Policy Consultation and Backgrounder 051325W4

Policy Consultation and Backgrounder: Strategic Incentives for Mobilizing Risk Capital in Canada May 14, 2025

Policy Consultation and Backgrounder: Strategic Incentives for Mobilizing Risk Capital in Canada

Updated May 14, 2025 v2 | National Angel Capital Organization

Executive Summary Canada’s long-term economic competitiveness hinges on the strength of its innovation economy—and that strength begins with early-stage capital. While Canada has made notable progress in scaling its venture capital sector through landmark public initiatives such as the Venture Capital Action Plan (VCAP) and the Venture Capital Catalyst Initiative (VCCI), the early-stage segment—particularly pre-seed and seed financing—remains underdeveloped and unevenly supported. This policy consultation explores targeted tax-based mechanisms to address these foundational gaps and strengthen the full innovation capital continuum. It focuses on three specific policy tools with the potential to increase private investment in early-stage ventures:

● A National Investment Tax Credit ● A Capital Gains Rollover Provision ● A Flowthrough Shares Adaptation for Startups

Stakeholder feedback will inform a white paper to guide federal policy recommendations, with the aim of enhancing Canada’s early-stage capital infrastructure, improving investor participation, and ensuring a robust pipeline of innovative companies poised for long-term growth. Version Notice: This document may be revised as new information becomes available. Please refer to the “Updated” date on the cover page or consult vision2040.ca for the most recent published version. Purpose of Consultation The National Angel Capital Organization (NACO) is seeking input from investors, entrepreneurs, policymakers, academics, and innovation ecosystem stakeholders on strategic policy mechanisms to increase the supply of early-stage capital in Canada.

This consultation is focused on the earliest stage of the capital lifecycle—where startups first raise external funding and where risk-adjusted capital is often hardest to access. Addressing these early bottlenecks is essential to ensuring a healthy, investable pipeline for later-stage venture capital and institutional capital. We are specifically requesting feedback on three tax-based proposals designed to catalyze early-stage investment, and we welcome insights on their design, implementation, and alignment with existing federal and provincial programs. The perspectives gathered will directly inform a white paper and formal policy recommendations to government. By engaging the broader ecosystem in this process, NACO aims to advance nationally coordinated strategies that position Canada as a global leader in early-stage innovation-driven economic growth. Context and Background: Strengthening Canada’s Full Innovation Capital Continuum Canada’s venture capital sector is a remarkable success story, providing vital momentum to our innovation-driven economy. Enhancing complementary early-stage mechanisms will further cement this success. Canada has made significant strides in growing a vibrant venture capital sector, supported by landmark initiatives like the Venture Capital Action Plan (VCAP) and the Venture Capital Catalyst Initiative (VCCI). Venture funds play an essential role in scaling high-growth companies, driving economic opportunity, and positioning Canada on the global innovation stage. Canada’s venture capital funds are world-class, led by highly capable general partners with deep domain expertise and proven track records, offering access to globally promising sectors. However, Canadian pension funds, given their large-scale capital pools and approach to fiduciary responsibilities, have historically prioritized established asset classes with predictable returns. Strategic policy incentives tailored specifically for early-stage and venture capital could align better with institutional investment criteria, encouraging increased participation from these significant capital sources. This presents a strategic challenge that straddles both the supply and deployment phases of capital: it underscores the importance of developing policy mechanisms that not only incentivize initial investment into early-stage ventures but also encourage greater participation by Canada’s Maple 8 pension funds and other major institutional investors in domestic venture capital funds. While this consultation focuses on pre-institutional capital—investment vehicles that typically fall below the threshold required to attract large-scale institutional capital—we recognize that early-stage and institutional capital formation are deeply interconnected. Strengthening one

segment reinforces the other. This interdependence will be explored more fully in a forthcoming companion consultation as part of NACO’s broader policy development process. Canada’s impressive venture capital growth is a major achievement essential to our economic competitiveness. Enhancing support for early-stage capital supply will ensure that Canada’s world-class venture funds continue to thrive with a strong and sustainable pipeline of high-quality ventures. Global Competition for Innovation Capital Building on this progress, it is critical to ensure a strong, sustainable early-stage pipeline that feeds and fuels continued venture success. The health of the entire innovation funding continuum depends on a strong start: without a vibrant early-stage ecosystem, even the best-capitalized venture funds face weaker deal flow, constrained investment opportunities, and diminished long-term returns. At the same time, Canada is competing within an increasingly aggressive global environment for investment capital. Strategic incentives like the U.S. Qualified Small Business Stock (QSBS) exemption have strengthened America’s early-stage funding environment, attracting risk capital and reinforcing their innovation leadership. Without comparable incentives, Canada risks losing talent, investment, and global competitiveness at the earliest stages. It should also be recognized that many of Canada’s angel investors and family offices are active Limited Partners (LPs) in Canadian venture capital funds. Their participation reflects the integrated nature of Canada’s innovation capital continuum—where a vibrant early-stage ecosystem and a globally competitive venture capital sector are mutually reinforcing drivers of long-term economic growth. It is crucial to emphasize that enhancing early-stage capital mechanisms will complement—not compete with—the institutional venture capital sector. Strengthening pre-institutional capital supply creates a stronger and more diverse investment pipeline, directly benefiting institutional investors through improved deal flow and risk-adjusted returns. Our shared opportunity is to build a unified, globally competitive capital continuum that positions Canadian entrepreneurs for success at every stage of growth. Against this backdrop, our consultation focuses specifically on the earliest stage of capital formation: the Supply of Capital. This consultation directly aligns with the Lifecycle of Capital™ framework—specifically focusing on the first phase: Supply of Capital . Ensuring robust early-stage investment incentives strengthens the foundational stage of the innovation pipeline, ultimately enhancing outcomes for subsequent phases of deployment and momentum.

