Free money: A primer on Eligible Business Corporations and Venture Capital Corporations in British Columbia
One of the greatest challenges facing entrepreneurs on their journey to take a business idea and turn it into a functioning, profitable company is securing investment capital. Getting the business up and running is the first step. But in order to grow — whether to accelerate development, meet increased demand, expand geographically, or weather unfavourable economic conditions — external operating capital provided by investors is often crucial.
Competition for this investor capital can be fierce, so early stage startup companies are often looking for ways to stretch those investor dollars further and further. In British Columbia, one of the ways they can do this is to offer a 30 percent tax rebate to eligible investors, through the two programs created under the Small Business Venture Capital Act (SBVCA): the Venture Capital Corporation (VCC) and the Eligible Business Corporation (EBC) programs.
Making any investment comes with a risk, but when that investment is made in a small business or a startup in an emerging industry, it can be even riskier. In British Columbia, the SBVCA was designed to provide a degree of risk-mitigation for investors looking to invest in these types of businesses, as a way of encouraging increased investment in certain types of BC businesses.
The SBVCA programs create two streams for these investor benefits. VCCs are corporations formed to act as investment vehicles standing between BC investors and small businesses in BC. EBCs are small businesses in BC that themselves register on behalf of and for the benefit of their investors.
Criteria to qualify under the SBVCA differs slightly depending on which program is being engaged, but at their core, both programs provide investors who make eligible investments with a 30 percent tax credit on the dollar amount invested. For VCCs, this tax credit is given to investors in the VCC itself, which then makes investment into an operating BC business. For EBCs, this tax credit applies to those who invest directly into the BC business.
The overarching purpose of the tax credit is to reduce the risk exposure for investors when an investment fails to pan out, while simultaneously making it easier for entrepreneurs pursuing qualified business activities to receive a flow of operating capital.
Qualified business activities
Importantly, not every investment in every business qualifies for the tax credit. Aside from being registered under the Act, investments are only eligible for the tax credit if they are made in businesses that are substantially engaged in certain business activities. These business activities are provided for in the Small Business Venture Capital Regulations and related policy documents in detail and include but are not limited to:
- Manufacturing and Processing of goods in BC, and services directly associated with exports of those goods;
- Tourism, where the majority of revenues are earned from tourists, including certain resorts, attractions, and tourist services;
- Research and Development of Proprietary Technology, including services directly associated with exporting the technology, provided the business maintains proprietary or ownership rights over the technology;
- Community Diversification for businesses outside of the Metro Vancouver Regional District (MVRD) and the Capital Regional District (CRD) which promote “economic diversification and development of community”;
- Development of Interactive Digital Media Product which proudly includes multimedia products for educational, informational and entertainment purposes, along with other criteria;
- Development of Clean Technologies for businesses substantially engaged in research, development, manufacturing or processing of clean technologies related to energy efficiency and conservation, reduction of greenhouse gas emissions, and otherwise reduction of environmental impact within the energy sector;
- Advanced Commercialization for businesses outside of the MVRD and CRD which use advanced digital technology to assist other businesses to scale-up, and
- Scale-up Activities for businesses otherwise qualified under another activity now seeking to scale-up their customer acquisition, marketing and other such activities.
Similarly, the regulations also prescribe certain business activities which are expressly not eligible for funding under either of the SBVCA tax credit programs. The exclusions are made on the basis that such activities are well developed within BC, and are not in need of additional support and incentive for investment, and include activities such as resource extraction, financial services, property management, land development, traditional agricultural activities, most retail and commercial services, and restaurant or food services.
Venture Capital Corporation program
A VCC as contemplated under the SBVCA is a corporation that is restricted to carrying out business by way of making investments in and providing business and managerial expertise to eligible small businesses (ESB).
Prior to application for registration under the act, an incorporated VCC must deliver a proposal providing certain disclosure around corporate structure, including among other specific requirements, details of capitalization, and details of any debt obligations.
