On Tuesday, the Canadian government released its latest budget. A lot of the spending had been announced previously, and the budget focused on how that spending would be paid for. One of the elements included an increase in the capital gains inclusion rate to two-thirds, up from the current 50%. The tech ecosystem, economists, and even the former Finance Minister immediately raised concerns that this would hurt innovation in a country that has already seen declining new business formation.
"My phone was exploding with texts from leaders across the country saying, 'This is a nightmare. You have to fix this. They don't know what they're doing,'" said Benjamin Bergen, president of the Council of Canadian Innovators industry group. Currently, over 150 Canadian tech leaders, including dozens involved in the cleantech space, have signed a letter to the government begging for a reversal. They worry that it will become more challenging to build in Canada if incentives are uncompetitive, and this may be even more true in cleantech, where businesses take longer.
Cleantech remains one of the fastest-growing venture categories globally. This means the decisions on where companies are built in this sector are happening rapidly. Countries are using policy changes to get a lead in cleantech and attract both teams and capital. We saw this in 2023 when Canada tried but couldn’t keep up with the uncapped incentives for clean energy investments in the Inflation Reduction Act (IRA). Responding to the discrepancies, Canadian companies started hiring and spending more in the US. “There's all these incentives that have really turbocharged our economics for our projects," said Janice Tran, the CEO of Kanin Energy, when commenting in 2023 on their increased presence in the US. Kanin Energy turns waste heat into power and is one of many companies creating new cleantech tools. This latest budget change has entrepreneurs reassessing their footprints again, as the US and the UK will now have lower effective tax rates for capital gains and much lower rates for founders and early employees when applying exemptions.
Hiring and retaining talent under the new tax structure is one of the primary concerns. Many critical startup employees take lower cash salaries and take considerable risks in exchange for equity, where the benefits are back-end loaded over several years. This timeline is even extended further in cleantech as the Cleantech Group and others have flagged that cleantech companies take longer to commercialize. Regulatory barriers, supply chain constraints around hard tech, and interconnected dependencies can extend cleantech timelines significantly compared to other tech sub-sectors. Cleantech teams will often take on extended risks as regulatory uncertainty means their business model could materialize or disappear. We have seen this in Canada already, as carbon capture founders wait for certainty from the government on pricing.
Early employees excited about cleantech today will now potentially join teams in the US, as the Qualified Small Business Stock (QSBS) tax benefit is a much broader exemption than Canada's, so employees can qualify. Every day, Canadian founders ask employees to take less cash in exchange for a higher upside, and the Canadian government just took some of that upside. Founders may now lose that employee and grow slower, or they will need to pay that employee more cash and then grow slower.
The new inclusion also applies to corporations, meaning it will be more difficult for founders in the country to raise from investment corporations vs. yesterday, as their potential return from Canadian companies just declined. Fewer founders, employees, and capital mean cleantech innovation may be at risk in a country that otherwise has publicly stated it as a priority. The longer timelines and regulatory uncertainties for cleantech amplify the risks being flagged by technology leaders across the country. The President of Shopify, one of the largest companies in the country and a supporter of entrepreneurs of all types, described the update as a “tax on innovation and risk-taking.”
