Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 6 - Evidence - November 30, 2011
OTTAWA, Wednesday, November 30, 2011
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:22 p.m. to examine the present state of the domestic and international financial system (topic: Financing Growth Capital for SMEs).
Senator Michael Meighen (Chair) in the chair.
The Chair: I welcome you to our meeting on the state of the domestic and international financial system. I am Michael Meighen. I am from Ontario and am honored to chair this Committee. I might, by way of introduction, introduce the senators here present.
Senator Moore from Nova Scotia, Senator Hervieux-Payette from Quebec, Senator Gerstein from Ontario, Senator Greene from Nova Scotia, Senator Smith from Quebec, Senator Stewart Olsen from New Brunswick, Senator Tkachuk from Saskatchewan and Senator Oliver from Nova Scotia.
We have an interested group of senators and I am sure some other senators will be here shortly.
We are continuing with our special study regarding the financing of growth capital for SMEs. We will be hearing from the Public Sector Pension Investment Board. Joining us from the board is John Valentini, Executive Vice President, Chief Operating Officer and Chief Financial Officer; and Jim Pittman, Vice President, Private Equity Division.
And Mark Boutet, Vice President, Communications and Government Relations. I wish you, gentlemen, a warm welcome.
If you have an opening statement, please proceed. The floor is yours. Afterwards I hope you will be amenable to answering questions from senators. Thank you for being here.
John Valentini, Executive Vice President, Chief Operating Officer and Chief Financial Officer, COO-CFO Office, Public Sector Pension Investment Board: Good afternoon. It is a pleasure to address you this afternoon. My name is John Valentini and I am Executive Vice President and Chief Operating Officer of the Public Sector Pension Investment Board, known more in the industry as PSP Investments. It is the name we operate under in the market. Mr. Pittman is Vice President of Private Equity. He is familiar with the private equity market and venture capital market, and invests in this market. Mr. Boutet has also joined us, and he is Vice President, Communications and Government Relations.
We appreciate your invitation to appear before your committee as senators take stock of the situation with respect to financing for small- and medium-sized enterprises, or SMEs, in Canada.
To put our input in perspective, I would like to begin this afternoon by briefly outlining the role and mandate of our organization. PSP Investments is a Crown corporation created in 1999 by the Government of Canada to invest the net contributions received on or after April 2000 from the pension plans of the Public Service, the Canadian Forces and the Royal Canadian Mounted Police. We also manage employer and employee contributions to the Reserve Force Pension Plan made after March 2007. It is important to note that we are an investment manager and not a pension plan manager. Responsibility for liabilities lies with the federal government.
PSP Investments came into being at a time when the structure and financing of public pension programs in Canada had been undergoing substantive changes. Traditionally such plans had been financed and administered directly by the government in question, inevitably raising concerns that governments could interfere with investment decisions. The new model that emerged entailed building up reserve funds and investing them in a portfolio of assets, managed by an independent professional investment management organization which would be accountable to, yet strictly at arm's length from, government.
PSP Investments statutory objectives, and I quote, "Are to manage the funds entrusted to it in the best interests of the contributors and beneficiaries of the plans, and to maximize investment returns without undue risk of loss, having regard to the funding policies and requirements of the plans and their ability to meet their financial obligations."
We report to the President of the Treasury Board and to each of our stakeholders through respective ministers, the Minister of Public Safety and the Minister of National Defence.
We are one of the youngest and fastest growing investment managers in Canada, with net assets under management of approximately $58 billion at the end of our latest fiscal year.
Prior to 2004, all of our investments were passive. We were replicating the public market benchmark indices. At that point, we embarked on a successful diversification strategy that continues today, introducing private market asset classes such as real estate, private equity and infrastructure, while extending our reach to seize more opportunities in global markets.
I wish to emphasize that PSP Investments remains a major investor in Canada. As of March 31, 2011, Canadian investments — including public equities, private equity, real estate and infrastructure — accounted for $29.5 billion, or 51 per cent of our total assets under management. That sum includes $18.7 billion, or 32.2 per cent of our total assets, invested in Canadian public equities alone. Percentage wise that puts us at the top of list compared to our peer group. In absolute dollar terms, it very nearly matches a couple of other pension funds in Canada whose total assets more than double those of PSP Investments.
We also have some $2.5 billion invested in Canadian real estate, with assets in 35 cities across the country and over 40 real-estate financing deals with an aggregate value of over $200 million. We are proud of the contributions PSP Investments has made to stimulating and supporting economic development and job creation here in Canada, through these important Canadian investments.
For instance PSP is a controlling shareholder of Telesat. Back in 2007, we were instrumental in bringing together Telesat Canada and Loral Skynet to form one of the world's leading satellite services providers, which, of course, is based right here in Ottawa. In addition to housing its world headquarters, Ottawa is also home to Telesat's world-renowned research and development lab.
Revera Inc., a provider of accommodation, care and services for seniors, is also part of PSP Investments' portfolio. With nearly 30,000 employees, Mississauga Ontario-based Revera operates in 258 locations across Canada and in the United States.
Those are just a couple examples from a portfolio of significant Canadian investments too numerous to list today. Let us turn to the current focus of your committee: venture capital financing for SMEs. Most committee members are aware that these sorts of investments tend to be high risk. By way of illustration, a typical venture capital fund strives to raise sufficient money to invest in 10 deals. On average, four of those deals will fail during the term of the fund, with the result that the investors lose money. Another three may do okay, although they would require additional injections of capital. That essentially leaves investors dependent on the three best performing start-ups in the fund to recoup their initial investments and, hopefully, realize some returns.
At PSP Investments, incidentally, venture capital is part of the private equity asset class. In contrast to that high risk venture fund scenario that I outlined, we expect other types of private equity deals to return approximately 15 per cent to 20 per cent annually. Aside from their aggressive risk profile, venture capital investments, in particular start-ups, are expensive to administer and oversee. They tend to require an inordinate amount of time and resources relative to the size of the investment. That was a major reason behind the decision approved by our board of directors to invest via the funds route and utilize mostly external investment managers in Canada for our venture capital investments.
Finally, I should note that due to the relatively small size of the Canadian venture market, deal flows are limited in number. Notwithstanding those considerations, PSP Investments has committed some $355 million to small cap and venture funds whose mission is to finance small business in Canada. That represents 5.5 per cent of all monies allocated to investment funds by our private equity group exceeding what some have suggested as a benchmark for venture capital investments by big pension funds. As an example, just last week CalPERS, the largest pension system in the United States, announced that it would reduce its venture capital program from 7 per cent to 1 per cent of its $49 billion alternative investment management program.
Approximately $216 million of our $355 million commitment has been invested to date through 16 different funds providing financing to 75 portfolios. There is almost $140 million more already allocated but yet to be invested. This reflects the reality that despite what we hear about a shortage of venture capital, it can be difficult to actually get money out the door and into what one hopes will prove to be sound investments.
Which brings us back to PSP Investments' legislated mandate, namely to maximize investment returns without undue risk of loss.
Venture capital remains a risky business where the risk and/or return profile is not as attractive as other strategies aimed at meeting PSP Investments' targeted return. This is not to say that large Canadian pension investment funds — individually or collectively — cannot have a significant positive impact on the SME sector. On the contrary, taken in the aggregate, there is some $15 billion invested in venture capital in this country. That is an important sum of money, of which a significant portion is coming from large pension funds.
Moreover, going forward, we expect that constructive dialogue between members of the pension fund investment community, private equity pools and Canadian entrepreneurs and possibly government will lead to innovative solutions to meet the crucial capital needs of SMEs.
For our part, you may rest assured that while maintaining an arm's length relationship with government, PSP investments will continue to be a major investor in the dynamic Canadian marketplace, helping drive economic development and job creation while complying with our mandate to maximize returns without undue risk of loss.
On that note, my colleague Jim Pittman and I would be pleased to field any questions the honourable senators might wish to direct our way. Thank you very much.
The Chair: Mr. Valentini, thank you for an excellent presentation, which I am sure will give rise to many questions. No doubt the last paragraph on page 7 will interest senators to have that discussion with you here as to how we can find solutions to help meet the "crucial capital needs" of SMEs, to quote you. That is what we are trying to determine, and your input will be valuable. We will go directly to questions.
Senator Greene: I have a general question. We have had some testimony from other witnesses who have questioned labour funds. Could you comment on that?
Jim Pittman, Vice President, Private Equity, Public Sector Pension Investment Board: Do you mean the labour sponsored funds?
Senator Greene: Yes.
Mr. Pittman: We have not studied that in great detail. Our general view on labour sponsored funds is that a lot of money was raised in a short period of time. There were some negative biases toward investing that money in a short period of time. One of things we have learned in allocating money, whether to private equity generally or venture capital even more so, is that if you are forced to invest that money in short periods of time, it is a negative bias toward the types of investments you may invest in.
That is one of the problems. There may be other problems with the labour sponsored funds as they pertain to the management ratios. That is our broad comment on labour sponsored funds.
Senator Stewart Olsen: Have you recently increased your venture capital funding? What types of funds and businesses do you pick? Who picks them and what are your criteria? Have you sustained losses on your venture capital funding?
