NDP's stock option plan would 'kill' Canadian startup ecosystem, tech leaders say

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Some of Canada's leading technology entrepreneurs are warning an NDP election pledge to change the tax treatment for stock options will have a disastrous effect on Canada's burgeoning startup scene, one of the brightest sectors of a sluggish Canadian economy.

"I think that option taxation will kill the Canadian startup ecosystem," said Ryan Holmes, founder and chief executive officer of Vancouver-based Hootsuite Media Inc., a seven-year-old social media management firm that has rapidly grown to an estimated $100-million-plus in revenues and is expected to go public within the next year.

"It is shortsighted and will be very negatively impactful."

Tobi Lutke, CEO of Shopify Inc., an Ottawa retail merchant software firm whose initial public offering in May was one of the most successful by a Canadian tech firm in years, said if stock option gains become fully taxable, "then there will be a lot less technology startups."

Under the NDP plan, gains from exercising stock options would be fully taxed. Currently, only 50 per cent of the gains from stock options are subject to tax, which is the same favourable capital gains tax rate that investors pay when they sell shares.

NDP Leader Tom Mulcair calls the tax treatment for options a "loophole" that benefits CEOs and "the wealthiest Canadians." His party estimates the government would save $500-million a year for the next four years by taxing the full gain on options. The Liberal and Conservative parties have not proposed changes to taxation of stock options.

But leaders of Canada's startup scene say options are not just for big company CEOs – they are also vital for young companies that need to attract employees and are challenged by a lack of money and a much greater risk of failure than an established firm. Employees accept lower pay and greater risk in the hopes that the stock options they receive could translate into valuable equity down the line.

"It's a super fundamental part of the startup ecosystem, and the reason startups work," said Mr. Lutke, whose company is hiring hundreds of people this year.

An NDP tax change, he said, "moves the needle up the risk-reward scale on the side of risk," which means the same people will not join startups any more. "The only reason Shopify exists is because we gave people equity before salary for the first couple of years."

Mr. Holmes agreed his company would not have been able to grow without the current favourable tax treatment for options.

"As the narrative around technology has grown [in Canada], as companies like Shopify and ours have been able to provide liquidity for early employees [by offering options], people have absolutely realized the value of options," Mr. Holmes said.

"It is one of our most important recruiting tools. By putting taxation on this they are going to hobble the potential of startups to incentivize and recruit employees…They will hurt small and innovative businesses."

Canada's venture capital sector has been an economic success story, attracting high levels of financing even as the economy faces volatility and stock markets have slumped. In the first half of 2015, completed venture capital deals totalled $939-million, up 23 per cent over the same period last year, according to the Canadian Venture Capital & Private Equity Association.

CVCA chief executive officer Mike Woollatt said if the NDP makes no modifications to the party's proposal for smaller companies, he believes it would have a large negative impact on growth in the startup sector in Canada.

"At a time when Canada needs innovation, I'd discourage us from looking at ways to decrease the financing towards innovation, which is effectively what this does," he said.

Mr. Woollatt said he suspects the NDP is unaware that a large proportion of stock options in Canada do not go to big company CEOs at all, but to other employees down the line at smaller firms.

And he said eye-popping statistics about big option gains can obscure the fact that a startup CEO may have earned a tiny salary for years before reaping that $200,000 stock option payout.

"I'd be willing to bet the vast majority of stock options are at small and medium-sized companies where the CEOs have worked like dogs for 10 years to try to grow something," he said.