What is “Venture Capital”?

       Venture Capital refers to the funds provided by investors (also known as the venture capitalists) to start-up companies and small businesses with the potential for long-term growth. Venture Capital provides the financial resources to start-ups which may not have the access to capital markets otherwise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. Venture Capital helps solve the problems for entrepreneurs who have difficulties raising funds by issuing debt. What entrepreneurs need to keep in mind is that venture capitalists usually have a say in company decisions on top of holding a portion of the company’s equity.

      

           The loans Venture Capital makes to start-up companies are often high in rates with the possibility of an annual return rate up to 50 percent. However, unlike banks and other lenders, venture capitalists can take equity position, which means that you can give a portion of your or other owner’s interest in the company to the venture capitalists instead of paying out cash in the form of interest and principal instalments. 

   
Companies that venture capitalists are most interested in are those who have:

     1. Rapid, steady sales growth;

     2. A new technology or dominant position in an emerging market;

     3. A sound management team;

     4. The potential for being acquired by a larger company or getting publicly listed in the stock market.

    
 There are three different types of venture capital:

  
 1. Private venture capital partnerships are perhaps the largest source of risk capital and generally look for businesses that have the capability to generate a 30 percent return on investment each year. They like to actively participate in the planning and management of the businesses they finance and have very large capital bases--up to $500 million--to invest at all stages.

     

      2. Industrial venture capital pools usually focus on funding firms that have a high likelihood of success, like high-tech firms or companies using state-of-the-art technology in a unique manner.

     

      3. Investment banking firms traditionally provide expansion capital by selling a company's stock to public and private equity investors. Some also have formed their own venture capital divisions to provide risk capital for expansion and early-stage financing.

The way to contact venture capitalists is through an introduction from another business owner, banker, lawyer, or other professional who knows you and the venture capitalist well enough to approach them with the proposition.

What do I need to know in order to set up a company in the U.S.?

    There are a few important questions you may want to ask yourself before you set up a business in the United States. 

1.     What will the company do? 

• There are some activities that require a license (such as medicine, dentistry or architecture) or special permission (banking, insurance, aviation) before it can be formed.

2. Who will own the company? 

• These will be the shareholders of a corporation or members of a Limited Liability Company ( also known as "LLC").

3. Who will manage the company? 

• These will be the directors and officers of a corporation or managers of an LLC. 

4.  What will the company’s name be? 

• It must follow the rules of the state where the company is formed, and have a corporate indicator.

5. What type of entity will it be? 

• Generally, it will be a corporation, an LLC, or a sole proprietorship. 

6. What state will it be incorporated in?

•  This will be either in the state where it is doing business, or in another state like Delaware where there are special legal benefits. 

7. What state will it do business in? 

• If this (or these) state(s) are not where the company is incorporated, it must register to do business there as a foreign corporation. 

8. Who will act as registered agent? 

• Almost every state requires its companies to maintain a legal address and agent within its borders to accept legal process and to which the state government can send annual reports, annual tax forms or other compliance matters.

To learn more about how to set up a company/business in the U.S., please come to our special seminar called "Setting up your U.S. Business" to be held in mid-October, 2013 by Renate Harrison, a US & Canadian Business Lawyer of HazloLaw. For more information about the seminar, please call HazloLaw at 613-747-2459 x 306. 

Ms. Renate Harrison: 
A graduate of the prestigious Harvard Law School, Renate Harrison is a U.S. and Canadian business lawyer at our Ottawa office and she practices in the areas of Business Law and Corporate Finance. Renate advises Canadian companies on the formation and operation of U.S. subsidiaries and on strategic alliances, joint ventures, mergers and acquisitions, divestitures and asset sales. In that capacity, she regularly acts for start-ups, private equity and venture capital firms, issuers and underwriters in placing  debt and equity securities in Canada and in the United States. Renate is a member of the Ontario bar and she is also admitted to practice law in Massachusetts and Tennessee in the United States. To learn more about Renate Harrison, please visit http://www.hazlolaw.com/people/renate-harrison.  

New Permanent Residents: Tax-related issues and obligations you should know about before and after you immigrate to Canada

In Marcil Lavallee LLP's most recent Tax Letter, they did a fantastic job summarizing the tax-related considerations and obligations for new immigrants (Permanent Residents) living in Canada and before moving to Canada. 

Tax on worldwide income

The most important thing to know is that, once a person becomes resident in Canada, they are taxable on their worldwide income from all sources, including foreign income. This will include, for example:

• Pensions from the home country;

• Interest being earned in bank accounts in the home country;

• Gains from selling property in the home country.

You should also know that Canada now has tax treaties or “tax information exchange agreements” with over 100 countries. More such agreements are being signed all the time, specifically for the purposes of exchanging information; and new mechanisms for computerized exchange of information are going to be introduced in at least some situations.

Expect the Canada Revenue Agency to find out about pension income, bank interest, sales of real property and other sources of income in the home country. Taxpayers who do not report their income can be subject to severe penalties and even prison.