Mr. Pittman: The best way to respond is to say that initially we allocated most of our money through a funds program in 2006. We invested it, as Mr. Valentini mentioned, in 15 partnerships. Those funds have invested in approximately 75 underlying companies. As we look through that portfolio, we see that the performance broadly in venture capital, per se, is about 10 per cent below what we expect in our broad private equity portfolio. It is much below expectations; but it is early days. Venture capital tends to take a while to create value. As my colleague mentioned, it is not unusual in the early days of venture capital to lose a few of the companies while you grow others.
In terms of allocation, about $140 million remains to be invested, so we do not feel pressure to allocate any more money in this year.
Senator Stewart Olsen: Are you cautious about your allocation?
Mr. Pittman: Absolutely. As we go forward, we will continue to invest in Canada, but we are cautious, particularly as it pertains to venture capital.
Senator Stewart Olsen: What about losses?
Mr. Pittman: We are about 10 per cent behind. We expected it to perform plus 5 per cent to 10 per cent; but it is clearly below that.
Senator Stewart Olsen: Are your other investments making up for that?
Mr. Pittman: Yes, absolutely.
Mr. Valentini: Historically the gap, based on data we have on the market over the last 10 years, has exceeded almost 10 per cent to 15 per cent between a venture capital and a buyout. Only that gap exceeds what our targeted rates of return are on our overall portfolio. That is the challenge. The data are historical, not ours. That is the reality of historical returns between venture capital and what we consider traditionally as private equity investment.
The Chair: What would encourage you to put more money into SMEs? Would it be more SMEs and more opportunities?
Mr. Pittman: Under our mandate, we are required to find managers who can allocate money successfully. Our biggest criterion is people who have generally a good successful track record that we can continue to allocate money to. They then allocate that money to the underlying companies. We are very measured in how we look at that. That is perhaps our biggest criteria at this point.
The Chair: Is there a growing or diminishing number of SME fund managers?
Mr. Pittman: I would say we are probably entering a period where we will see more managers leave over the next two- to three-year period. I would say that is not specific to venture capital. It will happen definitely in venture capital, but it is also in private equity generally: a little bit less so in Canada and much more significantly, as a matter of fact, in the United States.
The Chair: Is this a cyclical thing, in your view?
Mr. Pittman: It is a trend line that we see because many pension funds, like ourselves, continue to invest in successful managers. We have just come through a period where a lot of money was allocated to private equity and venture capital during this sort of 2003, 2004, 2005 period. The returns have not been very great.
The Chair: Have not been?
Mr. Pittman: Have not been as good as expected broadly. Therefore a lot of pension funds are retracting from private equity to some degree. They are still increasing their allocations of private equity but retracting from a number of what should have been or could have been top tier funds that have not performed. Those funds will struggle to raise more money, and may not raise enough to carry on.
Senator Oliver: We are a parliamentary committee, and one of the things that we are interested in doing is trying to develop good new public policy and to find ways to make recommendations to the government on things we think they should do to help business in Canada be more innovative and creative. Some of the things we have looked at in this committee are what, if anything, we should do to encourage more people to become angels or to have angel investors take some of the risks you started talking about. You have not mentioned angels at all in your presentation. You have not mentioned tax credits at all in your presentation.
What are some of the things that you would recommend to this committee that we look at in terms of new public policy to encourage the small entrepreneurs and businesses in Canada to become more creative and innovative? What are some of the things you would like to see done?
Mr. Valentini: I think some of the things that have already been suggested by people who have participated in this committee or even coming out of studies from the Canadian venture capital association in Canada. They talk about angel investor tax credits.
Senator Oliver: Do you favour them?
Mr. Valentini: Yes, we would favour them. We would favour government participating through tools of angel investor tax credits, corporate venture tax credits, improving R & D tax credits.
That would be good for an organization like ours. Basically the money is there. There is not really a lack of capital for SMEs, but we would like to have a pipeline of quality deals. That requires very early-stage seed financing.
We are talking about micro-financing, half a million dollars, and a lot of the things that were already suggested or are being proposed by the venture capital association are good things as to how government could participate.
Senator Oliver: Where would you suggest the early-stage seed financing of half a million dollars come from? It will certainly not come from you, so what is your recommendation?
Mr. Valentini: I think angel investors are a good source. It provides entrepreneurs with the experience and expertise to associate themselves with other entrepreneurs. There is good mentorship there, and it provides a tax incentive. If we provide those types of tax incentives to retail investors through labour sponsored funds, which I think is good, labour sponsored funds provide a pool of capital directed to venture capital. Why would we not have a similar tax credit scheme for entrepreneurs who are willing to invest significantly more sums of money than through a retail outlet?
I think that is probably a good way to create a new pool of capital.
Senator Oliver: What should we, in this committee, learn from the fact that CalPERS, who have just reduced the percentage of money they are putting into their venture capital program? That was a substantial reduction, so what should we learn from that?
Mr. Pittman: I think that the California situation, in particular, was somewhat forced upon CalPERS. They were required to set up certain types of venture. Some of it was around sustainable resources, and there were probably six or eight different specific requirements forced upon them to do this. It is a great policy or a great thought, but if you cannot match good managers with those specific policies, you are very unlikely to have any reasonably good outcome from it.
What CalPERS has experienced — I cannot speak specifically, but I do speak with CalPERS on a regular basis — is that they put a lot of money out and their returns have been just terrible as a result.
With such a large program, they have to cut back and reallocate money to what would be a better risk, return, reward scenario for them.
Senator Oliver: In your case, you seem quite proud of your real estate investments and you have $2.5 billion in real estate now in 35 towns. I would like to know some of the types of real estate products that you are investing in. Are buying REITs, commercial buildings or making preconstruction investment? What types of real estate are you investing in?
Mr. Valentini: From commercial to office buildings. Our largest investment is Revera, which is a single entity that operates, as I have mentioned, in senior housing. We own office buildings in Edmonton, Calgary and Montreal. We own commercial properties across the world, actually. In Canada we are in all sectors, I would say.
Senator Oliver: What is your annualized return on your real estate, $2.5 billion?
Mr. Valentini: The annualized return for real estate, I have the return on hand. Real estate was 13.8 per cent last year; 7.2 over five years.
Senator Oliver: Compared to some of your equities, for example, where were they in the same period?
Mr. Valentini: I can quote our returns for last year for different asset classes. The overall return of the fund was 14.5 per cent. Real estate was 13.8. Private equity was 20.9 per cent. Infrastructure was minus 1.6. It was the first year of a negative return. Public markets, fixed income, 4.6 per cent. The public market equities were 16.4 per cent. We are proud to state that the 14.5 per cent was the best return by a major pension fund in Canada last year.
Senator Oliver: You have a number of managers who you give some of your $355 million to. I am interested to know whether some of those managers have been coming to you over the last 12 months and saying, "We have pretty well used up this fund of money you have given us and we see good new prospects coming up. Can we get some more money from you?" Have there been requests for more funds from some of your managers?
Mr. Pittman: I would say that most of these managers do what they call pre-marketing. They will often come to talk to us about a year in advance of needing to raise more money. So far, out of the 15 we have talked about, there are three or four who are coming back. Those would be some of the funds that were a little bit on the larger side, as a matter of fact, rather than on the venture capital side. We have not been approached by any of the venture capital or the truly small SMEs. It appears they still have adequate capital to deploy.
Senator Oliver: They just cannot seem to find projects to invest in then?
Mr. Pittman: They have to be calculated in their investment. We often hear that you have to invest over a three- or four-year cycle. If you invest all your money in one year, that may be a great year, it may be the year before the markets come down. Most of our managers show prudence in terms of timing to invest. Once they have invested a certain portion of money it takes a while to manage those investments as well.
Senator Oliver: Do your managers all have to report to you on a quarterly basis?
Mr. Pittman: Absolutely, and they use fair-value accounting as well.
Senator Moore: You mentioned in your remarks, Mr. Valentini, that you report to the stakeholders. How often do you report?
Mr. Valentini: Our year end is March 31. We report to the three ministers, generally towards mid-June, and it is tabled in Parliament. Our annual report is usually tabled in Parliament towards the end of June.
Senator Moore: Do you physically sit down and talk to each of the stakeholders or do you just merely submit your printed report?
Mr. Valentini: We meet with our stakeholders on a regular basis.
Senator Moore: How often?
Mr. Valentini: I would say that to present our annual results, we meet formally with our stakeholders twice a year. Right after we finish our fiscal yea, we meet formally with each of our stakeholders annually, as prescribed by our legislation. We have a meeting with each of our stakeholder groups. It is TRIPAC. That was held last October 20. We also have an annual public meeting, where we disclose our results and our investment activities over the last year.
Mark Boutet, Vice President, Communications and Government Relations, Public Sector Pension Investment Board: I would add that we also provide quarterly financial statements and letters to each of the ministers.
Senator Moore: You say that it is important to note that you are an investment manager and not a pension plan manager. Could you tell the public what that means?
Mr. Valentini: We are an investment manager for pension plans. An example would be Teachers' Pension Plan and OMERS, where they manage the assets and the liabilities. If you look at their balance sheet, they have the assets and the liabilities. We just have the assets. The liabilities are still managed by the RCMP, by Treasury Board. They manage the liability side of the balance sheet. The pension plans basically send us their contributions and we invest the funds, so we are just an investment manager for the pension plans.
