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LSIFs Find Their Roots

By: John Sterling

Labour-sponsored investment funds suffered when many small technology start-ups went under. Now they are trying to get out from under the perception that they are technology funds. In fact, their real purpose is to provide a pool of capital for small- and mid-sized companies in all sectors. John Sterling, of the ROI Fund, looks at some of the characteristics of LSIFs.

Investors have endured much volatility of late and labour sponsored investment funds (LSIFs), in particular, have gotten a bad rap. Why? Because most LSIFs adopted investment strategies associated with small technology start-ups. And, when the technology sector found itself in decline, so did many LSIFs.

The truth is, LSIFs do not have to be associated with technology or be regarded as volatile and high risk. LSIFs account for one-third to one-half of available venture capital. There are even LSIFs whose mandates expressly forbid investments in technology companies or start-ups.

The objective of an LSIF is to assemble a pool of capital that supports the growth of small- and medium-sized companies in any sector to create jobs. In Ontario (and to varying degrees in other provinces), LSIFs can invest in any private company that pays 50 per cent of its salaries in the province, has less than $50 million, and has fewer than 500 employees. Many of these companies can generate sales of more than $70 million.

A company that can generate sales of $70 million or even more is hardly typical of a start-up company.

An LSIF with a solid investment strategy that diversifies across a number of business sectors can offer stability and regular returns, while providing an appropriate RRSP alternative for many Canadians seeking long-term growth for their retirement investments.

LSIF Roots

LSIFs have been available since the early 1980s when the Quebec Federation of Labour (FTQ) pooled retirement savings to generate jobs in local communities it became a venture capital model for other provinces. LSIFs did not gain prominence in Ontario until Working Ventures launched its first LSIF in 1989 and the NDP rose to power the year after.

Of the approximately 50 LSIFs available to Canadian investors that manage more than $3.5 billion in assets, 90 per cent of these assets are invested in technology and bio-technology companies. Not surprisingly (but somewhat unjustly), LSIFs in general have virtually become synonymous with high risk and volatility.

Investment Strategy First

One key to a successful LSIF investment is to invest in profitable companies belonging to stable and mature economic sectors. Such sectors include:

Further, debt-based LSIFs, rather than equity-based, may provide a more prudent investment approach in volatile times. In other words, when a debt-instrument LSIF lends money to companies, these companies start paying it back immediately and this ensures immediate and regular returns. An equity-based approach can be a gamble and is most certainly a longer-term strategy. You must wait for the return in either the form of growth, a takeover, or an IPO. With debt, the investment is on a scheduled exit that correlates to the loan repayment. Debt is also a more tax efficient investment vehicle for companies as the interest is expensed.

Tax Credit Bonus

While investment decisions ought to be based on the quality of the investment itself, the tax incentives for LSIF investments provide unique, added benefits.

Although LSIF tax credits vary from province to province, investors are encouraged with federal and provincial tax credits of approximately 15 per cent each on LSIF investments up to $5,000 a year. LSIF investments are RRSP-eligible, which make the investments an attractive RRSP alternative. In addition, individual provinces may provide additional tax credit benefits. Ontario, for example, offers a five per cent tax credit bonus – on top of the provincial 15 per cent credit – for LSIFs that invest in research-oriented companies.

This tax credit structure makes it possible for an investor to earn a total tax savings of $3,820 on a $5,000 LSIF investment.

This has been met with zeal among LSIF sellers, but also with understandable skepticism among media and investment experts. Indeed, if the underlying investment is unproven, as is the case with many LSIFs that invest in technology companies or start-ups, there is an obvious risk the investment will lose over time if the invested company performs poorly.

As a result, investors are required to stay invested for eight years, giving young companies the time required to mature and, potentially, see returns. If an investor exits an LSIF investment before the eight-year period expires, the investor typically pays back the tax credits and may also be subject to a sales fee.

Giving LSIFs A Second

Look While LSIFs provide immediate and attractive tax benefits, the underlying investment must be sound to promote longterm growth. LSIFs that invest in stable and mature sectors – such as manufacturing, health services, and financial services – work to provide stability and engender trust over the long-term. Debt-instrument LSIFs can provide immediate, regular returns.

Even though the overall LSIF industry is still in its infancy, the premature rush towards technology-related investments has prompted investors to approach LSIFs with a cautious, wait-and-see attitude. While this is prudent when approaching any investment, perhaps the tried-and-true strategy of investing in companies in established industries will help turn the unfortunate LSIF stereotype around, while providing long-term results for favourable retirement savings.


John Sterling is CEO of ROI Fund, a labour sponsored investment fund that launched in late 2002.

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