Canada’s tech sector badly needs more capital. Tech itself has a solution: the blockchain

So far, the pandemic has had devastating effects on Canada’s technology entrepreneurs.

Spending on technology has declined. Venture capital was never strong in Canada and is now more cautious than ever.

Small companies have received good support from the government through the Canada Emergency Wage Subsidy, the Canada Emergency Business Account and the newly improved Canada Emergency Rent Subsidy, and countless companies have been saved. Nonetheless, every Canadian city has empty offices where technology entrepreneurs are on the hook for rent.

As the pandemic wanes, companies that have survived have an opportunity to storm back, but raising money will still be a challenge. It’s time to adopt a popular financing incentive used in the resources sector known as a flow-through share. By applying this tool to the technology sector, Canada could generate close to $1 billion in new technology R&D.

The flow-through share is a special type of common share that allows eligible companies to “flow through” certain expenses to the holders of such a share. Investors may claim these expenses as a tax deduction, rather than the company’s deducting them from profits.

The use of flow-through shares fuelled investment in Canada’s mining, oil and gas, and renewable energy sectors over the past half-century. As the Prospectors and Developers Association of Canada put it, “Flow-through shares have helped make Canadian mining firms world leaders. Vijay Jog of the University of Calgary’s School of Public Policy identified in one survey at least 1,783 companies that raised funds through flow-through shares issued between January 2008 and June 2014. These companies completed financing valued at a total of $4 billion, of which flow-through shares contributed $2.5 billion — a substantial amount by any measure. This instrument has given countless entrepreneurs access to capital for high-risk projects, while offsetting some of the risk to their investors. Imagine the huge benefits that flow-through shares could bring to Canada’s AI, blockchain and fintech firms.

Even before the pandemic, Canada ranked dead last among OECD countries in creating billion-dollar companies. Prior to the pandemic, the U.S. venture-capital market was valued at $60 billion (U.S.), whereas Canada attracts only $3 billion (Cdn.) of this type of funding, less than half of what we might expect based on the size of the two economies.

Up to now, investment in startup technology companies has come largely from wealthy angel investors, venture capital pools, and private equity funds. Extending flow-through shares to the tech sector would not only give entrepreneurs access to a vast pool of funds, but also enable ordinary investors to share in the rewards (and, yes, the risks) of an exciting investment opportunity.

The idea has been resisted by governments, citing loss of tax revenue and the potential for abuse, and they are right to be skeptical. It’s one thing to account for an oilfield drill. But how can government be sure investments in software and programmers are valid ones? Further, memories remain fresh of the early 2000s when companies were lining up to convert themselves into income trusts. Ottawa decided to shutter the income trust scheme and finance officials are understandably reluctant to go down a similar path again.

However, the solution to these problems may lie in new technologies themselves. For example, blockchain offers a means to avoid these unintended consequences. Put simply, a blockchain is software that functions as a ledger distributed across nodes of a communications network. What differentiates it from traditional registries, shared databases, and accounting software is its immutability: no one can modify, reverse, or erase those transactions without approval from a majority of nodes. Blockchain provides a transparent yet encrypted solution to the challenges of validating and safeguarding investments in technology.

The Finance Department could set up a blockchain ledger and require companies to record, if not conduct, all flow-through share transactions there, including how they spent the money received. Anyone — shareholders, regulators, stock exchanges, the Canada Revenue Agency — could vet and audit the use of funds in real time. Can you imagine a more trustworthy system?

In addition to guaranteeing the efficacy of the program and limiting abuse, such a plan would demonstrate the Canadian government’s willingness to use new technology. It’s a win-win: flow-through shares would sustain research and development (and R&D jobs) in the technology sector through these difficult times, and Canada would pioneer a new funding platform leveraging blockchain’s capabilities and fuelling innovation.

At the Blockchain Research Institute, we estimate this could bring more than $800 million annually in new investment into Canadian technology and that any short term losses in tax revenue would be quickly recovered by the taxes paid by growing successful technology companies.