Senator Moore: I want to follow up on the questions of Senator Stewart Olsen and Senator Oliver. With regard to the monies that are invested — Senator Oliver mentioned the $2.5 billion — is that all invested in Canada? You mentioned around the world. Is that 2.5 in Canada only, or is part of that invested abroad, and where would it be?
Mr. Valentini: That one is in Canada, but 51 per cent of our total assets at year end, which was about $58 billion, were invested in Canada.
Senator Moore: Is the rest of it invested outside of Canada?
Mr. Valentini: The rest of it is invested throughout the world: the United States, Europe and South America.
Senator Moore: In the whole range of asset classes that Senator Oliver mentioned?
Mr. Valentini: That is right. Each asset class, in terms of geographic exposure, is fairly represented all over. They are invested in Canada, the U.S., Europe and South America.
Senator Moore: What portion would be in the U.S., in dollars and percentage?
Mr. Valentini: Twenty-two per cent in the U.S.
Senator Moore: Is most of that in real estate?
Mr. Valentini: No. I would say the 22 per cent is across all asset classes, from public market equities, private equity, infrastructure and real estate. All asset classes have exposure in the U.S. market.
Senator Moore: In terms of future business, how do people know to come to you, or do you go to them? How do people know that you are sitting there with a large amount of cash looking for deals? How is this hooking up done? Do you go out there looking? Did you pay a fee to bring deals or managers to you? How is that done?
Mr. Pittman: I can talk about the private equity strategy. It is somewhat similar across the private asset classes. We reach out and find managers worldwide in our private equity group. We have 20 managers worldwide. We go to them. We allocate them some money in a fund structure. We tell them that amongst the style of investments you have, we prefer a certain style of investment.
Senator Moore: In terms of the risk?
Mr. Pittman: Risk, reward, industry, sector, time of the economic cycle. We adjust this on a regular basis. We tell them this year we are not interested in financials in Europe, of course. However, if it is maybe cable assets in Asia, maybe certain different sectors are of interest this year, then we inform them. We spend a lot of time on the road. We inspect investments made by the managers and talk about what is of interest. We talk about investment ideas that they have, or potential ideas, and what level of interest we may have. We often allocate money alongside their fund in a deal.
I have a more recent example. Mr. Valentini mentioned Telesat, which we did a few years ago. We recently closed a brand new deal called Kinetic Concepts. The fund manager was Apax. It invested about $800 million, we invested just under $400 million, and Canada Pension Plan invested $480 million in that single deal.
Senator Moore: The fund manager comes to you and says, "We have a prospect"?
Mr. Pittman: Absolutely.
Senator Moore: Do you have to pay a commission for that?
Mr. Pittman: We have a strict rule with our managers. We have to pay a fee for the fund we invest in. When it comes to our co-investment — we call it a co-investment alongside the fund — there are no fees, no carry, and no other expectation from the fund manager there. We invest our money and we take the active risk.
Senator Hervieux-Payette: I would like to know how you do that. When do you evaluate their performance, and how long is the mandate? You say they come to you, but do you make some kind of a competition for that? I want to know how you select these people, because I guess you may have a lot of people interested in joining you.
Mr. Pittman: We have a lot of interest. There are about 5,000 private equity funds in the U.S. alone, so it is no small task to pick them. However, what we choose to do is pick sort of larger managers, internationally. We use a segregated account, so a fund manager who has had perhaps five to ten years of experience of already selecting managers, and we ask them to pre-screen, show us 10 or 15 investment managers that they think are what we consider top quartile. We take those 15 and do significant due diligence in-house, in our own perspective, measuring it against criteria called the Thomson Venture index, and select a very few amongst that. Of the 15, we may select one or two. Today we invest in usually three, maybe four, fund managers a year, so not very many managers.
Senator Hervieux-Payette: Do you give the same amount to everyone?
Mr. Pittman: Absolutely not. The smallest we have allocated is $30 million and the largest we have allocated is $500 million.
Senator Hervieux-Payette: How long is their mandate?
Mr. Pittman: Most of these structures have an investment period that runs five or six years for the fund itself. If they invest in the fifth year, they usually need five years to create value in the investment, so most of these structures run 10 years.
Senator Hervieux-Payette: Each year you review, and if the performance is not there, have you ever asked someone to change someone who was already with you?
Mr. Pittman: Basically, our way of getting out of a manager is to sell our proportionate investment in that fund manager. There is a secondary market, and we actually did that early last year.
The Chair: I think our deputy chair's attention was piqued by your 14 per cent return, and the other members of the committee as well.
Senator L. Smith: I have two questions. One is about lessons learned from the history of venture capital. Your body language seems to be very cautious when you talk about venture capital. Our study, of course, is for small- and medium-sized business. We are not talking deals of the magnitude of the kind of money that you were talking about; we are talking about small- and medium-sized business.
You talked earlier about seed capital. How would you construct the vehicle that could be successful to kick-start this again?
Mr. Pittman: A part of this is cyclical and sometimes it means you have to wait. Opportunity needs to be present in order to allocate money. Some money still sits on the sidelines; that remains.
I think the way you kick-start this is you leave most of the vehicles you have in play there, such as tax credits and the SR&ED credits. As professional investment managers, we continue to look at performance of existing investors. One of the most important elements is finding good investors. Perhaps one of the better ways for this committee to think about would be on the angel investor side. Some of those people provide new entrepreneurs with a lot of experience that is needed to get from one level to the next. When they become a company that is driving revenues, those easily get picked up by investors in the SME arena more than the VC arena. There are stages in venture capital, depending on the level of technology and sophistication needed to get from one step to the next. There are good managers who can help in that arena.
If we can advance more angel and corporate investors, that will help. There is part of a cycle to this. Raising money and venture capital will come back naturally. As there is less money chasing more deals, the potential for returns comes back and people allocate more money. Hopefully in the next cycle not too much money chases those opportunities. You also get too much money chasing too few opportunities; returns come down and people stop investing.
Senator L. Smith: It appears the specific area that the weakness exists in is the seed area for the first line investment. You are at a different scale. Moving forward, how do you set it up so you will have the proper interest in that seed area, which appears to be your highest risk area?
Mr. Pittman: We are always looking for intelligent investors. Our own view is we think the intelligent investors — primarily the angel ones, some of the corporate groups — are the best ones to help pick what are potentially winning opportunities.
There are some of the more pure financial players who will invest in venture capital and are willing to take other bets as well. It is a bit hard for us because we do not spend enough time in venture capital ourselves. We would like to be more constructive, but from our experience we tend to find our best results have always come from the best selection of managers. To the extent, we can entice more knowledgeable managers. That is perhaps your best gauge of getting things moving.
Mr. Valentini: To add to that, yesterday a press release was issued where the government had funded four angel networks. I thought that was a good initiative because many times the seed capital, the entrepreneur — not so much that there is a lack of capital — does not know where to go. We have people looking for $200,000 or $500,000 call us and they do not know where to go. That was a good initiative, where people have a type of association or network. They can go and get advice as to how they should seek out even seed capital. I think that is lacking as well. People did not know what door to knock on or how to go about it. Things like that — to help base level funding for these types of networks or associations and enhancing tax credits to help entrepreneurs at the angel level — are good initiatives.
Senator L. Smith: Perhaps the government can help by establishing the different levels. If you are an entrepreneur and need seed capital, here are the four levels to which you can aspire to go and talk to in terms of assistance. Perhaps part of the problem is that entrepreneurs do not have the financial literacy to know where to go, other than to one of us or some rich guy who has money to start it off.
Mr. Valentini: This type of organization could help him in that regard.
Senator Tkachuk: I am surprised that the lack of returns at the bank would not have stimulated investment in other parts of the economy like venture capital or straight investments in business. Generally, from your professional point of view, would that be true? They used to compete at the banks for dollars, but I do not think they are competing any more at the interest rates they are paying. Where is all the money going?
Mr. Pittman: I think the banks would struggle with finding the right types of managers as well. In many regards what the banks have learned is when there are no great investments, or the risk is too much for the return, you are better to sit and wait. That is really what we have all learned.
Senator Tkachuk: That is not quite what I was getting at. I am always worried when governments are there to help. If you get venture tax credits or venture funds, does that not distort the market? Does that not take people — who should be making decisions based on return on investments, retirement or consumer goods — away from areas by saying, "We will pay you to invest in here," even though there may not be a return down the road?
Mr. Pittman: Mr. Valentini and I are more favourable toward tax credits that are aimed toward angel capital and corporate. I think that labour-sponsored venture capitalists can still be useful. In a retail sense, one of problems may be if you raise too much money at the wrong time, it can turn out much worse than it should.
Senator Tkachuk: Would that not take away from what a company can spend on research and development? We have been lowering the tax rate to Canadian businesses to almost 15 per cent, or it will be this year. We have tax credits for research and development. We could be lowering the tax rate for small business. By putting tax credits for venture capital — if the business was making decisions on the basis of investment in the future returns — would that not be guiding money away from areas important to the economy like research and development? Where do people make all their great inventions from? Entrepreneurs make money because they have something new they want to sell. They were not thinking of a tax credit when they developed it. It was just a question of getting their hands on some money to further develop their project. You would think that good businessmen would be making the decisions on the basis of the idea and profit; not on the basis of tax credits.
