Canadian VCs caught flat-footed by “insane” changes in US investment regulation

As the Canadian Venture Capital Association (CVCA) urges United States agencies to exempt Canadian investors from a law that could stifle investments into US startups, Canada’s VC community appears caught off guard by the regulatory changes.

“Putting barriers is just increasing friction. It’s just going to be a lose-lose for everyone.”

Earlier this month, BetaKit was first to report on a letter co-signed by the CVCA, BIOTECanada, the Canadian Chamber of Commerce, and Medtech Canada, urging the US Department of the Treasury to exempt Canadians from a law that has the potential to stifle foreign investments into US startups.

The law has been called one of the most dramatic changes to the processes and jurisdiction of the Committee on Foreign Investment in the United States (CFIUS), an agency that reviews the national security implications of foreign investments in US companies, in its 44-year history.

Of the 12 prominent Canadian venture capital firms contacted by BetaKit regarding the letter, only three expressed an awareness of FIRRMA, with the remaining nine either previously unaware of the law, or unwilling to offer comment.

In addition, the CVCA claimed the letter was also sent to three Canadian federal agencies: Global Affairs Canada, Innovation, Science, and Economic Development (ISED), and the Department of Finance. However, when reached for comment, both ISED and Finance were unaware of the letter. Upon sending a copy to the Department of Finance, Global Affairs Canada provided BetaKit this comment:

“Canada and the United States work closely together on investment screening and share the same objective: maintaining an open investment climate while protecting our respective national security,” said Sylvain Leclerc, a spokesperson for Global Affairs Canada. “As the US updates [its] regulatory framework, it is our hope that this work will recognize the important strategic and economic relationship between our two countries.”

“Radio silence” from Canadian VCs

Passed last summer, the Foreign Investment Risk Review Modernization Act (FIRRMA) is designed to address growing US national security concerns over foreign exploitation of certain investments, speculatively, those coming from China. However, Canadian investors are also implicated by the law, meaning Canadian investments into the US will be subject to a higher degree of regulatory scrutiny from CFIUS.

“A move like this has the potential to stifle the exchange of resources, capital, talent, or otherwise, between neighbouring countries.”

The joint letter’s co-signatories are hoping that Canada will receive an exemption from FIRRMA. CEO of the CVCA, Kim Furlong, told BetaKit the organization’s position was to not jeopardize the trillion-dollar Canada-US trade relationship, as (under FIRRMA) Canadian investments would be treated in equal fashion to Chinese investments. Furlong said FIRRMA creates an additional step for Canadian investors, a step that could be “detrimental.”

She noted that the changes put Canadian VCs at risk, limiting their ability to syndicate deals with the US and potentially causing delays.

While Global Affairs’ comment did not specifically address the potential harm to Canada’s US investments, Furlong told BetaKit that CVCA members have raised complaints about delays and complications in deal flow since FIRRMA was passed into law. The CEO noted, however, that she did not have a definitive sense of the scale of that impact.

RELATED: Canadian VC investments up 48 percent since same time last year, CVCA report finds

Despite those complaints, Furlong later told BetaKit that she experienced “radio silence” from CVCA members when attempting to get them to speak publicly about their specific experiences.

Notably, representatives from three prominent Canadian VC firms with multiple US companies in their portfolios⁠ — Inovia, Relay Ventures, and OMERS⁠ — did not respond to BetaKit’s request for comment, as did several other CVCA members. Real Ventures, Panache Ventures, BDC Capital, and Luge Capital all declined to comment to BetaKit.

Cameron Burke, managing director of deals and tech sector leader at PwC, told BetaKit that the majority of Canadian VC and private equity (PE) firms he has spoken to about the potential impact of FIRRMA also expressed concern.

“There is a wide range of opinions amongst Canadian VC and PE firms about the impact, but a move like this has the potential to stifle the exchange of resources, capital, talent, or otherwise, between neighbouring countries that share both common culture and values, but also are jointly experiencing a wave of growth in their respective tech sectors,” he stated.

