The study assessed British Columbia's Equity Capital Program, which provides tax credits to encourage early-stage investing. It found the program successfully increased early-stage capital availability, though BC still lags larger markets. The program's direct investment model was particularly effective at attracting angel investors. However, a lack of follow-on funding remains a challenge. The study concluded the program meets its objectives and its tax credit model could be expanded nationally to further support startups.

1. The Equity Capital Program in British Columbia An Assessment of Capital Availability, Program Efficiency and Policy Alternatives National Angel Organization Summit Ottawa, October 2005

2. Study’s Terms and Methodology Terms: Commissioned by LEBC in 2004 in response to a request from the Premier’s Technology Council to expand the program’s tax credit budget LEBC selected Prof. James Brander with the UBC Sauder School of Business to conduct the study examining: Venture capital availability in B.C., Program efficiency in supplying early stage capital for small business, and Possible policy or program changes that would enhance supply Methodology: Over six months UBC conducted a comprehensive assessment by: Reviewing capital and financial data of 83 companies randomly selected from a pool of Small Businesses receiving capital under the program from 2001 to 2004, Conducting interviews with 35 members of venture capital community from B.C., and Reviewing private capital exemption data filed with the BC Securities Commission during 2003 and 2004

3. Equity Capital Program – an overview *

4. Capital Availability – BC’s Strengths BC through its improved business climate and program policy has come a long way in increasing the supply of early stage capital…particularly at the “seed” stage *

5. Capital Availability – BC’s Challenges BC has fostered a healthy climate for early stage capital…but there exists a shortfall of follow on financing for promising companies *

6. Capital Availability – BC from a North American perspective BC along with Ontario and Quebec have a “solid” position in comparison to the Tier II US jurisdictions…but maintaining or improving this position requires quality deal flow & supply *

7. Capital Availability – the importance of “Angel” investors Angel finance is important – far more important that formal venture capital…particularly for early stage equity finance. Most jurisdictions know very little about the availability of angel financing Using the program data and filings with the BC Securities Commission, it was estimated that between 60 and 80 per cent of all equity stage financing in BC over the past 24 months was provided from angels (approx $355M) The availability and organization of angel finance in BC is good and comparable to levels in the U.S. The Equity Capital Program – particularly the “EBC direct investment model” is an important factor in encouraging early stage investment in the province.

8. Capital Availability – Summary of Findings Progress is being made: BC remains well behind the U.S. Tier I VC jurisdictions, but it is competitive with the leading Cdn and Tier II jurisdictions…particularly in the area of early stage financing The program has contributed significantly to positioning the province as a national leader in “seed” round financing – particularly by attracting angel investors to the program Challenges still to overcome: A lack of institutional participation in form VC funds has lead to a shortfall of “follow on” financing in BC – this shortfall cannot addressed with retail VCC/LSVCC tax credit funds alone Inadequate funding by “deal” round has led to companies going “public” too soon draining their cash flow and leading to premature acquisitions – great opportunities for corporate / US investors

9. Seed Financing “Gap” : Since 2000 direct research funding has increased by $6.2B, while early stage funding has declined by $1.5B Source: Price Waterhouse Coopers and 2004 Federal Budget Company Stage Round Size Concept or Patent Prototype First Product Early Market Market Expansion Mainstream Market Expansion ($3M - $7M) Start-up ($500K - $1.5M) How does this new “direct investment” model work? Seed ($0 - $500K) Angels & Insiders Mezzanine ($7M+) Corporate / Others Early Stage ($1.5M - $3M) Lead Follow

10. Direct Investment Model (Eligible Business Corporation) Eligible Business Corporation (EBC) Province of British Columbia Investors Shares 30% Tax Credit $ The Investors: Arms-length from the owners of the Eligible Business Corporation Shares may not be transferred, redeemed, acquired or cancelled for 5 years. The Eligible Business Corporation: Less than 100 employees Pays at least 50% of wages to BC residents Engaged in one of the following: Manufacturing & Processing Destination tourism Research & Development of technology Community Diversification or, Development of digital new media

11. Program Capital Analysis: Average Number of Investors per Registrant Data observations: Small businesses opt for the simplicity and low cost of the EBC “direct investment” model despite the number of investors The numbers of investors remain below 50 to comply with securities regulations for the “Friends, Family & Associates” capital exemptions The portfolio VCCs are successful in attracting investors by being established, diversified and professionally managed

12. Program Capital Analysis: Average Amount invested per Registrant Data observations: An average of $200K was invested in technology related companies who are trying to bridge the “seed gap” of financing Most companies receiving financing have yet to receive funding from traditional or other VC sources – primarily funded through shareholder loans