Reporting foreign assets and trusts

All Canadian residents must state, on their annual income tax return, whether they have foreign investments (cost exceeding $100,000), or, in some cases, whether they are beneficiaries of foreign trusts or own shares (directly or indirectly) in foreign corporations. Starting next year, the information required for foreign assets and investments will be very detailed.

New immigrants need to take particular note of this requirement, and disclose assets or investments they have left behind in the home country.

Steps before immigrating to Canada

There are a number of tax planning steps that the prospective immigrant should consider before

moving to Canada.

• Arrange to receive all payments for pre- immigration employment outside Canada before immigrating. If employment income is received after immigration, Canada will tax it.

• For immigrants with substantial assets, consider setting up an “immigration trust”.

 If structured properly, this can allow the immigrant to keep funds offshore and not pay any Canadian tax on the income for five years.

• Note that capital property (e.g., real estate)  is generally deemed disposed of and  reacquired at fair market value on  immigration. This will boost the cost base of the property up to its current value, for purposes of future capital gain or loss calculations. The immigrant may want to obtain a formal evaluation of such properties to document the value for later.

• Any Canadian professionals who are advising the immigrant (e.g., lawyers or accountants) should render an account for  time spent to date before the immigrant  moves to Canada. The account will not  bear GST or HST.

Tax issues after becoming resident

If you are a new immigrant, you should consider the following:

• As noted above, you will pay tax on your worldwide income from all sources. Make sure to identify and report these to the CRA, even if you have left the income offshore. Note that some forms of income (e.g., pension income) may be given special relief by the tax treaty between Canada and your home country.

• Obtain a Social Insurance Number upon arriving in Canada. This number will be used as your Canada Revenue Agency account number.

• If you are carrying on business, consider whether you need to register for GST/HST, and to collect and remit GST or HST on your revenues.

• Have you become resident in Canada for tax purposes? Aside from the ordinary meaning of “resident”, if Canada has a tax treaty with the home country, check how the “tie-breaker” rule applies if you might still be resident in both countries.

 For example, if you still have a home in both countries and travel back and forth, the answer may not be obvious.

• If you control a foreign corporation, you generally have to report its passive income as “foreign accrual property income” (FAPI), and pay Canadian tax on it each year. The FAPI rules are very complex and you will need professional advice.

• If you receive income that is subject to foreign tax (e.g., foreign withholding tax  on interest or pension income), you can normally claim a “foreign tax credit” for  this tax on your Canadian return, up to a  limit of your Canadian tax on the same  income. The rules can become complex, but in general you end up paying the higher of the two countries’ tax rates in total.

• If you are a US citizen, you must continue to file US tax returns even though you are no longer resident there. To reduce the impact of double taxation, you will want to claim the US “foreign earned income exclusion” against your employment or self-employment income in Canada, as well as US foreign tax credits and any relief provided by the Canada-US tax treaty.

 Professional advice from a specialist in both Canadian and US tax law is usually recommended. Note also that the US and Canadian tax systems differ in many ways, and your calculation of income for the two systems may be very different.

• Consider setting up a TFSA (Tax-Free Savings Account) and contributing funds to it so that you can earn a certain amount of investment income tax-free. (If you are a US citizen, this is normally not advisable.)

• After your first year of earning employment or business income, set up a registered  retirement savings plan (RRSP) and  contribute the maximum possible to it  (unless you are planning to emigrate from  Canada within a few years, in which case  there could be negative consequences).

• If you have children under 6, apply to the CRA for the Universal Child Care Benefit. If you have children under 18 and your family is relatively low-income, apply for the Canada Child Tax Benefit. If your family is low-income, apply for the GST/HST Credit. (See cra.gc.ca for more information.)

• Payments under pre-existing spousal support obligations may be deductible for Canadian tax purposes. If the payments qualify, keep good records and make the claim on your Canadian tax return. 

• A person who dies while owning property in the US, or a US citizen who dies, is subject to US estate taxes. A credit to reduce or eliminate this tax is provided by the Canada-US tax treaty. 

4 ways of custom financing an acquisition

Acquiring a business often requires multiple sources of financing. This can be a complex undertaking, especially in cases when more than $500,000 is needed. In most cases, there are four types of lenders and investors willing to finance an acquisition.

Lenders interested in fixed assetsAcquiring a business often involves the purchase of buildings or equipment. Your tax advisor might suggest you take out a separate bank loan for this part of the project, either from your bank or jointly with other financial institutions.

The Canada Small Business Financing Program makes it easier for small businesses to obtain financing from banks up to a maximum value of $500,000, of which $350,000 can be used to finance the purchase or improvement of equipment and the purchase of leasehold improvements.

Lenders interested in the whole package BDC often supports expansion projects with term financing. Unlike conventional bank loans, this formula allows flexible repayment terms. Another advantage is that a BDC loan will not be called without a valid reason.

