The decline and fall of the labour-sponsored venture fund

David Levi thought a new kind of venture capital could do good and make money. Neither has happened yet

David Levi

(Portrait by Evaan Kheraj)

There’s no questioning David Levi’s powers of persuasion. Spend half an hour with this likable bear of a man in his downtown Vancouver office and, regardless of what you might have thought going in, you’ll leave reassured there’s nothing wrong with the investment funds he manages that a little time and a few profitable exits won’t fix. Of a $5-million loan consolidation to refinance his firm, Matrix Asset Management, he told me more than a year ago, “Once we get the transaction out of the way, then all of our debt falls away.”

This bullish prediction hasn’t proven true. But you sense how that unflagging optimism and salesmanship has sustained his career and found followers for his pioneering ideas on ethical investing and promoting corporate social responsibility to Canada. Following the example of the Fonds de solidarité des travailleurs du Québec, formed in 1983, he brokered a deal among B.C. trade unions, government and retail investors to create the Working Opportunity Fund (WOF) in the early 1990s. Investors would get a (then) 35% tax credit on money invested in a portfolio of startups managed by his firm, GrowthWorks Capital (now part of Matrix, a public holding company he created to bring together different divisions of his empire, including venture capital and mutual funds). The unions didn’t contribute any of their own capital to this so-called “labour-sponsored” fund, nor did they promote it to members. Instead, their main contribution was to furnish labour leaders to sit on its board.

Created during a time of high unemployment, the fund was meant to seed the next generation of companies and jobs in technology. (It currently holds stakes in high-profile startups such as quantum computing company D-Wave Systems, energy firm General Fusion and e-commerce enterprise BuildDirect.) He eventually took over similar funds in six other provinces. Outside Quebec, he became the face of this niche of the investment industry and the promoter of its goal to do good by both society and investors.

Today, at 59, the former financial wunderkind presides over an increasingly threadbare coast-to-coast financial empire. In October 2013, the GrowthWorks Canadian Fund board fired Levi’s namesake company as its manager. The Ontario-based fund then entered creditor protection, with only a series of high-interest loans keeping it from being liquidated. (One of those loans came from the WOF , which itself had encountered liquidity problems and shut down redemptions from time to time.) It had already been two years since investors in the Canadian Fund had been able to get at their money. Matrix, meanwhile, was labouring under a working capital shortfall, which in 2013 forced it to sell off its institutional and mutual fund arms.

Indeed, the once thriving labour-sponsored funds sector seems to be teetering on the verge of oblivion—a good thing, in the eyes of critics who claim it puts unsophisticated investors at risk and skews Canada’s venture capital market toward technology sector long shots with little chance of payoff. In part, the decline is due to a flawed business plan reliant on very generous tax credits. They were brought in by the federal and most provincial governments for labour-backed VC funds in the 80s and early ’90s, as a way to stimulate badly needed investment in technology. Ontario withdrew its tax credit in 2010, arguing that the venture capital market had grown and matured, and there were better ways of assisting the commercialization of Ontario-born technologies. In 2013, the federal government announced it, too, would be phasing out its 15% credit. By 2017, there will be no tax advantage at all to the funds for residents of Ontario, Prince Edward Island and Alberta (which offered no credits to start with).

Without these sweeteners, labour funds would be a hard sell. Almost all GrowthWorks’s funds have posted negative returns over the past decade. As it is, investment dealers who still offer labour-sponsored funds are exceedingly hard to find. “If somebody moves to us with these funds [in their portfolio], we’re looking for an immediate maturity date to get out,” says a Vancouver investment adviser with a nationwide wealth management firm who asked not to be named. “I never saw one that anybody made any money on. As a matter of fact, the losses were huge. So you’re really investing in the community. As an independent broker, my job is not to invest in local communities. My job is to preserve capital and to try to build wealth in a safe way.” Without the support of dealers to market his funds, Levi’s hopes for a rebound in the sector seem far-fetched indeed.

There was a time when Levi, a college dropout who got his start as a stockbroker and the son of a B.C. NDP cabinet minister, seemed to have the Midas touch. In the 1980s, he famously orchestrated a coup at Vancity, English Canada’s largest credit union, getting elected chairman of the board at the age of 30. In that capacity, he ushered in innovations to the Canadian financial industry such as daily interest savings accounts, open mortgages and ethical investment funds. All along, he preached an idea that seems only more poignant today, in the wake of the 2008 financial crisis: that capital can be corralled to do society good while it does well for itself. To this day, Vancity uses the tag line “Make good money” in its advertising.

