OTTAWA — The federal government’s proposed new rules for foreign investment in sensitive tech sectors could make it harder for Canadian startups to raise money and deter innovators from setting up their businesses here, dealmakers warn.  

Bill C-34, tabled last week, would amend the Investment Canada Act to require international entities to notify the government before closing deals in sensitive sectors, which Canadian authorities may then subject to national security reviews. It also gives the industry minister more power to extend investigations and prevent the firms involved from sharing data and IP while they’re underway. The legislation comes as Ottawa signals a stronger stance on China’s economic, technological and military activities, and amid growing global competition over innovative businesses and technologies.

U.S. funds have long been major players in Canadian tech dealmaking, leading and participating in ever more megarounds as the sector scales up. In recent years, Asian tech giants have joined them in backing and acquiring innovative firms here. But Canadian tech investors say uncertainty over the scope of the new requirements, and over how long those reviews might take, could hurt startups’ access to capital. 

If the bill passes, the federal government will publish regulations some time in the future identifying to which sectors the updated rules will apply, but speaking to reporters last week, government officials cited a March 2021 update to the national security review guidelines, which added critical minerals, sensitive personal data and 15 technology areas including AI, robotics and quantum.

“That is a huge swathe of potential transactions that will now come into this advance-notification process,” said Subrata Bhattacharjee, national chair of the competition and foreign investment review group at law firm BLG. The guidelines encompass “pretty much anything in the innovation economy.”  

Innovation Minister François-Philippe Champagne said last week he’s not concerned that the new rules will stem the flow of capital to domestic firms, citing Canada’s workforce, innovative ecosystems, critical mineral deposits, renewable energy capacity and access to markets via trade deals. 

But investors say Ottawa needs to carefully define which sectors and technologies it’s targeting. “Every company is potentially using AI at some stage,” noted Boris Wertz, Vancouver-based general partner at Version One Ventures. “Is that a catch-all clause for every single technology company?” 

If the government’s target list is too wide-ranging, it will cut into investment, particularly for newer firms, said Wertz. Investors won’t want to “file some additional paperwork to get a deal done at the early stages, where you don’t even know how this thing’s going to play out.” 

For investors in the smaller rounds typical of new businesses, “perception can really drive decisions,” said a Canadian VC, who requested anonymity because their firm is active in the ecosystem. By drafting a law that lacks precision and that defers decisions on crucial details, the government is creating uncertainty, they said. The more obstacles founders face to raising money from international investors, and to the prospects of a future sale or other exit, the more founders may choose to incorporate their startups elsewhere, said the VC. “It’s not like there’s some secret pot of gold here.” 

Investors also expressed concern that the new rules might see Ottawa clamp down on tech firm’s ability to sell out to foreign buyers. “Dollars from exits can be a total boon for a young ecosystem,” said the Canadian VC, noting founders and employees who cash out often start or invest in other companies. But Chad Bayne, co-chair of the emerging and high growth companies practice at law firm Osler, said Ottawa will actually increase clarity around national security reviews by publishing a list of sectors subject to the pre-notification requirement and timelines. “Right now, there is no real process—it’s very opaque,” he said.

Financiers and tech executives say they understand Ottawa’s concerns about the security risks that come with some foreign investments, and the need to keep hostile states from taking advantage of intellectual property developed here. “Canadian AI has the potential to have greater export value than maple syrup,” said Mike Murchison, CEO of Toronto-based Ada Support, a customer-service chatbot platform. “But this protectionism, if not properly stick-handled … runs the risk of curbing tech innovation in Canada.” 

Dealmakers also expressed concern that the new process would delay transactions. Innovation, Science & Economic Development Canada (ISED) will set the timelines via future regulation. “It definitely will slow down the ability for companies to raise money,” said Bayne.  

Under the current rules, when foreign investors close a deal to acquire a Canadian business they must inform the government within 30 days. Authorities then have an initial 45 days to say they’re launching a national security review. While the proposed new rules don’t go as far as making reviews automatic for deals in sensitive sectors, a startup “can’t really bank on the money” until after the 45-day window, noted Wertz. “What if it falls through? Then you’re back to square one.”

Most foreign funding isn’t coming from nations whose governments Canada has identified as disruptive actors. Both Murchison and Bayne pointed out that U.S. investment is essential to this country’s technology sector. Financiers from other countries are also increasingly investing in Canadian companies, Bayne said. Ottawa doesn’t plan to exempt U.S. investors or those from other allied countries from the new rules, officials said last week. Slowing the flow of international money is “a detriment to our industry here [because] there is just not enough capital in Canada to fund these companies,” Bayne said. 

The Investment Canada Act lets non-Canadian VCs skip the current post-closing filing requirements if they meet certain conditions, including that they’ve been active in the country for at least two years and are taking stakes with the aim of eventually selling them. “The new pre-notification requirements do not substitute the [law’s] exemptions,” said ISED spokesperson Andréa Daigle. But the application of the rules “would be entirely dependent on the facts of specific investment.”

Some prominent foreign funders that are recent entrants to the Canadian market may not qualify for the VC exemption. For example, New York-based Tiger Global Management may not have met the two-year activity requirement ahead of a trio of deals in May 2021 that included participating in mega-rounds for Ada  and Xanadu, a Toronto-based quantum computing firm. The hedge fund, known for fast closes, had previously made only one disclosed Canadian investment. Tokyo-headquartered SoftBank similarly had little track record in the country when it led a US$180-million Series C for Deep Genomics, a company applying AI to drug discovery, that July.

The Canadian Venture Capital & Private Equity Association is reviewing Bill C-34 to assess whether it “creates a chill on investments and adds hurdles to the growth of Canadian innovative companies,” CEO Kim Furlong said in a statement. The industry group previously successfully lobbied the U.S. Treasury Department to grant Canadian investors an exemption to the notification requirements and non-controlling investment reviews of the Committee on Foreign Investment in the United States.