Mr. Pittman: I agree to a certain extent. I would say on the other side that tax credits help investors defray some of the costs of getting it off the ground. Sometimes it is hard to find that seed capital during the initial cost. The tax credit can help there. Does it mean they are spending it just to get the credit back? We hope not. We hope those corporations and entrepreneurs are doing it so they can create something that is inventive.
Senator Tkachuk: On the Small Business Venture Capital Tax Credit program, do we have a body of evidence that shows a bunch of new business happened because of that tax credit that would not have happened anyway? Is there any evidence of that? I have not heard any here. There has been criticism about it, and there are no returns, from what we are told, of any extent. It has been a tax credit for years but I have seen no body of evidence laid on the table that says "this is working well; look at all the companies this started and all the entrepreneurs nurtured through the tax credit fund." We have not seen it. Until we see it, what would be the point of having more tax credits that do the same thing?
Mr. Pittman: I could not comment. They are very large funds. I believe they have invested in a significant number of companies. Some of those companies would have benefited from having the interim capital to move to the next stage. I have not studied it to the extent that I can make any comments.
Senator Gerstein: Mr. Valentini, I am still digesting your marvellous returns and looking at your investment objectives outlined on page 3; they are well detailed.
My first question is: Do you invest on a global basis or do you invest with keeping in the back of your mind, although it is not listed here, a specific amount in Canada? I note that you have 51 per cent. Would you take a lower return in Canada if you saw that you could get a better return somewhere else and the number went from 51 per cent up to 70 per cent? Do you have a direction in terms of your mandate as to how much has to remain in Canada?
That leads me to the final question: How do you go about deal sourcing? Do people come to you or do you reach out to people to invest?
Mr. Valentini: With respect to our allocation, the 51 per cent that we have invested in Canada to date is based on our belief that is the returns were. That is why we had allocated 51 per cent of our assets in Canada and invested in Canada.
Senator Gerstein: If there were better returns elsewhere, that number could change.
Mr. Valentini: Yes. There is no bias in Canada, per se. We will go where the returns are.
Obviously, I am sort of an advocate. If you cannot make money in your own backyard, you should not go and play in other people's backyards. We are in Canada so there is bias, in that sense, to invest in Canada. We build a policy portfolio with an asset mix. You invest an amount in public equity, private equity and real estate, et cetera. Every asset class has targeted allocations to the Canadian market. People have guidelines or allocations. There is no set rule. The 30 per cent foreign restriction limit was removed, and since then, funds have basically opened up.
Today, as I mentioned, we still have the highest assets or investments allocated in Canada relative to our peers. We did that because we believe that is where the returns are. It is strictly on that basis, and it has paid out for us. It has helped us to generate very strong returns — the best this year and even the prior year we have had very strong returns.
Senator Gerstein: Could you talk about your deal sourcing? Are you reaching out or do people come to you because they know you have a pool of money to invest?
Mr. Valentini: It works both ways. Obviously, when you have $58 billion, people know you and you get solicited if not over-solicited. The real work is selecting your partners and the people you want to do business with. We are well- known in the market. I will turn to Mr. Pittman because he has more hands-on experience with how we select our partners.
Mr. Pittman: As I mentioned earlier, we look at a lot of managers internationally in terms of sourcing. We do a lot of in- house analysis and talk to some external advisers to get information about who would be good managers that we may want to invest in. Perhaps most of our work is concentrated on staying away from managers we do not want to invest in. If you have 4,000 or 5,000 managers in the U.S. and you only want to have 5 or 10 managers, there is a lot of noise out there; and you have to stay away from the noise. We try to stay quiet and go to the managers we like and work with them. Having said that, a lot of bankers, lawyers and accountants know who we are, whether it is because we are $58 billion or they have heard of us recently closing a deal.
It is not difficult to get sourcing of deals, but it is difficult to get sourcing of very good deals. Most of our time is spent screening where the deals are coming from and whether they are the types of deals we are interested in today.
Senator Gerstein: You gave the examples of Telesat and Revera. Are they a couple of the relatively few number of companies for which you are the controlling shareholder or are they examples of a long list of companies for which you are the controlling shareholder of operating companies in Canada?
Mr. Valentini: We typically do not control. The typical structure is where we are partners. Our minority interests can range from as low as 5 per cent typically to 25 per cent or 30 per cent. There are situations where we exceed that, such as with Telesat and Revera. Typically, we are in partnership or are co-investors with other like-minded investors.
Senator Hervieux-Payette: I want to clarify that for all of us. I had the impression that you invest when a business is closer to being medium-sized rather than small. Was that a false impression? I had the impression that you do not invest a small amount of money like $1 million. Do you invest at a later stage when a company has a better chance of succeeding? A company starts with a concept and operates possibly for a few years before it reaches the breakeven point. At what stage do you invest? What is the average amount that you invest? I sense from what you said that you use people outside, but certainly you have people who specialize more in medium-sized businesses? Who exercises the vote on the boards once you are a partner for the shares that you own?
Mr. Pittman: We have 15 managers that we have allocated money to in Canada, in particular. Those are the funds that invest in the seed and early start-up stages. Once the companies grow to a much more substantive stage, they may approach us. That is how I would position where we come into the play of that.
What was the second question?
Senator Hervieux-Payette: Who exercises the vote for your shares that you own in all these investments?
Mr. Pittman: I can speak to Telesat. We own three of ten board seats; and we exercise our three votes at each board meeting.
Mr. Valentini: It will vary depending on the size of investment, and it is negotiated at a level to the degree of equity interest we own in a company. Obviously, if you own 100 per cent of the company, you have full discretion over the board, but that is unusual. Typically, we are partners and, depending on our level of interest, it is negotiated and can vary with different types of investments.
Senator Hervieux-Payette: Thank you.
The Chair: Thank you Senator Hervieux-Payette.
Gentlemen witnesses, thank you for your presence and your presentations. Your addresses were very interesting.
On behalf of all public sector pensioners, past, present and future, keep up the good work.
Welcome to the second half of the meeting of the Standing Senate Committee on Banking, Trade and Commerce, during which we will continue our special study of financing growth capital for small- and medium-sized enterprises.
Today we have a group of representatives of the Fonds de solidarité FTQ and of GrowthWorks Capital Ltd. Witnesses for the Fonds de solidarité FTQ are Messrs. Yvon Bolduc, President and CEO, Mario Tremblay, Vice President of Public and Corporate Affairs and Gaétan Morin, Executive Vice President of Corporate Development and Investments.
We are also joined by Mr. Thomas Hayes, Senior Vice President of GrowthWorks Capital Ltd. Mr. Hayes, you represent the Atlantic branch of your operation?
Thomas Hayes, Senior Vice President, GrowthWorks Capital Ltd.: I am president and CEO of our Atlantic fund, but I am also part of our national organization as well. In the audience as well is my colleague Tim Lee, who runs our Ontario-based fund.
The Chair: Perhaps when you give your presentation or few words of introduction you could indicate the structure of GrowthWorks Capital Ltd.
Mr. Hayes: Absolutely.
We will go first to the representative of the Fonds de solidarité FTQ.
Yvon Bolduc, President and Chief Executive Officer, Fonds de solidarité FTQ: Good afternoon Senators, ladies and gentlemen. Let me to thank you on behalf of the Fonds de solidarité FTQ for this opportunity to explain what the Fonds de solidarité means to Quebec's economy as well as to Quebec's venture capital industry.
I have with me Gaétan Morin, Senior Officer for Investments in the fund's mission-centered portfolio, and Mario Tremblay, Senior Corporate Affairs Officer.
Naturally we would like to take advantage of our presence here before you to respond to comments, which were rather negative, about the Fonds de solidarité FTQ, made here by Mr. Douglas Cumming about two weeks ago. Mr. Cumming spoke mainly of the displacement effect, the so-called crowding-out effect labor funds are taken to have on venture capital funding available in Canada. Later in our presentation today, we will show you some updated information that will prove beyond a doubt that the facts fully contradict these theoretical assertions.
I would also like it noted that despite the fact the Fonds de solidarité FTQ alone accounts for more than three quarters of Canada's labor fund industry, Mr. Cumming made no effort to consider our model in detail or to take it into account in interpreting our results.
To return to today's presentation, we would like to briefly introduce the Fonds de solidarité and its place in the Quebec economy. Then I would like to talk about the VC industry and the specific role the Fonds de solidarité and other retail funds have played in bringing Quebec to its current positive position in the industry.
I would like to turn to page 4 of our presentation.
This page summarizes in a single picture what the Fonds de solidarité FTQ is doing to address the three challenges the Canadian economy now faces: Employment, productivity, innovation and retirement savings. Fonds de solidarité FTQ is part of the solution with respect to these three challenges. We offer a retirement savings product to nearly 600,000 shareholders. Here we see we currently have 583,000 shareholders with the solidarity fund, all individual taxpayers. With the money raised from these shareholders, we invest $700 million in Quebec companies every year. Last year we carried out 161 transactions.
As of May 31, 2011, our assets of $8.2 billion were split between two portfolios: a "mission portfolio," which is our SME investment portfolio in consideration of the tax credit we receive. Although 60 per cent of the monies must be invested in this Quebec SMEs mission portfolio, we also have a portfolio to balance the risks incurred by geographical concentration and venture capital concentration in a single asset class. We have $3 billion invested in the major equity markets and elsewhere.