To be successfully registered under the SBVCA, a VCC must fulfill certain criteria, including:
- be a BC incorporated company and include the “(VCC)” designation in its corporate name;
- have never carried on any other business other than that of the VCC;
- have or will have at least $25,000 in equity capital; and
- have an authorized share structure consisting of only common shares without par value, provided that one or more class of common shares may have special rights relating only to redemption of shares by the VCC.
Operating and investing criteria
Once registered, additional criteria will continue to apply to the VCC on an ongoing basis. A VCC may not carry out any type of activity outside of investments permitted under the SBVCA. The equity capital of a VCC may also be limited to a prescribed maximum amount. All shares issued by a VCC Corporation must be fully paid for in cash, and the share certificates must contain certain written provisions warning investors that the value of the shares may be significantly affected by the repayment provisions under the SBVCA. If a VCC wishes to alter its notice of articles, its authorized share structure, or a provision of its articles, it must first obtain written approval of the administrator under the SBVCA.
From an investment standpoint, a VCC may only make investment into an ESB. In order for a company to be considered an ESB under the SBVCA, the business must:
- be incorporated in BC, or extra-provincially registered in BC (including by way of federal incorporation);
- have no more than 100 employees at the time of the initial investment, which includes employees of all affiliates;
- pay at least 75 percent of its wages and salaries to BC employees, or if the business is engaged in the export of goods and related services, 50 percent of wages and salaries; and
- be substantially engaged in one or more of the qualified business activities.
A VCC is prohibited from investing in an ESB if any or all of the investment funds are intended to be used for lending, investment outside of BC, investment in land, acquiring securities, purchasing goods or services from prohibited parties, payment of any amount of a debt obligation, or using the investment as part of a transaction concerning the purchase of previously issued shares of the small business, retirement of liability, and other prescribed events. Exceptions do exist for all of the above, but they remain narrow and are often subject to the discretion of the administrator.
VCCs are also prohibited from controlling ESBs by way of a majority investment, either alone or in conjunction with business affiliates. This rule may be waived by the administrator in the event an ESB is experiencing severe financial difficulties, however this would only occur in exceptional circumstances. VCCs are also not permitted to hold an investment in an ESB if any of the shares of the VCC are held by a major shareholder who is or was in the previous two years a major shareholder or associate of the ESB. Major shareholder is defined as someone holding 10 percent or more of the shares or convertible rights into shares of a corporation, including combined with any associate or affiliate.
Eligible Business Corporation program
An EBC is a company which registers under the SBVCA in order to have investments made directly into itself eligible for the 30 percent tax credit. All of the same criteria which have been set out for an ESB apply to an EBC: 100 employees or fewer at the time of the initial investment, 75 percent of wages and salaries to BC employees (or 50 percent in the case of export), and engagement in qualified business activities apply to the EBC. In addition, the EBC must also:
- have a minimum of $25,000 in equity capital in place prior to registration;
- maintain a permanent establishment in BC; and
- maintain at least 80 percent of its assets in BC.
The discussion of ESBs and EBCs can sometimes create confusion, however the only real difference is that an EBC is itself registered under the SBVCA and has the above additional qualification criteria, while an ESB refers to an unregistered company which qualifies for investment by a VCC.
Once registered, an EBC will receive a certain equity authorization under the program for the current tax budget year. The maximum equity capital that an EBC can raise under this program is $10 million, however not every EBC receives this maximum authorization, and tax credits claimed are on a first come, first served basis. In the 2021 fiscal year, for the first time the tax credit claims exceeded the budget for the venture capital program, and claims were suspended prior to the end of the year. It’s thus important to ensure that claims for tax credits are made promptly following a qualified financing.
Limitations for EBCs
To be an eligible investor into an EBC, and therefore qualify to receive the 30 percent tax credit on their invested amount, the investor must be either an individual resident in BC, or a corporation with a permanent establishment in BC (that is, a BC company, or another Canadian company extra-provincially registered in BC).