Lifecycle of Capital™ Framework Canada's innovation economy faces persistent challenges in mobilizing sufficient early-stage risk capital:

1. Supply of Capital : Incentivizing initial investment in early-stage ventures. Ensuring sufficient early-stage capital is available for investment. 2. Deployment of Capital : Supporting deployed capital and the growth of early-stage companies post-investment.

3. Momentum of Capital : Enabling liquidity, exits, and facilitating the reinvestment of capital gains into new early-stage investments when exits occur. This consultation specifically addresses the Supply of Capital phase, with future consultations planned for the other topic areas beyond those addressed in this document. For additional context on the evolution of Canada’s risk capital landscape and relevant international comparisons, please refer to the Backgrounder section further below in this document. Policy Mechanisms Under Consideration We are seeking stakeholder input on three tax-based mechanisms to increase early-stage capital supply. Each proposed policy mechanism aims to address specific gaps in early-stage capital availability by directly incentivizing investor behaviors that align with Canada’s broader economic innovation objectives: 1. National Investment Tax Credit A proposed tax credit aimed at incentivizing investments in qualified early-stage companies. Key features under consideration include: ● Encourages broader investor participation by enhancing investment returns through immediate tax relief.

● Determining an appropriate percentage to effectively mobilize capital ● Eligibility for both direct investments and investments through funds ● Requirements for qualifying companies and investors ● Integration with existing provincial programs

Catalyst for Portfolio Inclusion A national investment tax credit would serve as a critical market signal to private wealth advisors, multi-family offices, and investment consultants that early-stage ventures are a recognized, policy-supported asset class. Much like the RRSP designation unlocked mass-market access to mutual funds in the 1980s, a national credit would elevate early-stage innovation to a policy-supported component of long-term portfolio construction. Canada’s wealth management industry oversees over $6 trillion in assets. Redirecting even 0.1% toward early-stage innovation would unlock $6 billion in potential investment. At 0.5%—a realistic and ambitious target—this figure rises to $30 billion. With the right tax incentives, Canada has a historic opportunity to unlock this capital at scale and strengthen its innovation economy. This level of activation can be achieved over time through a combination of investor-focused tax measures, clear portfolio inclusion guidance, and nationally harmonized program design that supports intermediaries in allocating capital to early-stage ventures. Such a signal would empower intermediaries to include early-stage assets in client conversations and portfolios, broadening investor participation through mechanisms such as venture capital funds and angel syndicates. Given the diversity of provincial programs, a national tax credit must be designed to either harmonize with or supplement existing incentives—minimizing complexity, reducing duplication, and enhancing clarity and investor confidence across jurisdictions. 2. Capital Gains Rollover Provision A mechanism that would allow: ● Facilitated reinvestment of capital gains into innovation-driven companies, recycling capital from successful ventures back into the early-stage ecosystem. ● Deferral of capital gains tax when proceeds are reinvested in qualified companies ● Potential exemption of gains from investments held for specified periods ● Targeted approach to mobilize capital from successful entrepreneurs and investors Canada previously implemented a capital gains rollover mechanism under Section 44.1 of the Income Tax Act, which allowed individuals to defer tax on capital gains when proceeds were reinvested in eligible small business shares. Although this provision was repealed primarily due to administrative complexity and unintended tax sheltering concerns, revisiting the concept with modernized safeguards—such as stricter eligibility criteria, targeted innovation-sector definitions, and compliance infrastructure—could effectively mitigate these past issues while restoring its utility.

A reimagined rollover provision could be particularly effective in recycling capital from successful entrepreneurs back into the innovation economy, bridging gaps between exits and new venture formation. Canada’s earlier capital gains rollover provision under Section 44.1 of the Income Tax Act was repealed primarily due to concerns about administrative complexity and unintended use as general tax sheltering mechanisms. Modernizing this provision with targeted eligibility criteria, clearly defined innovation-sector usage, and robust compliance frameworks could effectively mitigate these past concerns. 3. Flowthrough Shares Adaptation for Startups Adapting the flowthrough shares model from the resource sector offers a promising way to unlock capital for early-stage innovation companies. This mechanism would allow qualifying expenditures to be passed through to investors as immediate tax deductions—improving the attractiveness and risk profile of high-potential ventures.