Our mission portfolio is made up of over 2,000 companies. We have invested directly or indirectly in 2,000 companies and in so doing, created and maintained more than half a million jobs. It is important to remember that the fund's ability to raise money every year, for which it is called evergreen or perennial, the wheel turning and turning about each year, allows us to provide a source of stable, patient capital to Quebec's companies, its SMEs.
On page 5, we clearly demonstrate our success at encouraging Quebecers to save for their retirement.
Of our 600,000 shareholders, more than 200,000 made their first contribution to an RRSP through the fund and 80 per cent of these 200,000 have increased their retirement savings by contributing to RRSPs in financial institutions besides the fund. To encourage this, we have set up mechanisms to facilitate employee saving in 6,500 companies, 6,500 Quebec SMEs.
From page 6 the figure I would suggest you remember is the $6 billion the Fonds de solidarité has invested in Quebec's economy over the last 10 years. We invest in all regions of Quebec, in almost all economic sectors and at all stages of business development, in amounts that can be as low as $30,000 and as high as $100 million.
We have invested nearly $2 billion in start-ups over the past decade.
Two weeks ago, Mr. Cumming claimed before this committee that the Fonds de solidarité FTQ invested in non- performing companies. The numbers on page 7, taken from a study by SECOR Group, show just the opposite. The fact is that our partners and the company in which we invest spent almost four times more in R & D and racked up three times as much export sales as the Canadian average. The added value per job is also greater than the Quebec average.
On page 8, in consideration of that tax credit, we must have invested 60 per cent of our assets mainly in SMEs located in the province of Quebec. In spite of that, we are in the second quartile with an historic return for the last 28 years of 3.6 per cent. In the last two years we had 9 per cent return and 8.5 per cent return, but historically we are still positive, 3.6, before the positive effect of the tax credit and obviously after a very reasonable expense ratio of 1.5 per cent.
Finally, on page 9 of this rapid overview of the fund, it is important to keep in mind that the SECOR study I just quoted shows that our two levels of government recover tax credits made available to taxpayers, within less than five years for the federal, and just over two years for the provincial government. The tax credit is not a government cost, it is truly an investment.
A payback within three to five years is a very good deal.
I would like to spend a few minutes on the venture capital industry and the Fonds de solidarité's role in this industry. Earlier, I listened to PSP's interventions and I am not revealing anything here by saying Canada's venture capital industry is doing rather poorly, especially at raising funds.
It may surprise you to learn that the venture capital industry is doing much better in Quebec and we will see why.
On page 11, you see what has happened in Ontario since the labour fund tax credit has been eliminated. As you can see, the funds under management have been declining ever since. In fact, Quebec now has the same amount of funds under management as Ontario, whose GDP, as you know, is twice as large.
The facts, to us, clearly contradict the crowding-out theory. I am asking you: Where are the dollars that were supposed to flow in once the Labour-Sponsored Investment Fund disappeared? It never materialized. The Ontario government had to invest millions to sustain the industry, $350 million to be precise, over the past five years. For the same investment in tax credits, Ontario would have been able to raise over $2.3 billion on the basis of a 15 per cent tax credit.
I told you earlier that the fundraising problem is less serious in Quebec than anywhere else in Canada. Why? Simply because in Quebec we have made use of labor funds and their great ability to raise monies, putting contributions to good use in the venture capital industry by investing directly in Quebec's private funds.
On page 12, you will see that the Fonds de solidarité has invested nearly $1 billion in 42 Quebec-based private funds. Of these 42 funds, 16 are foreign funds that came to Quebec, to invest in Quebec and support the development of Quebec firms.
I refer you to page 13. There are many figures on it, but I would like to draw your attention to the last line at the bottom. What you see here is that the Fonds de solidarité FTQ's initiative to attract foreign funds has cost the two levels of government, as of now, $39 million in tax credits. But it has made for total investments from different sources of $336 million. In other words, every public dollar has generated $8 of investment.
On page 14, as you can see, this is based on the OECD Entrepreneurship at a Glance report, dated June 2011. In that chart, Quebec ranks third, just behind Israel and the United States for VC investment, expressed as a percentage of GDP. Unfortunately, Ontario is well behind. These figures clearly show Quebec's success in venture capital and the benefits of having organized labour and their fund contributing to the industry.
Before concluding, I should mention that all provinces with a labor fund program have enhanced it by increasing either the tax credit or the contribution limit, or both. Furthermore, a study in British Columbia shows that the program is beneficial in that province. Finally, in 2009 the Standing Committee on Finance, chaired by James Rajotte, recommended increases of the tax credit to 20 per cent and of the maximum contribution amount to $20,000.
As for the Fonds de solidarité, over the 28 years since we came into existence I think we have proven ourselves in Quebec. We encourage nearly 600,000 Quebecers to save for retirement. We offer Quebec businesses a stable source of capital, capital that is patient, different from that of many other sources and complementary to that of banks because our funding is subordinated and unsecured. We actively provide direct support to the Quebec venture capital industry. Governments recover their investments in the form of tax credits, within that I find to be quite reasonable time frames.
The Chair: Thank you, Mr. Bolduc. I would ask Mr. Hayes to speak and then we will move on to the question period.
Mr. Hayes, welcome to you. Thank you very much for joining us. I appreciate it. Perhaps you can give us a short presentation and then be good enough to answer questions.
Mr. Hayes: I will be brief, senator. I thank you and the committee for providing me with this opportunity to explain the role of retail venture capital funds outside of Quebec, since my friend here did such a good job in talking about Quebec, and how these funds support Canadian entrepreneurs. In fact, we are delighted to be here as well to support the good work this committee is doing in terms of making recommendations on government policy.
I would like to say a few introductory words about GrowthWorks. We are a recognized leader in the Canadian venture capital industry. We are national in nature. We have offices across the country: Vancouver, Saskatoon, Winnipeg, Toronto, Fredericton and Halifax. We have an affiliate office in St. John's, in Newfoundland and Labrador. We have specialized investment teams in core sectors. We, as a fund, have won numerous awards in terms of deal of the year/entrepreneur of the year. We manage about $500 million in capital in assets under management. We are a top-quarter manager in terms of venture capital and we focus on early-stage companies, which I think is the area of interest of this committee in particular.
In terms of our national presence, outside of Quebec we would probably be considered to be either the most active or just behind BDC in terms of activity, even in these past five or six years where fundraising has been low. We have, on average, invested in the area of $70 million each year. We have funded about 165 companies in the last six years as well.
You have heard from previous witnesses about the crisis in VC here in Canada. The investment and fundraising activity has dropped significantly, by as much as 80 per cent since the bubble of 1999 and 2000. We know the VC market is stagnant and the fund-raising pool is drying up.
We also know that VC capital develops great companies and industries. There is insufficient venture capital available for start-up companies. Frankly, both the federal and provincial governments, as well as the private sector, invest huge amounts of money annually in research and development, somewhere in the range of $25 billion to $30 billion a year. If there is no private-sector capital available to take it and commercialize that R & D, there is a tremendous lost opportunity here in the country.
Companies are, in fact, dying on the vine that cannot attract capital, either at the start-up stage or the follow-on stage, and in some cases are leaving Canada to access that capital.
I have a quote here from Greg Smith, President of the Canadian Venture Capital Association, recently this year when he said:
Fundraising continues to be the major challenge facing the venture capital industry. Without a fully-funded domestic industry, the future prospects of thousands of innovative firms that depend on a steady, reliable flow of venture capital investment to grow and prosper will be compromised.
We all know that venture capital is a driver of job creation of the future, innovation, new technology development and economic growth. VC has backed many of Canada's largest public and private technology companies. VC-backed companies generate almost 150,000 jobs in Canada, 1.3 per cent of all private sector employees and 1 per cent of the Canadian GDP.
The companies in which we invest have growth rates that are significantly higher than the average in their sector, they are highly R & D and innovation intensive and highly export oriented.
Mr. Bolduc referenced what happened in Ontario when they cancelled the retail tax credit, and it shows what government can and cannot do in terms of leveraging on the supply side. The Ontario numbers, I think, are as good an example as any of what can happen in that kind of a situation.
Interestingly, in addition to Quebec, the retail venture program has been strongly supported in other provinces. Over the last three or four years improvements have been made to the RVC tax credits. We have had increases in Saskatchewan and Nova Scotia, New Brunswick, and Newfoundland and Labrador. We have also had increases in the allowable contribution limits to individuals to invest in retail venture. It has worked very well outside of Ontario and is an important funding element in the rest of Canada.
In terms of specific ideas, I know you have had a number of witnesses who have talked about various things in terms of angel tax credits, corporate tax credits and trying to get the pension funds interested in investing in this sector. One of the specific things that we made representations on to the House of Commons Finance Committee in previous years was returning the federal tax credit back to the original 20 per cent from the current 15. We have already heard that the House of Commons committee in 2009, on a unanimous recommendation, agreed with that.
As well, another important measure would be to increase the amount that was available for tax credits on an annual basis. When the program started in the 1980s, I think the RRSP tax credit limit at that time was around $7,500 and the retail venture tax credit was $5,000. The venture tax credit remains at $5,000, and the RRSP limit has gone up to around $22,000.
