A new survey of venture capital finds that although Canada remains one of the top three targets for increased VC investment, 40% of U.S. respondents and 28% of global respondents cite Canada’s unfavourable tax environment as a key reason for not investing in Canadian companies.

This level of concern is five times higher than for any other country in the survey and reflects the current investment crisis within Canada’s venture capital industry, it finds.

“The outlook for the Canadian venture capital industry is bleak given its ecosystem is broken and there is no immediate solution at hand. The Canadian government and the domestic VC community must join forces to bring the industry back from the brink of collapse,” says John Ruffolo, national leader, technology, media & telecommunications industry group, Deloitte. “Although remedies exist at each investment stage, the country must act quickly to remove major tax barriers preventing critically needed international flows of investment capital from crossing our borders.”

According to Ruffolo, the results of the global VC survey should trigger alarm bells throughout the industry and government. “If not fixed in the near term, the Canadian VC ecosystem — made up of successive and sequential stages of capital investment from early seed financing through initial public offerings — will collapse. We need the government’s help to pull the industry out of this crisis,” he says.

The firm argues that without a healthy VC ecosystem that is able to convert the ideas into real products that create revenues, jobs and taxes, much of the Canadian government’s $9 billion a year in research and development investment will be wasted.

It says, in a five-year comparison, VC investment in Canadian operating companies in the third quarter of 2007 ($517 million) is almost 21% lower than in the third quarter of 2002 ($653 million). In addition, almost a third (31%) fewer Canadian operating companies (147) were funded by VC firms in the third quarter of 2007 compared to the third quarter of 2002 (215).

As of the end of September 2007, new capital commitments by venture firms into Canadian operating companies totalled $852 million, down 72% from the $3.087 billion committed during all of 2002. Further, over five years, the total amount of capital raised by Canadian venture capital firms has decreased at an alarming rate from $3.087 billion (2002) to $1.973 billion (2003) to $1.779 billion (2004) to $2.21 billion (2005) to $1.635 billion (2006) to a year-to-date total of only $852 million (2007).

The government of Canada can remove the tax barriers preventing the flow of direct foreign VC investment into the country, and it can also play a critical role in reviving the Canadian domestic VC ecosystem, Deloitte says. At the seed and early stage financing rounds, both federal and provincial governments could provide incentive tax credits, flow-through tax deductions, and/or reduced capital gains taxes for investors. At the first round of institutional VC funding, the federal and provincial governments could also improve retail venture capital programs, particularly for provinces where such programs have been curtailed (Ontario) or do not currently exist (Alberta). And, at the latter round of institutional VC funding, the government can play a pivotal role as a source of capital for these VCs.