Levi’s timing seemed equally fortuitous when he, along with six B.C. trade unions, set up GrowthWorks in 1991, at the start of a decade-long tech boom. With a 20% tax credit from the provincial government and 15% from the feds, early investors snapped up WOF, his first fund. And, for a while at least, they could be satisfied with WOF’s returns, especially after the $414-million sale in 1999 of portfolio company HotHaus Technologies to Broadcom Corp., a semiconductor maker and Fortune 500 member.

The past decade was not so kind, to Levi or to the venture capital business in general. Still, he saw opportunity. When a number of Ontario funds—at one point, the province was home to 46 labour-sponsored funds—started failing due to a combination of poor investments, falling sales and rising redemptions, he scooped up several and consolidated them into the Canadian Fund. Ontario had taken a “Wild West approach with poor oversight,” Levi says. “We saw an opportunity to roll up the country on the VC side.” Then, in 2010, GrowthWorks merged with Halifax-based Seamark Asset Management, a diversified fund manager. The expansion was not just geographical. Under the new publicly traded vehicle Matrix, Levi had fingers in the mutual fund and institutional pies, along with venture capital. The diversification, he thought, would bolster the business in the event a province made a policy change or there were challenges to any one business line.

But instead of rebounding, assets under management shrank over the following years, as sales lagged, investments soured and investors pulled their money—to a total of $210 million as of Sept. 30, 2014. In the midst of this, Levi came under criticism for Matrix’s management fees and his personal compensation package that, while heading downward, still topped $400,000 in 2012. Though hardly extravagant by financial sector standards, this champion of the public good owned a vacation home in Belize and led a lifestyle that placed him firmly within the ranks of the 1%.

As Levi tells it, Matrix was a victim of timing. “Unfortunately, we were largely caught up in the crisis of 2008,” he says. It was “a bad time to get into the mutual fund business, and though we got in inexpensively, the growth was not what we’d anticipated.” Seamark’s institutional business lost its biggest client, Manulife Financial, in 2012.

But even had the financial crisis not happened, Dan Hallett believes the labour-sponsored funds industry would still be in trouble today. The Windsor, Ont., certified financial analyst, now vice-president and principal of HighView Financial Group, had researched the sector for a number of years up to 2006, when he concluded that it was in irreversible decline. “I figured these things would all hit a liquidity crunch at some point,” he says. Returns were lousy, the early-stage companies the funds invested in constantly needed more money, and Ontario had already decided to cancel its tax credit in 2010, which became a deal-breaker for many investors. “If you have no money coming into the fund and more people wanting out, you have a cash and liquidity problem,” he says.

That pretty much describes what happened to the Canadian Fund. It suspended redemptions in 2011 and took on a series of high-interest loans, most notably a $20-million secured loan from U.K.-based Roseway Capital, in order to make follow-on investments just to maintain its stakes in portfolio companies. Another loan came from the WOF (since repaid in full), which at one point was forced to borrow $10.5 million itself from Beedie Capital Partners (the finance arm of Vancouver developer Ryan Beedie) at 15% just to make its own follow-on investments. Without the follow-ons, Levi says, “we would have seen significant dilution and diminution in value.”

But the B.C. Securities Commission had sufficient unease with the movement of cash around the various funds to launch a field audit. In April 2013, it “identified deficiencies in [GrowthWorks’s] system of compliance procedures and internal controls,” Matrix reported in a news release, a characterization the firm disputed, though it co-operated with the investigation. Regulators also found fault with Matrix’s working capital position, which had fallen into a $7-million deficit.

Then the TSX piled on. Matrix’s market value had fallen below minimum levels to stay listed on the big board, it said in August, giving the company 120 days to return to compliance. Like its funds, Matrix had taken on some high-interest loans. With the sale of Seamark to management and Marquest Asset Management’s purchase of the mutual fund business over the summer, Matrix consolidated those loans into a single $5-million note from an unnamed Canadian lender. The problems persisted, however. Matrix voluntarily delisted from the TSX last March. In August Levi was forced to inject $400,000 of his own money to keep the firm going.

The Canadian Fund’s sudden termination of its management arrangement and creditor protection proceedings took Matrix by surprise. “We were quite shocked,” Levi says. In December, Matrix sent a letter to the fund seeking $16.8 million in damages for wrongful termination. The fund responded that the claim was without merit and would be vigorously contested.

With the ongoing liquidation of the Canadian Fund and the loss of Ontario and federal tax credits, how much remains of the dream of labour-sponsored venture capital in English Canada? Levi, once optimistic Ottawa would reverse its decision, now pins his hopes on the provinces to increase their credits. The Atlantic provinces, Saskatchewan and B.C. remain supportive, he notes. (Saskatchewan in 2013 moved to cap investments under the program at $80 million.) So is Manitoba, though the 2005 collapse of the Crocus Investment Fund there appears to have poisoned the well among retail investors. The industry’s days are numbered in provinces that don’t step up, Levi concedes: “It would be very difficult to raise eight-year locked-in money in a blind venture capital pool from Canadians without a 30% tax credit.”

Even as the financial argument falls apart, there are still some who think labour-backed funds serve a necessary goal. Nick Worhaug, Canadian director of hotel and food-service union Unite Here and a director of the Working Opportunity Fund, sees its primary mission as helping to diversify the B.C. economy and create jobs. He blames the financial crisis of 2008 for the challenges WOF has seen in recent years. “There’s a whole bunch of problems in the economic systems in the world now, and we’re wrapped up in that as much as anybody else was,” he says.

But returns for labour-sponsored funds have rarely, if ever, been competitive. GrowthWorks’ longest-standing product, WOF Balanced Series I, has returned 0.35% a year on average over the last 10 years (much improved by a 21.4% surge year to date), according to Morningstar. Even the Fonds de solidarité des travailleurs du Québec, the $10.1-billion gold standard of Canada’s labour-sponsored funds (it also invests in more mature sectors of the economy), has a 30-year annualized return of just 3.8%. (Even worse, the Fonds and its sponsor union were linked to organized crime last year in evidence presented to the Charbonneau inquiry into corruption in Quebec’s construction industry.)

Of course, the returns look better when you factor in federal and provincial tax credits. An investor in WOF, for example, could expect a positive return in the low single digits when you account for the (now) 45% of the initial investment rebated by the B.C. and federal governments (provided the money stays invested for eight years). As for the losses WOF has posted without the credits, Worhaug says, “I use the expression, ‘If my aunt had balls, she’d be my uncle.’ This is a tax credit that works well for the fund and for government.”

True enough, a 2010 evaluation of B.C.’s venture capital program by Thomas Hellman of the Sauder School of Business and Paul Schure of the University of Victoria determined that the province’s current 30% tax credit generated nearly $2 in provincial revenue for every $1 in credits. The authors recommended B.C. continue the program. What the study didn’t say was whether the investee companies would have existed without the tax credits.

Moreover, in deciding to cancel its credit, Ottawa came to a starkly different conclusion. “The Labor-Sponsored Venture Capital Corporations [LSVCC] tax credit has been criticized by academics, the Organisation for Economic Co-operation and Development [OECD], as well as venture capital industry stakeholders as being an ineffective means of stimulating a healthy venture capital sector,” a Department of Finance background document explains. The Paris-based OECD specifically blames the program for distorting the venture capital market, because investment decisions are made for reasons other than minimizing risk and maximizing return, such as geography—providing capital to startups located in the province that offers the credit.

“In hindsight, part of the problem is the set of restrictions that comes with the tax credit support,” says HighView Financial’s Hallett. Recognizing the lack of access to capital for small, early-stage companies, governments used labour funds to steer capital in that direction. “Labour funds, at one time, grew to provide half the venture capital in the country,” he says. “As a result Canadian venture capital became a very early-stage game.” That’s one of the reasons, he says, that Canadian VC returns underperformed the U.S. and Europe.

Worhaug advocates a more holistic view, noting WOF helped grow groundbreaking companies such as D-Wave and General Fusion. “One of the things labour has to do is be involved in all aspects of the community,” he says. “Most folks think labour unions are, to a degree, self-serving. They’re either going on strike, coming off a strike or between strikes.” Funds like WOF provide a way for unions to give back.

However, they are giving back not with their own money but with other people’s—retail investors’ and taxpayers’. But given the events of recent years, perhaps not for very much longer. Levi no doubt will continue to talk a good game in the provinces where his funds are still welcome. “The [labour-sponsored funds] industry is now a small, focused industry. But it is still a very large portion of the venture capital scene in Canada,” he says, noting early-stage fundraising is half what it was in the 1990s and early 2000s. And in the midst of its troubles throughout 2014—Levi stepped back as president and CEO to become executive chairman in November—GrowthWorks was the recipient, along with BDC Venture Capital, of the “Deal of the Year” award from Canada’s Venture Capital & Private Equity Association following its sale of Layer 7 Technologies, a developer of security software for businesses. Levi can talk, all right, and occasionally even deliver. The problem is fewer and fewer investors are listening.