Key features under consideration include:

● Pass-through of qualifying R&D expenses from the company to the investor ● Immediate deductions against investor income to improve after-tax returns ● Targeted application for research- and technology-intensive early-stage ventures ● Stronger investor appeal by lowering the effective cost of high-risk innovation capital For example, a startup developing proprietary artificial intelligence software could enable investors to deduct eligible expenses—such as engineering salaries or third-party validation—against their personal income, making innovation investments more tax-efficient and attractive. However, applying the resource-sector model directly presents structural challenges. In the resource industry, eligible expenditures are typically tangible and capital-intensive—such as exploration or equipment—which align with established tax treatment. By contrast, early-stage innovation companies rely heavily on intangible R&D expenses. Without careful adaptation, this mismatch could result in fiscal inefficiencies or unintended use. To maintain policy integrity and ensure impact, the model must incorporate tailored safeguards—such as minimum eligible expenditures and independent validation of R&D activities—to target genuine innovation and prevent misuse.

Consultation Questions Strategic and Comparative Insights

Mechanism Effectiveness:

1. Which of the three mechanisms (National Investment Tax Credit, Capital Gains Rollover Provision, Flowthrough Shares for Startups) would most effectively mobilize early-stage investment in Canada, and why?

Complementary Impact:

2. How could these mechanisms strengthen or conflict with existing federal and provincial initiatives?

Opportunities and Challenges:

3. What key opportunities or potential challenges should be considered when implementing these mechanisms?

Additional Insights:

4. Are there any additional insights you would like to share that were not specifically addressed in the consultation questions? How To Respond Please submit your response by the published deadline. Submissions can be made through:

● Online portal linked on https://www.vision2040.ca ● Email: vision2040@nacocanada.com

We welcome responses to any or all questions, as well as additional insights not specifically addressed in the consultation questions. Your feedback is invaluable to our advocacy efforts and will directly inform our recommendations to policymakers. Substantive contributions may be acknowledged in the final publication of our white paper report. If you prefer not to be acknowledged, please indicate this clearly when submitting your feedback.

Next Steps Following this consultation period, the National Angel Capital Organization will: 1. Review and analyze all submissions 2. Publish a summary of feedback received 3. Develop comprehensive recommendations based on stakeholder input 4. Prepare a white paper report to share with government officials and policymakers 5. Make policy recommendations for the implementation of the most promising mechanisms. Future consultations will address the Deployment of Capital and Momentum of Capital phases. Contact Information For questions about this consultation process, please contact: vision2040@nacocanada.com . National Angel Capital Organization, MaRS Heritage Building, 101 College Street, Suite 250 Toronto, ON M5G 1LG

[Backgrounder on next page]

Backgrounder: The Evolution of Venture Capital and Angel Investment in the U.S. and Canada Executive Summary Canada's risk capital ecosystem faces a critical imbalance: while the venture capital (VC) industry has experienced substantial growth through successful government initiatives like VCAP and VCCI, the pre-institutional capital ecosystem (angel investors) has not kept pace. This disparity threatens the sustainability of Canada's innovation funding continuum and risks undermining the significant public investment in building the country's venture capital capacity. Key Findings: ● The ratio of venture capital to angel capital in Canada has reached approximately 56:1 ($14.7B to $262.1M in 2021), compared to a healthier 20:1 ratio in the U.S. ● Canada’s current venture capital to angel capital ratio highlights a valuable opportunity to enhance early-stage capital availability. Emulating aspects of the U.S. model, where strong angel investment significantly enhances venture capital performance, could reinforce our broader innovation ecosystem. ● While VC investment grew by 308% between 2017 and 2021, angel investment grew by only 61% during the same period. ● Canada's pre-seed ecosystem remains fragmented and less professionalized than the venture capital industry, with inconsistent support across regions. ● Institutional and pre-institutional capital operate under fundamentally different dynamics, requiring distinct policy approaches. Note on Terminology: In this document, pre-institutional capital refers to early-stage investment —such as angel networks, family offices, or micro funds—that typically operate below the scale or structure required to attract investment from institutional sources like pension funds or endowments. Institutional capital , by contrast, refers to capital allocated by large-scale capital providers (e.g., pension funds, sovereign wealth funds, endowments) into professionally managed venture capital funds and other investment vehicles with institutional-grade structures, governance, and scale.

Data Context and Methodological Note: Investment data across early-stage and venture capital segments should be interpreted with nuance. While total dollars invested and number of deals are both important indicators, they capture different aspects of ecosystem activity. Angel investments are typically smaller and more numerous, while venture capital tends to involve larger amounts deployed across fewer deals. In some cases, overlap may occur—for example, when an angel group participates in a round also reported by a VC fund, or when investments appear in multiple data sets (e.g., NACO and CVCA). Despite these differences, the overarching trends are clear and consistent across sources. Together, deal volume and investment amounts offer a complementary view of Canada’s capital continuum—and both underscore the persistent gap between early-stage and venture capital financing. 1. Introduction This backgrounder provides essential context on the historical development and current state of risk capital in both the U.S. and Canada to inform policy considerations for mobilizing early-stage capital more effectively. Understanding the specific development trajectories of venture capital and angel investment in both the United States and Canada offers valuable insights for stakeholders considering policy interventions to strengthen Canada’s early-stage capital environment. Today, Canada is operating within a highly competitive global environment for innovation capital, where countries like the United States have implemented powerful incentives—such as the Qualified Small Business Stock (QSBS) exemption—that significantly enhance the risk-reward profile for early-stage investors. These policy tools have played a critical role in attracting and recycling entrepreneurial capital at scale, underscoring the urgency for Canada to develop similarly competitive strategies to retain and grow domestic investment in innovation. 2. Institutional vs. Pre-Institutional Vehicles: A Critical Distinction A fundamental distinction in Canada's risk capital ecosystem exists between institutional capital vehicles (primarily through venture capital funds) and pre-institutional investment vehicles (primarily through angel investors). These two segments operate under different dynamics that must be recognized in policy design:

Institutional Capital Infrastructure ● Professional Structures : Formalized fund management, standardized investment processes, and substantial minimum investment thresholds ● Government Alignment : Federal initiatives like VCAP and VCCI designed to complement institutional VC frameworks ● Scale-Oriented : Designed for efficiency at scale, optimized for larger investments in more developed companies Pre-Institutional Capital Dynamics ● Personal Decision-Making : Highly personal investment decisions rather than institutional committees ● Network-Based : Reliance on networks for deal flow rather than formal pipeline development ● Relationship-Intensive : Higher emphasis on founder relationships and proximity, less on standardized metrics ● Community Ecosystem : Angel investing thrives in community-based ecosystems with close entrepreneur relationships Implications for Policy ● Effective mobilization of pre-institutional capital requires policies specifically designed for its unique characteristics ● While institutional capital vehicles benefits from macro-scale structural interventions, pre-institutional capital may respond better to micro-incentives ● Tax-based incentives that directly benefit individual investors may prove more effective than pooled capital programs for mobilizing angel investment Just as founders can face barriers in reaching angel investors, venture capital fund managers—including those with established track records—can struggle to access institutional sources of capital. This reflects a broader challenge of accessibility across the capital continuum. 3. Venture Capital Development in the United States Foundations (1940s-1970s) ● American Research and Development Corporation (ARD) : Founded in 1946, pioneered the professional VC model ● Small Business Investment Companies (SBICs) : Created by the Small Business Investment Act of 1958, provided 75% of early-stage VC by 1968

● Limited Partnership Structure : Established the standard legal framework featuring carried interest and management fees Growth and Institutionalization (1970s-1990s) ● ERISA "Prudent Man" Rule Revision (1979) : Permitted pension funds to invest in VC, dramatically increasing available capital ● Capital Gains Tax Reduction (1978) : Reduced rate from 49.5% to 28%, improving after-tax returns ● Early Success Stories : Venture-backed companies like Apple, Microsoft, and Cisco demonstrated extraordinary potential returns ● Emergence of Sand Hill Road : Created industry nerve center that reinforced Silicon Valley's dominance Maturation and Cycles (1990s-Present) ● Internet Boom and Bust : VC commitments surged from $7.4B (1995) to $106B (2000), followed by contraction ● Emergence of Micro-VCs : Smaller funds filled early-stage funding gaps beginning in mid-2000s ● The Unicorn Era : Companies remained private longer with abundant late-stage capital ● Specialization : Development of sector-focused and stage-specific funds 4. Angel Investment in the United States Early Angel Investing (Pre-1990s) ● Traditional Model : Wealthy individuals, often former entrepreneurs, provided first external capital ● "Friends and Family" : Earliest risk capital from entrepreneurs' personal networks ● Regional Concentration : Initially concentrated in technology-rich regions like Silicon Valley Professionalization and Organization (1990s-2010s) ● Angel Groups Formation : Started with Band of Angels (1994), Common Angels (1998) ● Angel Capital Association : Founded in 2004 as professional association for angel groups ● Standardized Deal Terms : Developments like Y Combinator's SAFE (2013) reduced transaction costs

Democratization and Platform Models (2010s-Present) ● Equity Crowdfunding : JOBS Act of 2012 established regulatory frameworks for broader participation ● Syndication Platforms : Online platforms like AngelList enabled lead angels to syndicate deals ● New Investment Vehicles : Rolling funds and alternative structures expanded access ● Operator Angels : Tech executives becoming active investors, bringing operational expertise. A distinct category of “founder angels” has also emerged—entrepreneurs who invest in or alongside their own ventures at the earliest stages. These individuals are often indistinguishable from founders in their risk appetite and involvement. 5. Venture Capital Development in Canada Early Attempts (1960s-1980s) ● Government Origins : Emerged primarily through government initiatives rather than private sector ● Labor-Sponsored Venture Capital Corporations (LSVCCs) : Became dominant vehicle after 1988 federal tax credits ● Provincial Initiatives : Provincial development corporations with public mandates Evolution and Reform (1990s-2010s) ● Private Sector Emergence : Independent firms began to emerge, though remained small by international standards ● LSVCC Performance Concerns : Poor returns led to reduction of federal tax credits ● Limited Partnership Adoption : Gradual shift toward U.S. model, though with smaller fund sizes ● Venture Capital Action Plan (VCAP) : Launched in 2013, committed $400M in federal funds to catalyze private capital Recent Developments (2010s-Present) Canada’s venture capital sector has been significantly shaped by two landmark federal programs: the Venture Capital Action Plan (VCAP) and the Venture Capital Catalyst Initiative (VCCI) . VCAP, launched in 2013 with a federal commitment of $400 million, sought to strengthen Canada’s VC sector by leveraging private sector expertise and capital through a fund-of-funds

model. It catalyzed over $900 million in private commitments and contributed to the growth of several large Canadian VC funds. Building on VCAP’s foundation, VCCI was launched in 2017 with an initial $400 million commitment, followed by a further $450 million in 2021. In 2024, the federal government announced an additional $1 billion commitment to VCCI. This ongoing investment reinforces the government’s commitment to supporting Canada’s innovation economy through venture capital funds. When we refer to institutional capital vehicles in this context, we are speaking of venture capital funds that are professionally managed and structured to attract and deploy capital from large investment institutions such as pension funds, endowments, and sovereign wealth funds. These funds are characterized by formal governance structures, rigorous due diligence, and scalable investment models capable of absorbing and managing significant capital allocations. ● Sectoral Strengths : Particular strengths in AI, clean technology, life sciences, and enterprise software ● Fund Size Growth : Several firms raising funds exceeding $300M since 2018 ● International Expansion : Leading Canadian firms expanded presence across North America ● Corporate Venture Capital : Major corporations established venture arms ● Persistent Scale Challenges : Canadian funds still typically operate at smaller scales than U.S. counterparts Role of the Business Development Bank of Canada (BDC): As a federal Crown corporation, BDC has played a foundational role in developing Canada’s venture capital ecosystem through BDC Capital, with over $6 billion in capital committed to VC funds and direct investments. BDC was the lead implementation partner for both the Venture Capital Action Plan (VCAP) and the Venture Capital Catalyst Initiative (VCCI), catalyzing institutional capital formation and strengthening fund governance. While BDC has contributed meaningfully to scaling institutional venture capital, equivalent federal instruments for pre-institutional capital—particularly angel investment—remain disproportionately limited and regionally imbalanced. This underscores the importance of developing complementary mechanisms that mobilize earlier-stage capital across the full risk continuum. BDC’s role is crucial as a catalyst for institutional venture capital, complementing rather than competing with private-sector actors. Strengthening complementary mechanisms at the pre-institutional stage will ensure an even more robust pipeline to benefit Canada’s thriving venture capital industry.

The 2022 Legislative Review of the BDC Act reaffirmed BDC’s role as a critical public-market actor focused on addressing capital market gaps. The review emphasized the need for BDC’s interventions to complement, rather than displace, private investors or parallel ecosystem actors. It also highlighted the importance of prioritizing underserved segments—such as early-stage companies, underrepresented founders, and geographically disadvantaged regions. BDC’s role uniquely complements private-sector capital by addressing market gaps that private investors find challenging, such as early institutional-stage investment or specialized sectoral funds. A concrete example includes BDC’s role as anchor investor in early venture funds, catalyzing additional private investment by signaling institutional confidence. These findings point to a compelling opportunity for policy innovation at the pre-institutional level. Strategic, investor-facing incentives—such as a national investment tax credit, capital gains rollover, or a flowthrough model for innovation—can expand participation, attract new capital, and ensure that early-stage funding is not confined to those with privileged networks or concentrated geographies. 6. Angel Investment in Canada Early Development (Pre-2000s) ● Informal Networks : Primarily through personal connections without structured organizations ● Regional Business Communities : Local business leaders provided capital in major urban centers ● Limited Recognition : Remained largely unrecognized as distinct asset class Organization and Growth (2000s-2010s) ● First Angel Organizations : Groups like Toronto's Maple Leaf Angels (2007) and Vancouver's VANTEC (1999) ● National Angel Capital Organization (NACO) : Founded in 2002 as industry association ● Provincial Tax Credit Programs : Several provinces introduced investor tax credits for angel investments Current Landscape (2010s-Present) ● Growth in Angel Groups : Over 45 angel groups operating across Canada by 2023 ● Angel Activity Data : $100-200M invested annually across 400-500 deals according to NACO ● Regional Ecosystem Development : Angel groups emerged across Canada, including smaller centers

● Cross-Border Investment : Increasing connections with U.S. startup ecosystems ● Persistent Gaps : Early-stage funding gaps persist, particularly the "Series A gap" The rise of formal angel groups has helped address fragmentation by pooling capital, standardizing due diligence, and increasing deal syndication, thereby improving both professionalism and geographic reach. While Canada has over 45 active angel groups, the pace of new group formation has slowed. This suggests a maturing market and points to the need for targeted strategies to seed new groups, particularly in underserved regions. 7. Comparative Analysis: Key Differences Between U.S. and Canadian Risk Capital Ecosystems Structural Differences in Venture Capital ● Scale and Concentration : U.S. features larger funds in major hubs; Canadian VC is smaller and more dispersed ● Government Role : Canadian VC relies more heavily on direct government intervention and tax incentives ● Return Profiles : U.S. VC has generated higher returns, creating self-reinforcing capital attraction ● Stage Focus : U.S. spans full spectrum while Canadian VC has historically concentrated in early stages Contrasts in Angel Investing ● Organization Level : U.S. benefits from greater professionalization, larger check sizes, and developed networks ● Policy Approaches : U.S. has implemented significant federal tax incentives (e.g., QSBS exemption); Canadian support primarily at provincial level ● Investment Culture : U.S. angels typically demonstrate greater risk tolerance and comfort with longer timelines ● Sector Preferences : U.S. spans broader technology sectors; Canadian angel investing shows more concentration The U.S. has implemented significant federal tax incentives for early-stage investment, notably the Qualified Small Business Stock (QSBS) exemption under Section 1202 of the Internal Revenue Code. This provision allows individual investors to exclude up to 100% of capital gains on qualified stock held for more than five years, up to the greater of $10 million or 10 times their investment basis.

This exemption has been instrumental in encouraging long-term, high-risk investment in early-stage U.S. companies—especially in the technology sector—and is widely cited by stakeholders as a catalyst for angel capital formation. QSBS has significantly bolstered U.S. early-stage investment appeal. A similar or more ambitious policy in Canada could significantly enhance our competitive position in global innovation markets. A comparable Canadian incentive could significantly improve the risk-return profile for angel investors and encourage broader participation in innovation-focused enterprises. While the U.S. QSBS exemption significantly enhanced early-stage investment appeal by aligning risk and reward through tax incentives, it also benefited from America’s distinct capital market depth and high-risk tolerance culture. A Canadian equivalent should thoughtfully adapt to domestic market conditions and investor behaviors rather than directly replicate the U.S. model. 8. Core Challenges in Canada's Risk Capital Ecosystem 1. Disproportionate Growth in Funding Continuum ● Government Success with Venture Capital Policy : Canadian VC investment grew from 0.15% of GDP (2017) to 0.71% (2021) ● Record Investment : $14.7B of VC invested in Canadian startups in 2021, positioning Canada third among OECD countries ● Continued Government Commitment : Proposed $1B recapitalization of VCCI in 2024 ● Growth Rate Disparity : Angel investment grew 61% (2017-2021) while VC grew 308% in the same period ● VC to Angel Capital Ratio : Approximately 56:1 in Canada vs. 20:1 in the U.S. ● Recent Angel Investment Volatility: Peaked at $262.1M in 2021, dropped to $114.9M in 2023, partially recovered to $137.26M in 2024. While NACO data shows that angel investment activity in Canada has grown over the past decade—peaking at 653 deals in 2022—it still lags behind venture capital activity, which reached 706 deals in the same year, according to CVCA data. Even during periods of heightened angel activity, such as in 2021, the gap persisted: 635 angel-backed deals were completed, compared to 805 venture capital investments. The disparity becomes even more pronounced during periods of market contraction. In 2023, the number of angel investments declined sharply to 338—a 48% year-over-year decrease—while venture capital activity proved more resilient, recording 660 deals, nearly double the angel total.

These figures point to a structural imbalance in Canada’s capital continuum. While angel capital plays a vital role at the earliest stages of company formation, it remains more volatile and comparatively underdeveloped relative to institutional venture capital. This asymmetry constrains the consistency and depth of the early-stage funding pipeline—particularly during downturns when stable risk capital is most critical. These dynamics underscore the need for targeted policy interventions that broaden participation in angel investing and expand the volume of early-stage deals to ensure a more resilient and sustainable pipeline of investable companies feeding into Canada’s venture capital sector. ● Creating a Top-Heavy Ecosystem: A fundamental supply-demand imbalance persists between angel and venture capital. While Canada’s angel investment ecosystem has expanded, there remains substantial opportunity to accelerate its growth to better match and support the tremendous success of the venture capital sector. ● Canada’s current venture-to-angel capital ratio of approximately 56:1, compared to the 20:1 ratio observed in the U.S., represents a significant opportunity for growth. Narrowing this gap would further reinforce Canada’s robust innovation ecosystem and enhance early-stage funding dynamics similar to successful global models. ● Venture Capital Deployment Challenges: Well-capitalized funds face increasingly difficult investment choices due to this imbalance. This analysis draws on the most comprehensive data available from NACO and BDC/CVCA; however, it likely underrepresents the unstructured segment of the angel investment community, where deals often occur informally and outside of organized networks. This distinction between structured and unstructured angel capital underscores the need for inclusive national policy mechanisms that broaden participation. By reducing reliance on pre-existing “family and friends” relationships or socio-economic privilege, such incentives can help ensure that early-stage capital is more equitably accessible to founders from diverse backgrounds and regions—including those outside historically privileged networks and major urban centres. In 2023, Southern Ontario and British Columbia accounted for 62.6% of all angel-backed investments and over 55% of capital deployed. By contrast, Prairie provinces and Atlantic Canada received just 11.6% of deals and 7.6% of total investment. The Northern Territories represented less than 0.2% of all activity. This stark regional disparity highlights the need for nationally harmonized incentives to ensure early-stage capital reaches high-potential founders across all regions of Canada.

2. Limited Institutional Investor Support ● Institutional Participation Gap : Canadian VC depends more heavily on government support than U.S. counterparts ● Asset Allocation Disparities : Canadian institutions maintain lower allocations to domestic venture capital ● Scale Limitation : Smaller size of Canadian institutional investors limits meaningful allocations ● Risk Perception : Canadian institutions often perceive domestic VC as higher risk with lower returns ● Expertise Gap : Many Canadian institutions lack specialized knowledge in venture investing 3. Structural Weaknesses in Pre-Seed Ecosystem ● Fragmented Organization : Loosely-defined collection of independent investors and organizations ● Professionalization Gap : Mix of nonprofit and for-profit entities, many managed by volunteers ● Regional Disparities : Vast differences in resources available across regions ● Limited Policy Focus : Less coordinated policy attention to strengthening angel investment ● Insufficient Scale : Individual angels lack scale to support companies through multiple financing rounds 9. Policy Implications and Recommendations In policy analysis, “access to capital” is often measured by the total amount of investment deployed in a given period. But for founders—especially those outside major hubs or established networks—access has dimensions that go beyond aggregate investment figures. To be accessible, capital must not only exist in sufficient quantity; it must be reachable within reasonable timeframes and through a diversity of viable funding channels. Capital that is too administratively burdensome to access—due to complexity, delays, or rigid criteria—can be just as out of reach as capital that doesn’t exist. While this consultation focuses on increasing the supply of capital—particularly private capital—it’s important to recognize that efforts to expand supply must also consider the journey required to access funding opportunities.

For a more detailed explanation, see Appendix: Access to Capital Framework.

Ecosystem Approach ● Address the entire capital continuum rather than isolated segments ● Recognize the interdependence of funding stages from pre-seed through growth Private Sector Alignment ● Design policies that work with market forces rather than replacing them ● Focus on mobilizing private capital alongside public investment ● Encourage co-investment fund models—where government or institutional actors invest alongside private angels and seed-stage funds—as proven in regional examples such as Build Ventures in Atlantic Canada. Non-dilutive public funding programs (e.g., grants, subsidies) play a critical role in de-risking early-stage ventures, making them more attractive to both angel and institutional capital. Tax-Based Incentives for Angel Investment ● Consider federal-level tax incentives specifically targeting angel investors ● Evaluate models like the U.S. QSBS exemption and UK's SEIS/EIS programs Regional Balance ● Develop approaches to address geographic disparities in access to early-stage capital ● Support formation of angel networks in underserved communities and regions Without inclusive national programs, there is a risk of investment leakage—where investors in smaller provinces or local ecosystems reallocate capital toward perceived “stronger” opportunities in major hubs. Nationally harmonized incentives can reduce this disparity and retain capital locally. Long-Term Policy Stability ● Provide predictable, long-term policy frameworks to build investor confidence ● Avoid frequent changes to tax incentives and support programs Canada’s risk capital framework must be rooted in long-term thinking. Innovation returns follow exponential—not linear—curves, and policy must be calibrated to match.

Case Study: The Avro Arrow – A Lesson in Long-Term Policy Vision In the late 1950s, Canada stood at the forefront of global aerospace innovation. The Avro Arrow—a supersonic interceptor aircraft developed by Canadian engineers—represented a significant technological achievement and a potential foundation for sustained leadership in a strategic industry. However, in 1959, the program was abruptly cancelled despite its progress and promise. The decision resulted in the sudden displacement of thousands of highly skilled engineers, many of whom subsequently migrated to the United States and contributed to the development of NASA’s space program and the broader U.S. innovation economy. The lesson of the Avro Arrow is not just about a plane—it’s about policy. Canada made a short-term decision in a moment that called for long-term vision. And in doing so, we forfeited the chance to lead in an industry that would define the next century. Today, Canada faces a similar inflection point. The innovation economy is characterized by long-term, exponential return profiles that do not follow linear growth trajectories. The economic impact of innovative companies often emerges unpredictably over extended periods, making it difficult to anticipate through traditional models of extrapolation. Yet when strategically supported, these ventures can generate transformative outcomes—driving sustained national prosperity, technological sovereignty, and industrial resilience. As leading global powers—particularly the United States and China—intensify their investments in science, technology, and early-stage innovation, Canada must ensure it does not fall behind. Strengthening domestic innovation capacity is not only an economic imperative but a matter of economic sovereignty: long-term policy commitments are essential to building a more self-sufficient and adaptable economy—one capable of withstanding global disruptions, reducing dependence on foreign sources of innovation, and sustaining national competitiveness over time. 10. Case Study: How the UK’s SEIS and EIS Schemes Unlocked Billions in Early-Stage Capital The United Kingdom’s Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) stand as exemplary models of how targeted tax policy can unlock substantial private capital for high-risk, early-stage ventures. Policy Design ● SEIS Limits: As of April 6, 2023, the maximum amount a company can raise under SEIS increased from £150,000 to £250,000. Simultaneously, the annual investment limit for individual investors doubled from £100,000 to £200,000. Additionally, the eligibility

criteria expanded to include companies up to three years old, up from the previous two-year limit.

