Cultivating a Rewarding Ecosystem for Canadian Entrepreneurs

Canada's outdated capital gains policies are driving entrepreneurs and investors away. We need competitive tax reform to keep talent and investment here, building the businesses of tomorrow.

We have just 33 small businesses per 1,000 people vs 124 in the US. Fixing our capital gains system could help us close this gap with the US and create hundreds of thousands of new jobs.

Modern capital gains reform will unleash Canadian innovation, create more high-paying employment, and ensure our world-class graduates build their companies here, not elsewhere.

Goals

To ensure a prosperous, sustainable, and growing economy, