B.C. you later Net entrepreneurs are heading to U.S. Steve Ernst Staff Writer
Speeding tickets are no longer a worry for Dimitri Sirota.
Until a few months ago, the 29-year-old entrepreneur was driving 300 miles twice a week. He would zip down to Seattle to raise money and line up partnerships, then travel back to Vancouver, B.C., to run his telecommunications infrastructure start-up, eTunnels Inc.
Finally, like a growing number of his countrymen, Sirota moved his 8-month-old company to Seattle in hopes of attracting more venture capital and establishing a foothold in the much larger U.S. market.
“It’s very, very hard for an Internet company to make it in Canada,” he said. “And it’s not just because of the taxes. The Canadian business environment just doesn’t offer the opportunities that are here. People are more conservative and are far more risk-averse up there.”
An increasing number of Canadian entrepreneurs are being lured to the Seattle area by the city’s large pools of venture capital, this country’s more accommodating tax and securities regulations, and the proximity of other established e-commerce and technology companies. While start-ups in Canada don’t pay for employee medical benefits and can receive liberal tax credits for research and development, those advantages don’t seem to offset other factors luring firms to the United States.
Sirota is following a trail most recently blazed by Canadian expatriate Glenn Ballman, chief executive officer of Onvia.com Inc. Ballman moved his company’s headquarters to Seattle in 1998 and went on to raise $71 million in venture financing for the small-business e-commerce site before taking it public last month.
And he isn’t alone. This week Canadian Terry Drayton will take public the company he founded, HomeGrocer.com Inc. Drayton started the company in Vancouver before heading south in search of capital.
The publicly traded company NetNanny Software International Inc., an Internet filtering and security firm, last month moved its headquarters from Vancouver to Bellevue, in hopes of raising more private equity and to be closer to its biggest market.
George Hunter, executive director of the British Columbia Technology Industries Association in Vancouver, is familiar with the syndrome. “The story I hear most often is Canadian companies can achieve better valuations by moving to the States,” he said. “Many of them link up with U.S. venture firms early on and set up their business development and marketing headquarters in the U.S., but keep research operations in Canada.”
Canadian venture investors also tend to be more conservative than their American counterparts, said Gordon Ross, CEO of NetNanny and a third-generation Vancouverite.
“Getting investments in Canada can be a long, long process,” Ross said. “And with technology companies, you really can’t wait. Venture capitalists down here really understand that, they understand the risks and the nature of the business.”
Last year overall venture capital investment in the United States was 18 times greater than in Canada, according to a study conducted by the Boston Consulting Group, a Boston-based research firm. An estimated $1.2 billion in venture capital flowed into the Pacific Northwest last year, while all of Canada collected about $2 billion in private financing.
One thing Canada lacks is a large pool of institutional investors, the report concluded. “The environment is less dynamic in Canada because the venture capital market is dominated by passive and semi-public investors,” the report stated.
Canadian law prevents pension funds and other government-sponsored investment funds — which constitute more than 60 percent of the venture capital investors in Canada — from taking a large ownership stake in companies. Those venture capital investors tend not to take an active role in companies primarily because labor-sponsored funds receive an upfront tax credit for their investment, lessening their drive for high returns, the report concluded.
Ross, who started NetNanny 10 years ago, plans to keep the company’s software research and development operation in Vancouver to take advantage of tax credits and government grants.
The company also recently closed on $6 million in private equity from a group of European investors.
“It’s a totally different dynamic here,” said Buzz Leonard, chief operating officer of NetNanny. “Investors here really understand the business models of dot-coms and software companies and they know how to help them. In Vancouver, particularly, it’s still very much a resource-based economy and investors just don’t move as quickly.”
In addition to a lack of early-stage investment capital, Canadian start-ups are also following Interstate 5 south to escape tax and securities regulations that can inhibit a company from going public.
Last year 165 U.S. technology companies went public on the Nasdaq exchange, while only four Canadian companies held IPOs on Canada’s major exchange, the Toronto Stock Exchange, according to the Boston Consulting Group’s report. Venture capitalists trying to cash in on Canadian investments can face several challenges, observers said.
In many cases, capital gains tax rates in Canada are double those in the United States, eating into investors’ winnings.
Also, under Canadian securities laws, investors who acquire shares of a company before its IPO must hold those shares for 12 months after the IPO date. Underwriters in the U.S. typically require pre-IPO investors to hold their shares for at least 180 days.
American VCs can also face higher tax rates when investing in Canadian companies. Most venture capital firms in the states are formed as limited liability companies or partnerships and under Canadian law those operations are subject to higher capital gain tax rates. Canadian firms trying to raise money across the border also face a similar problem.
In addition, stock options for Canadian workers are typically taxed when the options are exercised, as opposed to when the shares are sold. That gives workers even more incentive to join what Canadians are calling “the brain drain” by moving south of the border.
ETunnels CEO Sirota got what he was looking for: he is now using a $4 million infusion of venture capital, garnered from a mixture of Silicon Valley and Canadian venture firms, to set up shop in Seattle.
“It’s also just a much bigger market,” Sirota said. “It just makes more sense to start a company here or San Francisco or Boston or Austin than in Canada.”