A huge distribution channel for our funds has been lost because most of the investment advisers who work particularly in the IIROC channel. The bank-owned brokerage firms do not want to sell this asset class anymore. They do not get compensated for it. That is one of the issues. Moving that annual contribution amount would be a huge benefit in allowing us to raise more money, which then benefits the entrepreneurs who receive it.
You have heard some of the myths and realities in terms of some of the other witnesses who have appeared before you. I will not repeat that. I will close my formal remarks and we will get into the question and answer section. Thank you again.
The Chair: Thank you very much, Mr. Hayes. Excellent presentation, both written and verbal: succinct and to the point. We appreciate it.
Mr. Bolduc, do you have any comments to make on Mr. Hayes' presentation?
Mr. Bolduc: No.
The Chair: If not we are going directly to our list. The first to put a question to you will be Senator Ringuette.
Senator Ringuette: I have questions for Mr. Bolduc, but I will start with GrowthWorks.
Your recommendation, essentially, to the federal government is to increase to 20 per cent. As you have indicated in one of your slides, many provinces have moved to the 20 per cent. I am looking at your slide number 3 and the investment that was placed from 2004 to 2010. I was struck by the fact that in 2010 you are lower in investment, even in real dollars, than 2004. Explain that to me. Is it a lack of cash to make these investments or a lack of attractive venture capital to assist in the commercialization?
Mr. Hayes: Very simply, we can only invest what we raise in terms of the capital that we raise. In the heyday of this asset class, outside of Quebec they were raising close to $1 billion a year. I think last year nationally we probably raised, not just GrowthWorks but as an industry, $100 million outside of Quebec.
Senator Ringuette: Why is that? Is it because of the financial crisis, the crunch, or the fear of liquidity availability from our different funding institutions?
Mr. Hayes: There is a variety of factors, complex in some respects. I think the industry returns, poor returns in venture capital generally, and in the retail sector there were certain funds that did extremely poorly. That created an issue around the reputational benefits of the asset class.
Some of the structural issues are around the level of capital we can raise that provides tax credits. The $5,000 limit has been a huge impediment from a sales and marketing perspective for us, we think. We have, as a firm, continued to be active on the investment side with very little new capital coming into the funds. That has been a real challenge for sure.
Senator Ringuette: This is an assumption, if you want, but you say that in 2010 you invested slightly over $52 million.
Mr. Hayes: Right.
Senator Ringuette: Considering the number of companies that made financial requests where you have reviewed their portfolios and did all the risk analysis, if you would have had the cash, if the cash to invest was not a factor, how much would you have invested in regard to the number of companies that have made requests and the amount of cash that you would have advanced?
Mr. Hayes: That is a good question. I probably have not done that calculation nationally. In Atlantic Canada, we could invest between $15 and $20 million a year. We used to raise $80 million a year in British Columbia and had no trouble putting that money out. In Ontario, in the heyday, we raised as much as $600 million in a year, which was probably more than we could reasonably put out. My colleague would know better than I, but in Ontario I believe our firm could probably put out somewhere in the range of $150 million to $200 million; and there are other people in the business.
Senator Ringuette: You are saying that if there were incentive programs that would increase the availability of funds for you to invest, instead of looking at $52 million just for your firm, you might be looking at $1 billion?
Mr. Hayes: I would think so, collectively for the industry. I know from personal experience that there are opportunities we are unable to fund at the moment or deals that we are unable to participate in because we do not have the capital available.
Senator Ringuette: Mr. Bolduc, it is a pleasure to see you again before our committee. You mentioned in your presentation that 16 foreign funds were contributing to the industry in Quebec. How were these foreign funds invited to invest in Quebec?
Mr. Bolduc: In Canada, and in Quebec in particular given it is our job to invest in that province, we know there is science, technology. There is a lot of inventiveness, a great deal of innovation in Quebec, but often the problem is marketing. We watched what was happening in the United States and we said, how is it that it works better there? The reason is that they have networks, and there is incredible networking. It is difficult for a province, especially a French- speaking province by definition, to access these markets.
Over the years, we have developed relationships with major funds, in California, Boston, New York, North Carolina, in the areas of life sciences and technology. We have worked closely, I will not hide the fact, with the Caisse de dépôt et placements du Québec. The Caisse de dépôt manages $150 billion. It is obviously a world-class player, and all the large funds want investment funding from the Caisse de dépôt.
The Caisse de dépôt has opened the door for us on many levels. We had a large portfolio of Quebec firms in the new economy, and we wanted to have it better known. By dint of negotiations, and it took several years to implement, we now have a valuable network of funds that have settled in Quebec or have opened offices in the province. Sometimes they have investors on site who are able to get to know our businesses.
We have had several success stories as co-investors. They have brought us investment opportunities, we have brought them some, and more often than not we have been successful. When the bubble burst in 2002, everyone suffered. That is one reason why, even today, the industry is suffering in Canada. We are still up against the consequences of that bubble. We organized ourselves and today, our venture capital performance in the new economy sector has increased from less than 15 per cent to 5.9 per cent despite all the negative factors of recent history. All because we have become better organized, we have brought in more networking. We also learned better ways of doing things. We learned a lot from these relationships. Everyone has come out ahead.
Gaétan Morin, Executive Vice-President, Corporate Development and Investments, Fonds de solidarité FTQ: Good thing we did it. For example, in the field of life sciences, biotechnology. Currently in Quebec and in Canada, the biotechnology sector is performing very poorly. However, even though it is doing poorly in Quebec, we still have partners, because we ourselves have invested in private funds, both those of Quebec and Canada, but also in private U.S. funds.
So despite the fact there is insufficient capital available for biotechnology in Quebec, we have at least some partners with whom we can organize to invest anyway. Even though we are living in difficult times, we can afford to keep a few companies alive. The situation is very difficult in biotechnology. Fortunately we have created a network, as Mr. Bolduc said earlier, and, unlike other regions in the world, we can get together and at least provide enough oxygen for some companies in biotechnology.
Senator Ringuette: You mentioned, Mr. Bolduc, the example of one of these foreign funds coming from California. Is that mainly foreign funds coming from the United States, or do they come from elsewhere like Europe or Asia?
Mr. Bolduc: We have some in Europe too. We invested in an Israeli fund as well. We know the Israeli venture capital industry is model. That is why we approached them. One of these funds has also put monies into companies in Quebec.
It is a network that aspires to be international. We are less present in Asia, because it is fairly new and it is another reality, but Europe and North America represent the major portion of the international market for venture capital.
Senator Ringuette: How do SMEs approach you for funding? Do you have regional offices? Is there a Quebec government database listing all SMEs in need of venture capital, that you can draw on to make contacts? How does your process work?
Mr. Bolduc: I will leave part of the answer to my colleague who is responsible for the mission portfolio and for investment, but first I will respond to your question.
The way we have structured ourselves probably accounts for part of our success. On one page of my presentation, you saw all the sectors we operate in. We are present in 28 economic sectors. We have three levels of intervention. Locally, we have 85 local funds distributed all over Quebec, and we work closely with the CFDCs and the CLDs — Quebec local development centers. Whether it is at the federal or provincial level, local offices handle the investment business. It is the provincial government on the one hand, for the CLDs and the CFDCs are federal.
We have 85 local funds, where our investing is more "micro." The size of an investment can be from $50,000 to $100,000. That is why our portfolio is 83 per cent made up of SMEs with fewer than 100 employees, because we support regional development. Fifty-five per cent of our portfolio is outside the area of greater Montreal. This is our first level of contribution.
As to the second level, we have 16 regional funds in the 17 administrative regions of Quebec. They really are our eyes and ears on the ground in the regions. Each region has special needs. Each region has its advantages, and we try to understand these matters. The only way to do so is to put down roots there. It is a big advantage because we couple this with the third level where, in the Montreal head office, we make investments of more than $2 million. Regional funds have a responsibility to invest between $100,000 and $2 million; in Montreal we handle the investments over $2 million.
How do we do all this? With teams of specialists. We have a dozen venture capital funds. Internally, we have set ourselves up with people with expertise who often come from business. They come to the fund with their expertise and knowledge of the market, players, issues and they're able to ask the right questions. Over the years, a reputation has been built on that.
I give you the example of 7-G Entertainment in Vancouver coming to settle in Montreal. In Montreal, there is a lot of excitement around everything called video games. They came knocking on our door on the recommendation of other players, banks or other players in this field. Why? Because we have a reputation for getting the deal done, the common good of the partners is first and foremost that the transaction should work well, that the business goes well, then everyone comes out a winner.
The fund's outstanding feature is its complementary capital offer and it is important to understand this. I believe in a financial ecosystem with a variety of types of capital. Venture capital is going to be in a bigger rush. After 10 years, the money must be given back to the sponsors. Ten years is short. You have three or four years to invest, three or four years to make it grow and then two years to return the money. It is more rushed.
The Fonds de solidarité has patient capital. I am not saying it is better, I am saying it is complementary. Developing or setting up a business isn't something one does in six months. It takes years of support for the business.
We have the luxury of having patient capital to complement that of a venture capital firm, or of a bank which is guaranteed and takes precedence. We are subordinated and unsecured. We are not complaining, it is our mission, and it is why there is a tax credit. The business model is to tell your shareholders there is a tax credit. Why? Because the fund takes high risk: geographic concentration; concentration in a single private-equity asset class, Quebec SMEs. Sixty per cent of our assets are in it. You have seen PSP put five per cent of its assets into this class and they do it all over the world. Complementarities are a big advantage in a financial ecosystem.