Companies that have a competitive advantage in a fast-growing industry should consider subordinate financing. Under this formula, financial institutions lend higher amounts than they would under other circumstances and accept subordinate security in return. But such arrangements will always require a higher return for the lender, who may also ask for royalties on future sales or stock options.

Equity investorsDepending on your situation and the amount you need to raise, you can seek out venture capital from investment banks, institutional investors and mutual or labour-sponsored funds. Your new financier will become a major financial partner, taking an ownership stake in your company and the right to name some members of your board in exchange for a significant injection of capital. Industry Canada's web site has more information on this subject.

Venture capital firms invest across all sectors of the economy but target only businesses with excellent growth potential. Sometimes technology-oriented venture capital companies also consider outright acquisitions. For example, they will look favourably on buying a leading-edge business with products almost ready to put to market that would complement a more mature company's product line.

Strategic investors
These investors focus on certain types of businesses and are often faster than others to grasp developments within a particular industry. These are often groups of professionals from the same industry who keep close tabs on their market and are therefore quicker to recognize risks and opportunities. Major corporations also sometimes acquire equity in companies whose growth they believe it is in their interest to support. The goal can be to exploit a promising niche in their industry, for example, or to improve their firms' technological know-how. Regardless of the type of financing you have in mind, management consulting companies and accounting firms specializing in acquisitions can provide invaluable outside advice. Their contacts with investors and financial institutions often help them quickly identify people who are interested playing a role in an acquisition. Getting specialists involved at the outset also greatly simplifies tax reporting.

How to evaluate a proposed business acquisition

There's nothing simple about estimating the value of a business you want to acquire. Valuating a business is not a simple exercise, nor is it an exact science. It simply provides a theoretical value that will give you an idea of the fair price to pay for a business.
You mustn't rely only on the judgement of your accountant or of the seller. It is recommended that you have an expert, who specializes in business valuations, produce an independent report. While this is an unregulated field, the Canadian Institute of Chartered Business Valuators (CICBV) does provide guidelines and a code of ethics.

In general, you will rarely be able to compare your potential acquisition with a similar transaction. There is little information available on such transactions and they may not even apply to your specific conditions. Also, the terms may be too closely related to a particular sector to be useful.

3 degrees of assurance
According to the CICBV, there are three types of reports, they vary from the most general to the most detailed:

• Calculation report: provides an approximate valuation for initial planning
• Estimate report: ideal for preliminary negotiations, succession planning, and situations involving important issues that are subject to budgetary constraints
• Comprehensive report: appropriate in situations that involve high risks, important issues, or when there are legal proceedings
• To prepare their reports, evaluators look at the facts and financial data, formulate a conclusion, and the possible impacts on the estimated value. They will also add a disclaimer regarding the scope of the mandate, which varies with the quality of the report provided.

Work required
To produce a calculation report, the valuator reviews and analyzes the financial information and may meet with management.

The estimate report takes the same approach but is more exhaustive.

In the comprehensive report, the valuator provides an opinion. It is a more in depth analysis of the business and it reviews:

• Patents, bylaws, and shareholder agreements
• Business' economic situation and sector
• Market conditions and the competition
• Clientele and any contracts, backlog of orders
• Suppliers contracts and commitments
• Visit to the business
• Financial and forecast data
• Rationale for the choice of discount and capitalization rates using accepted financial models

Basic valuation principles

The first step in the process of establishing a price consists of determining the fair market value of the business. The three main valuation principles are:

• Value is dependent on expectations
• Value is dependent on future cash flows
• Value is dependent on tangible capital assets

Valuation methods and techniques
There are two basic ways of determining the value of a business:
 Asset-based

• Book value: company's net worth, which is equal to assets minus liabilities. What is shown in the financial statements
• Liquidation value: assumes that the business sells all its assets, pays off all its debts, including taxes, and distributes the surplus to its shareholders

Earnings and Cash flow

• Discounted cash flow: value is based on the future cash flows of a business
• Going concern value: assumes that the business will continue operating and compares the current cash flows with future inflows to make projections

Some of the most common techniques used to calculate a business value include:

Capitalization of typical net earnings
A value can be attributed to future earnings resulting from the acquisition. To obtain the going concern value, a capitalization multiple is applied to these earnings and non-operating assets are added.

Capitalization of typical cash flows
The same as above with the exception that cash flows, rather than earnings, are capitalized.

Discounting of expected future cash flows
Consists of determining the most likely future cash flows and discounting them at the valuation date.

Determination of adjusted net assets
Liabilities are subtracted from the determined fair-market value of the assets. It is used for businesses, such as those in the real estate sector, whose value is asset-related rather than operations-related

For more information, consult the Steps to Capital Growth guide included on Canada Business website.

Other rules
In some sectors of the service industry the value of a business is based on a multiple of revenues. For example, an insurance brokerage firm can be worth 1 to 1.5 times the commissions received over a period determined by negotiation.  In the final analysis, purchase conditions and the final price paid will be determined in your negotiations with the vendor