● EIS Limits: The EIS continues to offer 30% income tax relief on investments up to £1 million annually, or up to £2 million for investments in knowledge-intensive companies. Investors can also benefit from capital gains tax (CGT) deferral and loss relief on unprofitable investments. Impact Metrics ● SEIS: By the end of the 2022–2023 tax year, SEIS had facilitated over £1.9 billion in investment across more than 16,000 companies since its inception in 2012. In the 2022–2023 tax year alone, 1,815 companies raised a total of £157 million under SEIS. ● EIS: Since its launch in 1994, EIS has unlocked over £32 billion for more than 56,000 companies. In the 2022–2023 tax year, 4,205 companies raised a total of £1.957 billion under EIS. ● Investor Behavior: A 2020 UK government evaluation found that 70% of SEIS-funded companies would not have been able to raise capital without the scheme, and 78% of investors reported that SEIS relief was a deciding factor in their investment. Regional and Sectoral Reach While London and the South East continue to dominate SEIS and EIS investment, accounting for approximately 65% of total funds raised, there has been notable growth in regional hubs. Cities such as Manchester, Edinburgh, Bristol, and Belfast have emerged as significant centers for early-stage investment, supported by local incubators and innovation ecosystems. Sector-wise, the Information and Communication sector remains prominent, with companies in this category accounting for 39% of SEIS investment and 34% of EIS investment in the 2022–2023 tax year. Company Spotlight: Gousto (EIS-backed) Gousto, a meal-kit delivery startup now valued at over £1 billion, is a leading example of EIS’s catalytic potential. Early-stage funding from EIS investors enabled Gousto to expand operations, hire talent, and invest in technology before venture capital became available. The company later attracted institutional funding from Unilever and SoftBank. Several of Gousto’s angel investors were able to reinvest returns into new startups, demonstrating the compounding effect of a well-structured early-stage capital ecosystem.

In contrast, Canada’s largest provincial angel tax credit program supported just $30–40 million in early-stage capital in 2022—representing less than 2% of the UK’s national EIS output. This disparity underscores the scale advantage of nationally consistent programs and the opportunity for Canada to unlock significantly more capital with federal coordination. Policy Lessons for Canada The UK experience illustrates the power of well-calibrated, nationally consistent, and investor-targeted tax policy in mobilizing risk capital at scale. It also underscores the importance of policy continuity—SEIS and EIS have remained largely stable for over a decade, providing predictability to investors. Canada’s current patchwork of provincial tax credits lacks this coherence, scale, and national alignment. A federal initiative modeled on SEIS/EIS could provide the missing link between government-led VC strategies and a robust, self-reinforcing angel capital foundation. In contrast to Canada’s existing fragmented provincial incentives, the UK’s nationally consistent SEIS and EIS policies have successfully provided investors with clear, predictable, and scalable frameworks. Implementing a similar national approach in Canada could streamline investor decisions, promote consistent market signals, and address regional disparities more effectively. 11. Conclusion Canada has made significant progress in strengthening its venture capital industry through targeted government initiatives. However, the disproportionate growth between venture capital and angel investment threatens the sustainability of the entire funding continuum. Addressing this imbalance requires policies specifically designed for the unique characteristics of pre-institutional capital, with particular attention to tax-based incentives that directly influence individual investor behavior. By taking a comprehensive approach that recognizes the distinct dynamics of institutional capital vehicles and pre-institutional capital, Canada can build a more balanced risk capital ecosystem capable of supporting innovative companies from inception through to scale and transformative impact on Canada’s economy. By strategically enhancing early-stage capital incentives, Canada can ensure sustained success and global leadership in innovation. Strengthening the entire capital continuum benefits venture capital funds, early-stage investors, and Canadian entrepreneurs alike.

Appendix A: Summary Comparison of Proposed Early-Stage Investment Incentives

Appendix C: Access to Capital Framework A healthy capital system depends on a ready supply of capital from a variety of sources. This applies not only to founders raising from angel investors or early-stage funds, but also to venture capital fund managers raising from institutional limited partners. When capital is available through multiple channels—with differing mandates, timelines, and investment approaches—it enables better alignment, more competitive terms, and a stronger overall pipeline. Policymakers often equate access to capital with the existence of funding programs or the overall size of investment pools. But for founders and emerging fund managers, this view is too simplistic. Access is not a binary condition—it is a lived experience shaped by speed, sufficiency, and optionality. Capital that is slow to arrive, too limited in size, or restricted to a narrow group of providers may be technically “available,” but practically out of reach.

A more sophisticated understanding of access recognizes three interdependent dimensions:

● Supply of capital refers to whether enough capital is available at the right stage. For example, even with strong growth in venture capital, pre-seed and seed-stage capital pools often remain too small to sustain a healthy startup pipeline. ● Time to capital reflects how long it takes a founder (or fund manager) to raise funds. Prolonged diligence processes and slow-moving decision-making can disproportionately affect underrepresented or first-time founders (and emerging fund managers). ● Avenues to capital describe the diversity of viable funding sources available to founders. When those avenues are limited—concentrated in major urban hubs or among a homogenous investor base—it reinforces systemic inequities and restricts who gets funded, and on what terms. This lack of diversity can lead to power imbalances, where investors operate from an outsized bargaining position, imposing onerous deal terms or exercising outsized influence. It also increases the risk of founder-investor mismatch, where capital is deployed without adequate alignment on values, sector focus, or time horizon. Together, these dimensions shape whether capital is not only present but actually accessible. Policy interventions that increase the supply of capital without addressing these access dynamics may unintentionally reinforce existing gaps. Conversely, efforts to improve speed or broaden funding channels must be supported by sufficient scale. Broadening the availability of capital—at both the venture and fund level—is essential to building a resilient and responsive innovation economy.

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