All investments into the EBC under the venture capital program are subject to various criteria as well, including:
- the aggregate investment from all eligible investors cannot exceed $10 million, given that this is the maximum limit of the program;
- eligible investors must not make or hold an investment in an EBC in conjunction with any business affiliates that would result in such an investor owning 50 percent or more of the voting rights of the EBC, or in any other manner control the EBC;
- all shares issued to eligible investors must be newly issued from treasury, and not the result of a secondary sale;
- any share or convertible right with retraction or redemption must not be exercisable within five years of issuance;
- the EBC must not redeem or register a transfer of such shares within five years of issuance (i.e. the investment must remain in place and the shares must be held for a minimum of five years);
- investors must be at arm’s length from the EBC, and must not have disposed of any of the EBCs shares or convertible rights within the previous two years (i.e. a current investor cannot dispose of shares and then “reinvest” in order to claim a credit);
Each eligible investor will be required to complete a Share Purchase Report, which is then submitted in order to receive the applicable tax credit certificate. Individual investors will receive a refundable tax credit, which can result in an actual refund cheque from the Ministry of Finance, while corporate investors will receive a tax credit which may be applied to current or future tax payable.
Contravention of any of the required criteria or prohibitions prescribed can result in an EBC having their registration suspended or revoked. In the event of shares being transferred or redeemed within five years of issuance, any tax credits claimed will be required to be repaid by the investor. However, given that the EBC is the entity registered under the SBVCA, and is not permitted to allow such early exit without consent of the administrator, orders can be made to require the EBC to itself repay such amounts to the Minister of Finance.
Where the shares of an EBC are acquired by another entity within this five year period, through a typical exit event, it’s important to factor in any required repayment of tax credits to avoid future challenges from the relevant authorities.
It’s important to re-iterate that debt is anathema to either program under the SBVCA. Investment into the VCC cannot be debt-like, investment into an EBC or an ESB cannot be debt-like, and the funds invested cannot be used to create or to service debt.
While this certainly means that the investment cannot take the form of a convertible note, it also means that there are limits on the sorts of special rights and restrictions which can be placed on shares with respect to redemptions, or protected returns. Similarly, while a convertible right to receive shares (such as in a Simple Agreement for Future Equity or SAFE) may qualify for investment, this is only the case if the form of SAFE is modified so as not to include debt-like provisions guaranteeing a minimum return on liquidation ranking ahead of equity shareholders.
Qualifying investments under the SBVCA must also be net new equity capital. The tax credits will not apply retroactively to investments made prior to registration of the VCC or EBC. Similarly, to be eligible for the tax credit, investors must not have disposed of any shares or convertible rights in the ESB or EBC within the past two years, to avoid quick swap out transactions. Companies or investors who attempt to get too clever in trying to work around these restrictions can find registrations revoked, which would require repayment of any tax credits paid out.
Another consideration to keep in mind is that the sale of securities within the VCC, ESB or EBC is still subject to any other applicable securities laws and regulations. While there are certain criteria required for an investor to be eligible under the SBVCA to receive a tax credit, they must also be qualified under applicable securities laws to actually make an investment. This is particularly important given that a small business under the SBVCA will almost certainly not be issuing a prospectus, so applicable prospectus exemptions must be considered.
Both the VCC and EBC programs under the SBVCA offer valuable opportunities for BC investors and small businesses alike. The availability of the 30 percent tax credit allows ESBs and EBCs to provide incentives to their investors, allowing them to stretch those investor dollars further with the goal of expanding and supporting innovation and growth of BC companies. For investors, the tax credit allows them greater security in early stage investing. The programs are powerful, and well utilized, but as noted it can be complicated to ensure proper compliance with the various requirements and regulations. We strongly encourage any company or investor seeking to take advantage of the programs under the SBVCA to seek qualified legal and accounting advice from advisors familiar with these programs.