On August 27, 2024, Communitech hosted a meeting with over 25 tech founders to discuss the recently revised Canadian Entrepreneurs’ Incentive (CEI). The CEI was introduced as part of this year’s federal budget in an attempt to offset the increase in the capital gains inclusion rate. 

The discussion made it clear that while the CEI is a step in the right direction, it still falls short of levelling the playing field. Recent revisions to the CEI have expanded eligibility to include more founders, but employees and angel or early investors – who play a critical role in startup success – are still largely left out.

Founders agreed that the updates don’t recognize that attracting global talent is critical for companies, since over 98 per cent of employees are excluded because they don’t own five per cent or more of a company. Similarly, angel and early investors – key players in the innovation economy – are left out, as 98 per cent of them don’t meet the five per cent ownership threshold.

One CEO said the current threshold-based system doesn’t properly value the contributions of employees with smaller stock options. The CEO argued that companies rely on all their employees to grow and described the thresholds as regressive.

Tech leaders warned that these limitations could lead to decreased Canadian investment and increased U.S. ownership in Canadian companies, which is already at 74 per cent.

During the discussion, an example was shared of a founder who tried to bring a U.S. leader on board; however, the leader opted to stay south of the border due to the tax situation. With part of the leadership team now based in another country, there’s concern that others might follow, potentially threatening the company’s Canadian roots.

With an eye to maintaining the vibrancy and global competitiveness of the startup ecosystem, Communitech is advocating for the harmonization of the CEI with the U.S. Qualified Small Business Stock (QSBS) program. The proposal includes introducing tax credits or refunds for Canadian innovation investments, along with increased funding from agencies like EDC and BDC for early-stage ventures. There is also a recommendation to extend preferential capital gains tax rates to all employees holding stock options, with adjustments for those granted under previous regulations. 

During the discussion, Chris Albinson, President and CEO of Communitech, addressed how these proposed changes could help Canada remain competitive by attracting talent, boosting risk capital investment and promoting growth in company formation and employment, which would provide a more equitable approach and strengthen the country’s tech ecosystem.

In just over 20 years, interest among Canadians in starting a new business has decreased by more than half. Only 1.3 out of every 1,000 Canadians started a new business in 2022, compared with three out of 1,000 in 2000. Unless mitigated, changes to capital gains will accelerate an already dangerous trend reducing productivity and economic growth.

The conversation also addressed broader issues affecting Canadian tech companies, such as the need for increased investment from Canadian pensions and improved procurement practices. Currently, a significant portion of Canadian capital is still invested in traditional sectors rather than innovative tech startups. One founder called attention to the struggle for Canadian companies to find local buyers, leading them to rely more on international markets.

The discussion wrapped up with the agreement that while the CEI revisions reflect progress, there's still more to be done. The updates help founders, but don’t fully support employees and early-stage investors. The big takeaway was that aligning the CEI with the QSBS program could level the playing field and create a fairer, more effective incentive, strengthening Canada's tech ecosystem and making it more competitive.