Mr. Morin: I could complete that with an example. It is a fairly complete answer. I would like to illustrate it with an example.
Monday, I was in Chibougamau in Northern Quebec, in a mining and forestry area. We mentioned specialization. Our people who invest in the forestry sector, are investing in the forestry sector. They have acquired expertise. It is the same in aerospace or in biotechnology.
Although it is well known that the forestry sector has been in extreme difficulty, especially in the east of the country, over the past year we invested $125 million in this sector, with a strategy and by seeking out the best players. Our people know the best players and they have a strategy in relation to them. They go to all regions of Quebec to get the best player, the consolidator, the best company to add value. The company I visited Monday, with value-added products, is selling for four times the price of a two-by-four. In Quebec we say we have to stop exporting them to the United States. We have to export value-added products. This company does so. We build relationships with entrepreneurs, the best, we don't wait for them to call us, we call them, we tell them we have the capital, what our strategy is, who our partners are, should they need equipment. We know a company, Compaq, Sainte-Clotilde de Beauce who will deliver the equipment to you. It is a network. This detailed knowledge of our business segments allows us to get the yields we have to show for ourselves.
Senator Greene: I would like to return to the question of the labour fund tax credit. You did a great job in demolishing the arguments of Mr. Cummings, but I would like to go back to that.
On slide 11 in your presentation you show the growth in Quebec and the decline in Ontario relative to 2005 when the phase-out in Ontario began. I agree that they correlate with that, but are there any other factors that would explain why Quebec was increasing during that period and why Ontario was declining? It is not all about that tax credit, is it?
Mr. Bolduc: You are probably right, but that is the main factor. That is the only explanation I can logically provide. The crowding-out theory is that if you get rid of the labour sponsored fund, private money will flow in. The only explanation I can add to this is that there was a question of timing. Frankly, 2008 and 2009 were not very good years for investment. To be very blunt and honest, if you couple this fact with the LSIF, that can be one the explanation. I am trying to defend Mr. Cummings. That is probably one factor that explains why not as much money flowed into the province once the LSIF was terminated. We did not see that drop in investment in Quebec in the same period.
Going back to the ecosystem, sometimes part of the financing system does not work, but if you have diverse sources of capital another part may be accessible. That was the case in 2008 and 2009. We committed more than $1 billion. People from the industry came to my office and said I was crazy, that I would lose that money. I said that this is why we exist. We have a tax credit and we must be present when things get tough, and we were. We committed $1.2 billion.
Senator Greene: What would the market look like if we got rid of all of those in Canada?
Mr. Bolduc: You would probably lose a different source of capital. Taking Quebec as an example, our typical shareholder is the typical middle class worker. He gets access to this tax credit and makes a typical investment of about $2,300 per year. He receives a 30 per cent tax credit and is happy with that because it provides him free cash that otherwise would not be available. That $2,300 would not normally go into projects or SMEs. You would not even dream of getting that kind of money in the new economy where risks are huge. We have essentially mutualized the risk. These people are willing to take the risk, first, because there is a tax credit, but second, because we have the experience to know how to invest that money profitably. They trust that we can invest the money in Quebec properly.
That kind of money would not otherwise be available. Last year $700 million was invested. We were able to make 161 deals because we had access to that pool of capital that otherwise would not be available. It would probably be spent on a Ski-doo, which is not bad, but certainly not as good for the development of the economy.
Senator Greene: Israel has the highest per capita rates of investment. Do they have these funds?
Mr. Bolduc: No. It is purely government money, but they have a huge advantage: New York. They are able to get their companies and bring them to the U.S.
Senator Greene: You consider Israel to be an offshoot of U.S. market?
Mr. Bolduc: Absolutely, yes.
Senator Hervieux-Payette: Can I complete what you said about the advantage? I think we have achieved one thing, which is educating Quebec people — or as you say, the average worker — to invest.
Senator Greene: It is a cultural thing.
Senator Hervieux-Payette: It is an educational thing. There were employees and the boss. The boss was making money and exploiting the employees. Now they understand how the system works. If the boss makes money, so will they. It has also reduced the numbers of strike days in Quebec tremendously. The time I was working there in the Department of Labour, this was probably the best result. It is not just money. It is that people now know how the economy works all over Quebec, because they are present in every region of Quebec. In fact we have their full contribution and when they go to work, they go for themselves. I think it is complementary.
Mr. Bolduc: You are absolutely right and I do have those numbers. When the FTQ was created in 1983, the number of man days lost in conflict, work stoppage, strikes, was 2.4 million per year. This year, the number is 250,000 days. It is a huge change. I am not saying it is all because of FTQ. I have been there for 10 years and things change. People trust each other more, they better understand what making money is all about, how important it is to reinvest and bring in new machines, even if it costs jobs. That is a huge impact on the economy. It is the same thing from the point of view of the owners. They understand that if you trust the brains — the intelligence of the workers — that very often they have the solution, because they are on the floor and know what is going on. If you start listening to them, suddenly you get better communication and better performance. We do influence that because we have a program. We call it « formation économique. » We train people in the companies where we invest. If you do it for one company it is good, but if you do it in thousands of companies it changes the economy.
Senator Greene: Why do you think Ontario has given up on these things?
Mr. Bolduc: First, when you invest, you invest for retirement purposes. You cannot buy back the shares until you retire, lose your job, start a company, start a business, go back to school, or buy a house. Otherwise you cannot buy back the shares until you retire.
It is not forced saving, but very close. That is the first difference.
Senator Greene: In Ontario you are allowed to sell at any time?
Mr. Bolduc: I think it is six or seven years. It is almost too easy. You have to find a way to get liquidity otherwise you will not be able to buy it back. That puts pressure on those funds that we do not have. We have the luxury of sitting on investments. We keep good investments in the portfolio for 20 years, if necessary.
The second reason is in Quebec we were able to say we will limit the number of funds, because we need critical mass. If you do not have critical mass then the expenses related to running the fund does not make sense. If you have 50 funds it would not work. The third reason is that we structure the access to the funds through the FTQ network. The FTQ started with companies that were unionized. The first contributors were union people. Now, out of 583,000 shareholders, 55 per cent is unionized and 40 per cent is general people not related to any union. That was key to the success of the FTQ.
Senator Ringuette: I am from New Brunswick, but continuously keep abreast of what is happening in Quebec having also lived in Quebec for some time. There's an effect of financial education, but there's also the matter of having told Quebec investors that their investments would be invested at home.
Mr. Bolduc: We have 583,000 shareholders. We provide them with a personal portfolio and they get a report each year. We personalize the report, and they know how we have invested. If they are in Gaspé, we will point out in the report what kind of investment, the amount we have invested, and in which company we have invested in their region. We do this for all shareholders.
Senator Ringuette: There's a sense of belonging.
Mr. Bolduc: We do respect the spirit that was behind the creation of the FTQ.
The Chair: What exactly are the criteria? Do you invest in a company that itself invests outside Quebec or that operates plants outside Quebec? What is the minimum requirement? Does there have to be a factory or place of business in Quebec?
Mr. Bolduc: An eligible investment, by the rule that sets the 60 per cent proportion, is quite complex. The idea is to invest in a SME established and headquartered in Quebec. However, one can also invest in companies outside Quebec if they undertake to do business in Quebec or if there are economic benefits for Quebec.
I will give you an example. I myself tour throughout Quebec given it is part of my duties. In 2009 — I will always remember it — on one of my tours, a worker whom I do not know comes up to me and shakes my hand, warmly thanking me. I really wonder why. He then tells me that over several years, he had invested the equivalent of the value of a case of beer in the Fonds de solidarité.
When the Thurso mill closed, he lost his job. But as he was able to redeem his shares of the fund, he told me it allowed him to get through that difficult period with more dignity.
The mill was then reopened because a company in Vancouver, Fortress Paper, became interested in the mill and decided to reopen it. They sat down with us, looked at it, and then with investments of several million dollars, the plant was reopened. So the gentleman in question got his job back and he still contributes to the Fonds de solidarité for his retirement.
So this was a company from outside Quebec, investing in Quebec. Right now, we are restarting another pulp and paper mill in another region of Quebec, with the same company. It is a synergy very difficult to calculate, as to whether the tax credit is good or not.
Also, what I said about the dignity of the individual is another intangible. As stateswomen and statesmen, I think you might also take this into consideration.
The Chair: If I understand you correctly, you said the headquarters should be in Quebec. If the head office is in Gatineau but the plant is located in Ottawa, does that work?
Mr. Bolduc: Yes, you can invest.
The Chair: Because the workers cross the river.
Mr. Bolduc: Quebec, it is still a small market. Obviously, we encourage our companies to develop markets outside and we will fund expansion and acquisition projects.
So much so that we are sometimes criticized in the newspapers, publicly. People say, « Hey, tax credits, look, it is to open a factory in the United States! » Well, yes, but if we don't do this, we will not have any more Bombardiers or Cirques du Soleil in Quebec.
We have to be able to support those companies, and we will continue to support them, in spite of the flak we will get.
The Chair: Do not worry what they will say about you.