13. Program Capital Analysis: Individual Investment Amounts Data observations: While an average of $13K is invested per investor across all deal sizes, a significant amount of this capital came from smaller investors investing in portfolio VCCs When portfolio VCCs are excluded, the average investment amount rises to $25K suggesting that these investors are relying on private capital exemptions (not retail/prospectus offerings)

14. Data observations: The sectors appealing to program investors include information technology, life sciences, and manufacturing The majority of capital raised outside the Lower Mainland continues to be placed in the manufacturing sector Small Business Profiles: EBC Activity Type in 2005

15. Small Business Profiles: EBC Regional Location in 2005 Data observations: Of the program registrants located outside the Lower Mainland, 22 were registered as EBCs representing 28% of program uptake Traditionally only 2% of the VC market serves the regional areas of the province With the introduction of the Direct Investment Model in 2003, the percentage of registrants in the regions has remained constant

16. Program Efficiency – are objectives being met? Additionality – study concludes that 60% of the investments made under the program would not have been made without the tax credit – actual range is between 50 and 70 per cent , which is consistent with the Cambridge study evaluating the UK’s Enterprise Investment Scheme program Early stage capital supply – presently supplying up to $36M per year for investment in early stage companies (and increasing) – in sum: The total supply represents 15% of total formal VC investment, Representing 9% of the total annual VC investment levels in BC – consistent with the level of SBIC programs in the US, and While the program is far from dominant…”it is viewed as highly significant”. Program acceptance – based upon survey information there is a high level of support for the program from the investment and the knowledge based entrepreneurial communities Later stage investing – a minimal amount of program capital (10% or $4m per year) is invested in companies that are beyond the “early” rounds of financing – most often this involves retail VCC funds either providing follow-on financing or trying to achieve “portfolio” diversification

17. Program Policy Alternatives – ECP a “national” program? Consensus Reached – the studies’ authors found broad support through client surveying for a “national program” model after the ECP. The key elements of this consensus are as follows: In favor of a systematic national program like ECP, with the federal government providing half of the tax credit, just as is currently done with the LSVCC program, Eliminating the “LSVCC” distinction and simply allowing any qualifying fund – VCC, EBC or LSVCC – to qualify for tax credits on the same basis, A resulting national program should include both an “EBC” direct model and a portfolio component, however the latter model might not necessarily be built around retail investors, and Tax credits under the program be “capped” (as with the ECP) and that tax credits be allocated based on performance. National Support Received – ECP as a national program is also supported by the National Angel Organization, BC Technology Industries Association and… most recently the Conference Board of Canada named the program as one of the six “key drivers” for Canadian commercialization of technology.

18. Program Policy Alternatives – Tax credit % & budget management Tax credit % – the studies’ authors suggested to curb excess demand program capital reduce to the credit to 20 to 25% rather than 30% - they believe this would not only increase program capital supply, it would also ensure an optimal allocation of capital to efficient enterprises based upon fundamental economic analysis. However the study does acknowledge: The current 30% tax credit is “on par” with competing jurisdictions offering similar programs both in Canada and the U.S., and Reducing the tax credit would leave the VCC retail fund managers at a disadvantage with managers offering competing “tax assisted” financial products (I.e. Cdn Exploration Expense unit trusts). Budget Management – two recommendations calling for: A “pooling” of tax credits over a finite period of time to deal with unexpected market demand for program capital – government still has the ability to budget and clients don’t have to experience a “claw back” of capital allocation, and More allocation of total program capital to the EBC “direct model” based upon feedback from the VC community who like the efficiency of this model.

19. Program Policy Alternatives – other options to consider Additional Items – two recommendations calling for: Reducing the hold period of the program from 5 years to 3 which is in line with traditional venture capital investment, and Future program studies that would gauge: An assessment of performance of firms supported by the ECP, and Ecosystem dynamics – considering strategies needed to allow the private equity ecosystem to absorb and derive the maximum benefit from knowledge based ventures in the future.

20. Program Study Contacts: Dr. James Brander Asia-Pacific Professor of International Business Sauder School of Business, 2053 Main Mall University of British Columbia Vancouver, B.C., V6T 1Z2 Phone: (604) 822-8483 E mail: [email_address] R. Todd Tessier, CMA, CA A/Vice-President, Private Capital Markets Leading Edge British Columbia #900-1188 West Georgia Street Vancouver, B.C., V6E 4A2 Phone: (250) 882-7862 E mail: [email_address] or, todd.tessier@gov.bc.ca