The impact on Canadian VCs

One VC investing in the US told BetaKit that they have yet to experience any delays caused by FIRRMA. Elaine Kunda, managing partner of Toronto-based Disruption Ventures, made an investment in San Francisco-based SaaS company Hostfully earlier this year, noting that she didn’t experience any hiccups as a Canadian VC investing in a US startup.

“I think the impact could be quite significant.”

“At this stage, I’m not sure if it’s being enforced,” Kunda told BetaKit. “But the concern would be the impact it could have on the industry if they decided to enforce it. And I think the impact could be quite significant.”

“While too early to call, given that FIRRMA has only been effective since August 2018, and therefore there isn’t a clear track record of how the US government will apply the FIRRMA rule, it has the potential to be a significant speed bump in what has otherwise been years of progress built between Canadian and US investors in joint deal-making,” said Burke.

Historically, every investment transaction from outside the US must go through CFIUS. A report published by law firm White & Case stated that for FIRRMA, the short-term effects could include potentially longer timelines, as the legislation lengthens the CFIUS process by 30 calendar days.

Kunda pointed out that if a US startup is choosing between taking investment from a US firm versus a Canadian one, it is likely the startup will take investment from the firm that presents the least risk or red tape.

“If it’s a competitive situation, they may not choose to engage with me,” she said. “They don’t want that extra step or that risk. If it’s not approved, then they may miss out on investments they could have had more freely in a different situation.”

Kunda expressed that she would also be concerned if Canadian investors experienced more difficulty in attaining seats on company boards under FIRRMA, pointing out that board seats can be a very important part of the equation in investment deals.

“Venture capital is such an important part of both of our economies,” Kunda said. “I think that it’s important that Canada continue to put pressure on clarifying and rectifying this, because if something happens, and they decide to enforce, then it can make the process very messy for a lot of people.”

A lose-lose negotiation

Several Canadian VCs with whom BetaKit spoke on the condition of anonymity called the new legislation a protectionist policy by the Trump administration, and potential leverage in future trade negotiations. Eva Lau, managing director and co-founder of Two Small Fish Ventures, however, called the legislation “insane,” noting that US startups will be equally harmed by investment barriers like FIRRMA.

“Exclusionary regulatory measures are a swing in the wrong direction if you want collaboration.”

“Because of this hurdle that is being arbitrarily set up, you just limit access on both sides of the economies,” Eva told BetaKit. “If every opportunity has to be approved … it’s actually affecting founders adversely. Putting barriers is just increasing friction. It’s just going to be a lose-lose for everyone.”

Lau’s husband, Small Fish co-founder and Wattpad CEO Allen Lau, told BetaKit that FIRRMA appeared similar to that of Section 116 of the Canadian Income Tax Act, an investment barrier aimed to ensure that non-resident vendors did not shirk their Canadian tax obligations. The result, he said, was a great deal of red tape for foreign investors interested in Canadian tech ventures (investment surged after the language in Section 116 was changed).

“Once we removed that, US VCs started investing much more in Canada,” he added. “That’s an example of why removing the hurdles can help cross-pollinate investments. This will only hurt US companies.”

US venture capital firms have been sounding the alarm for some time regarding the CFIUS reforms. Scott Kupor, former chairman of the board of the National Venture Capital Association (the CVCA’s US equivalent) testified to the U.S. Senate Committee on Banking, Housing, and Urban Affairs, in January.

“Policymakers should encourage, and not be fearful of, foreign investment into US venture funds,” he said, adding that filing requirements or uncertainty could jeopardize the tight timelines of competitive investment rounds. “This could result in a US startup missing out on key investment capital as the company seeks to grow.”

“Exclusionary regulatory measures are a swing in the wrong direction if you want collaboration. Canadian VC and PE fund could be excluded from deals due to the nature of having to go through a review system that may slow down the ability of a Canadian investor to get into a deal (if at all), hindering the relationships needed to bring US investment into Canada,” Burke said.

Isabelle Kirkwood

Isabelle Kirkwood

Writer, globetrotter, drone pilot & David Attenborough enthusiast