Senator Moore: We heard criticisms from previous witnesses that with regard to the labour-sponsored funds, there is a heavy administration expense ratio and also that there are problems because they often raise too much money at the wrong time. Mr. Bolduc, you said your expense ratio is 1.5 per cent.
Mr. Hayes, where does your company fit in terms of expense ratio?
Mr. Hayes: Each fund has a separate expense ratio, depending on the size of the fund. We would love to have the kind of assets under management that Mr. Bolduc has, to lower our MERs. They range anywhere from 4 to 5 per cent, depending on the funds. As the funds grow, those numbers will go down.
Mr. Bolduc: Mutual funds have an average of 4 to 5 per cent. We are really low. We are at the bottom of the ratio here.
Senator Moore: What about the comment of raising too much money at the wrong time? What does that mean?
Mr. Bolduc: If you ask the question to companies and entrepreneurs who operate new businesses and try to start a business or expand their business, I do not think you will get the comment that there is too much money available.
I think the key, going back to my analogy of the financial ecosystem, is that it is not the quantity of money but the type of money that becomes available.
Senator Moore: What do you mean by the "type"?
Mr. Bolduc: Our capital, for example, is patient, because we are an evergreen funding and we do not have to return the money until people retire, and sometimes it is 20 or 30 years down the road. We are sometimes able to reinvest. The tax credit is very efficient because we will invest two or three times the same money into different companies, with the same tax credit; whereas in Ontario, for example, after eight years you would have to pay another tax credit to get the same money back into the system. That type of money is very patient. For a business or entrepreneur, it is comforting.
Do we have too much money? My answer is certainly not. We have been able to invest and our pipeline is really strong. The demand is there, and we can afford to be very selective and we have to be very selective. We have to, on the one hand, support development, jobs, creation, et cetera, but on the other hand we also have to be responsible to our shareholders and provide a return that is reasonable, given the risk they are taking and the fact that they get a tax credit for that type of risk.
Mr. Hayes: That comment comes from a situation that arose only in Ontario, only in one or two years, back in the mid-1990s. When working ventures raised significant capital, they have overly aggressive pacing obligations put on them by the Ontario government.
Senator Moore: "Pacing" meaning what?
Mr. Hayes: Having to invest the money and get it out in a certain period of time. Thus, those funds went off sale for a couple of years to reduce the level of capital they had.
However, that is a myth today. That is just not the case. Demand far exceeds the supply. What is frustrating for some of us is that it is all about Ontario, when in fact the program is working very well in the rest of Canada, for the most part. That is what people have to recognize and remember. Some of these myths that have been put out there are based on false information, false assumptions, and it is a program that is working well in most other provinces.
Senator Moore: The previous witnesses from PSP Investments said that out of ten deals, four fail, three are okay but usually require additional monies, and three are well performing. Is that your experience from your two funds?
Mr. Bolduc: In VC it is true.
Mr. Hayes: It is. However, you can hit home runs. The best two deals in Canada in the last 10 years were in New Brunswick this year — Q1 Labs and Radian6 — and they made huge returns on those deals. You get a couple of home runs and it makes up for a lot of the walking wounded and the folks that go south.
Mr. Bolduc: That is the nature of the business everywhere in the world. Those ratios are true. That is why it is a high- risk business.
Senator Harb: The chair and others have asked about how to increase the amount of funds available. One comment was to return to the 20 per cent tax credit to match the provinces' various credits. Any other ideas besides the tax credit vehicle? Is there anything else we could do that you can say to the committee we could recommend to government?
Mr. Bolduc: I have been made aware of a report called the Jenkins report. There are a few recommendations that we think should be supported. We believe in those recommendations, because we do it right now. There is a tax credit for research and development, and we have to be able to support manufacturing in Canada.
I do not know the proportion in the rest of Canada, but in Quebec it is 15 per cent. We see in the United States how important manufacturing is. The tax credit for industrial innovation, internal improvement, more efficiency and more productivity, is key.
Senator Moore: Within the existing plant?
Mr. Bolduc: Yes. That is key. That is for sure. I was saying that I have travelled around Quebec, and the first concern for most business owners is jobs and how to get specialized jobs filled. At the same time, we have a number of unemployed people. One thing that would be very important is to try to get those unemployed people retrained. Mobility and retraining is key.
Mr. Hayes referenced commercialization. You have to be able to take a new product, sometimes a great product, and be able to sell it and find a way to support. EDC does a great job. Finding ways to help companies sell their products worldwide is key. How do we do this? We have a financial product that helps companies, and if they are successful, then we get a dividend out of it. Otherwise, we try to help them, and we have a minimum return. If it is a success, they win and we win. We need to help them find networks and find ways to sell their products.
The last one is to support a culture for entrepreneurs and to develop entrepreneurs across Canada and across Quebec. That is very important. Too often, our graduates go and work for huge corporations, and you have to find a way to keep young people hungry with a desire to succeed. How do you do that? There are many ways, but certainly it is key to support the entrepreneurial culture.
Mr. Hayes: In addition to that, if you look at the U.S. model, which is deemed to be quite successful, the role that universities have played in conjunction with the VC industry has been critical. We have wonderful universities in Canada. Some, we think, are better than others, but I will not go there. I think that is an opportunity that we need to focus more on, to get that R & D out of universities and into the commercial marketplaces and utilize these universities in a more effective way in that sense.
For those of you who are from Atlantic Canada, you have Memorial, UNB, Dalhousie and St. Mary's. These are all good schools. Those two companies in New Brunswick, which created $1 billion worth of wealth for shareholders, one founder from UNB was the founder in both companies. That is incredible.
The Chair: Mr. Bolduc, suppose you had someone who had a wonderful product, but it is quite clear that his marketing is not as wonderful.
The person needs training. Can you invest, knowing that the money you will put in will be used to improve their marketing, or would you need to invest in the machinery, in the company's shares?
Mr. Bolduc: This guy is on the ground on a daily basis.
Mr. Morin: Let me go back to proactivity for a moment. When we invest in a company, we ensure we are present on the company's board of directors. If there is no board of directors, we do not invest, it is a condition. From the outset of investment, a board of directors has to be created so that the entrepreneur can be supported by different areas of expertise.
The Chair: Even the person to whom you lend $50,000?
Mr. Morin: Maybe not for $50,000, but I would say to invest $2 million or more, it is a requirement. And if we see there are gaps in the marketing, we will sit down with the entrepreneur and explain that we have, in our network — because we have a databank of administrators classified by expertise —, a person who has marketed products in the past, and that we think that a certain person should be their representative on the board of directors. So the idea is to give entrepreneurs the leverage to make it possible for them to export outside the country, for example.
Mr. Bolduc: We are not there to lecture them. They're the ones taking the risks. We are looking for managers, but sometimes you have to fill in specific gaps. This is a contribution we make, besides the money obviously.
The Chair: We have already had witnesses tell us how important networking is to marketing.
Mr. Morin: As we were saying earlier, of ten cases, we will lose two or three. I would say about 75 per cent of the files we lose, regardless of sector — new economy, traditional sectors —, are the ones for which the marketing has not been well planned.
Senator Hervieux-Payette: It is a subject I have often discussed. Sometimes you have companies with a turnover of $20 million, and you still have to inject more money, especially in marketing because some expensive products sold in Canada should be sold on a larger scale. Is this one of the things you notice?
In this case I think you had injected a few million, and finally, it was an American who bought the company. But he gives nothing back to Canadian society, neither more tax credits nor what you invested. He takes off with the company after you've already invested $20 million.
So if it is good for an American, why would it not it be for us?
Mr. Bolduc: You are right. This is one reason why we have structured the venture capital industry, saying that to have a strong industry in Quebec, we will help fund funds, we will attract foreign funds. We were often the only ones with the financial means to do so. We have invested $20 million, do we put $20 million more without knowing where we are headed? We had to find another investor with deep pockets, believing in the project, and at that time this investor would share the risk with us. And that is what we managed to do.
So instead of having made an acquisition and being forced to liquidate because we had no other choice, we thought we would buy time by finding other U.S. funds that could invest the $20 to $30 million we need to help this company. We go no further. We can add a little, but we just shared the risk, which makes our investment much more reasonable.
I will not hide from you that we use all kinds of procedures to calculate our risks, our funding envelopes by risk type. When we exceed a certain level of types of risk, we stop, otherwise it would be disastrous. We juggle all the factors and try to do the best we can.
It is a great question and yes, it was a problem that we tried to avoid. What we saw coming, too, was that after the financial bubble, for venture capital and fundraising it was going to be a desert for the next 10 years. That is what's happening. And we wondered what we were going to do in Quebec to avoid this. Solidarity and labor funds are extraordinary fund-raising engines.
I sat down with the key venture capital players in Quebec and we said we are going to invest sums of money, we will undertake to support industry in order to be able to show that, yes we have suffered, but that the talent is there, the skills. So we will support industry and give you the chance to prove you're a self-sustaining industry. We have invested $1 billion to this end, and we will see what the results are. But I am confident it will work.
The Chair: We have had a fruitful and interesting dialogue. On behalf of all the members of the committee, thank you, Mr. Morin, thank you, Mr. Bolduc.
Mr. Hayes, it has been a very useful evening, and I appreciate your frankness and the fact that you stuck to our mandate, and I think you have helped us immeasurably.
(The committee adjourned.)