What are labour-sponsored venture capital investments?

Spiders, Goats and Venture Capital

What do spiders and goats have to do with labour-sponsored venture capital investments? In a recent issue of The MoneyLetter, successful investor and author Gordon Pape, featured a story on Nexia Biotechnologies Inc., a labour-sponsored company that has developed a super-strength material by transplanting a single spider silk gene into the genetic make-up of an African dwarf goat. Not surprisingly, Pape called the cover story "Weird Science."

Characteristics of labour-sponsored venture capital investments

Labour-sponsored venture capital investments are often described more simply as labour-sponsored, or venture capital investments. In general, venture capital companies are start-up or emerging, small capitalization companies, with less that $5 million in assets. In the mutual fund industry, there are more than 20 labour-sponsored funds in Canada. These funds are of interest for two reasons: These invest- ments can be tax sheltered in a self-directed RRSP and the generate tax credits.

Tax sweeteners

Depending on the province, labour-sponsored funds can generate a 15 per cent tax credit and a 15 per cent provincial credit. (Ontario added a 5 per cent tax credit in 2000 for which only a few funds, such as Canadian Medical Discoveries, can qualify.) While the amount you can contribute to a labour-sponsored fund is unlimited, the maximum that you can contribute for the tax credit is $5,000 per year. As well, if the fund is held in an RRSP, you also benefit from the normal RRSP deduction.

Example:

If you put $5,000 into an RRSP, you will not only gain a total tax credit of $1,500, but you can also claim a $5,000 tax deduction for the RRSP contribution.

Other advantages of labour-sponsored investments

A labour-sponsored fund in an RRSP boosts the plan's foreign content room to a maximum of 45 per cent in 2000 and 50 per cent in 2001. Potential long-term gains with successful venture companies, offer diversification in a portfolio similar to sector investing with mutual funds. Because labour-sponsored funds generally have heavy exposure to private companies, you won't experience the volatility attributed to Nortel Networks Corp., for example. They also tend to hold greater cash reserves, creating more stability in see-saw markets.

Cautions

• These funds are suited to patient people who are investing for the long term.
• If you buy a labour-sponsored fund today and sell it before 2008, you must pay back the tax credits you receive. As well, there may be additional sales charges on redemptions.
• Labour-sponsored venture capital companies have no long-term track record, so they are more difficult to research.
• It is a highly speculative investment. There is no guarantee of returns.
• In the case of labour-sponsored investment funds, management expenses are often more expensive.

Strategies for choosing a venture capital investment

• First and foremost, do venture capital investments suit your investment personality, risk tolerance and time horizon?
• Your choice of a venture capital investment should be based on the sound management of the fund.
• Look closely at the management team: Do they have hands-on experience running businesses?
• Study the prospectus closely: Does the management team make their own decisions or do they have to go through a board for decisions?
• What qualifications and expertise do the managers have? They should be much more than stock buyers and sellers.
• Protect your portfolio by limiting your exposure to a small percentage of venture capital holdings.
• You may also want to invest in two or three labour-sponsored investments to spread the risk.

Research tips

• If you are purchasing a labour-sponsored fund, check out the fund's web site to develop an understanding of each holdings and earnings potential.
• Look at the prospectus for fund specifics. An excellent online source of prospectus information can be found at www.sedar.com.
• Discuss labour-sponsored venture capital investments with your financial advisor or tax professional.