four deals worth CAD $14.4B; 65% of total PE investment.

Overview of Canadian VC investment activity

In a previous post, we highlighted the increasing trends in Canadian VC investment in the first half (H1) of 2018, which saw 7% more VC funding in H1 2018 compared to H1 2017. Ultimately, VC funding in Q4 2018 saw CAD $1.3B invested over 165 deals, bringing the year end Canadian VC investment total to CAD $3.7B over 610 deals — a 2% decline from the previous year. This total represents an average deal size of CAD $6.1M, marking a 3% decrease from 2017, but a 16% increase compared to the average deal size in the five years between 2013-2017 (CAD $5.3M). Indeed, 7 out of every 10 deals were under CAD $5M. Fifteen mega-deals (CAD $50M+) accounted for 30% of the total VC dollars invested — down from the 39% share in 2017. The largest disclosed VC mega-deal was the CAD $161M raised by Assent Compliance through an equity infusion from Warburg Pincus.

Territorially, Ontario continues to be the hub of the VC landscape: Ontario-based companies received 51% of VC investment (CAD $1.9B over 252 deals), up significantly from 39% in 2017. Quebec-based companies followed with 29% (CAD $1.1B over 172 deals) and BC-based companies rounded out the top three with a 12% (CAD $441M over 84 deals) share. Toronto-based companies received 41% (CAD $1.5B over 197 deals) of the total VC investment in 2018. Once again, the ICT sector dominated the VC investment environment, grabbing over two-thirds of the total funding in 2018 (70%; CAD $2.6B over 386 deals). This was followed by the life sciences (17%; CAD $630M over 101 deals) and Cleantech (7%; $264M over 47 deals) sectors. Finally, while the number of M&A exits in 2018 paralleled 2017 (34 compared to 35 last year), the average exit value dropped by a third to CAD $24.4M.

Overview of Canadian PE investment activity

Canadian PE investment in Q4 tripled from the previous quarter to CAD $6B, resulting in a year-end total of CAD $22.3B over 543 deals. Two mega-deals (CAD $1B+) in Q4 lifted the 2018 total of such deals to four, amounting to 65% (CAD $14.4B) of all Canadian PE investment. Indeed, the aggregate value of all 2018 mega-deals was greater than the sum of all other PE deals, a phenomenon that had not occurred in the Canadian market since 2014. The largest disclosed mega-deal was the CAD $5.1B recapitalization of GFL Environmental Inc. by a syndicate that included Ontario Teachers’ Pension Plan. Smaller sized deals (less than CAD $25M) accounted for 68% of all PE deals, a noticeable increase from 2017 (60%).

Montreal-based companies were involved in a higher number of PE deals (98 deals representing 26% compared to 78 deals representing 20%), while Toronto-based companies received a significantly greater share of PE funding (CAD $11B compared to CAD $2.6B). Across the various sectors, PE investment displayed a more balanced distribution as compared to VC funding: slightly more than one-fifth of the PE deals in 2018 were in the industrial and manufacturing sector (22%; 118 deals), which was followed by the ICT (16%; 88 deals), consumer & retail (11%; 59 deals) and business products & services (10%; 7 deals) sectors. Most notably, PE exists slowed significantly this past year with only 82 exits (CAD $11.1B), including four IPO exits, compared to the 149 exits (CAD $11.6B) in 2017.

Looking ahead to the Canadian VC and PE landscape in 2019

Following the release of this report, Kim Furlong (CEO of the CVCA) provided her assessment of the VC climate in Canada: “2017 was just like a home run, so 2018 is a continuation of that growth trajectory.” This level of VC investment, particularly in new and later-stage companies, points to a robust Canadian start-up environment and shows the trust investors have in the system. In 2019, it will be interesting to see if Canadian VC investment can sustain the tremendous growth it has experienced over the past couple of years.

On the other hand, Canadian PE investment remains variable and has now failed to post back-to-back years of growth over the past five years. One item to follow will be whether the mega-deal trend — which Canada has not witnessed since 2014 — will continue or whether there will be a shift back to the more conservative sized deals seen over the past few years. As private investors continue to favour innovative ventures that are focused on R&D, only time will tell if Canadian PE investment can maintain a pattern of consistent growth.

The author would like to thank Neil Rosen, articling student, for his assistance in preparing this legal update.

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Outlook for 2019: cross-border M&A and post-merger integration

Despite a general environment of uncertainty, 2018 was quite active in the cross-border M&A arena. However, observers expect a global drop for this year, especially for the mega-deals (i.e. transactions with deal values exceeding $10 billion) amid uncertainty over Brexit and the threat of globe trade wars.

Accordingly, acquirers are increasingly focusing on domestic deals rather than cross-border opportunities, and as corporate leadership remains bullish towards cross-border M&A, industry experts have suggested placing a greater emphasis on managing post-transaction integration issues.

Why? Because poor post-merger integration can hamper value creation. A mismatch of cultural fit, particularly magnified in a cross-border deal, is often cited as the primary reason for failure to achieve synergy. The difficulties at the outset begin with an inaccurate understanding of the foreign target’s operations and any political and regulatory issues connected to the transaction. Companies that underestimate the time and expense that go into deal-making, due to a failure to account for challenges caused by language barriers, cultural and time zone differences, or delays in obtaining third-party and regulatory approvals, often find themselves setting unrealistic timelines for closing. Unfeasible expectations can dampen or even derail the transaction.

Secondly, acquirers should learn about and appreciate the differences between the way the merging companies operate. Understanding the nuances such as risk tolerance and decision-making processes of the staff and senior management can play a key role not only during the deal negotiation stage but specifically during post-merger integration. Acquirers would be remiss to leave developing an integration plan to post-closing stage. Challenges such as IT integration, IP assignments, cultural fit, cooperation and teamwork should be addressed from a holistic and strategic consideration well before closing.

Practically speaking, senior management ought to conduct cultural assessments to understand the different standards and expectations between the target and the acquirer with respect to people, practices and management. These are also opportunities for each organization to determine the benefits and drawbacks of their current structures and management styles, as well as opportunities and threats posed by merging cultures.

Lastly, probability of a successful integration for an acquirer can increase through the development of strong working relationships with target company employees at an early stage. The employees at the target company should be properly incentivised both financially and culturally so that they become invested in the merger, with a view to integrate into the larger post-merger company.

The author would like to thank Coco Chen, articling student, for her assistance in preparing this legal update.

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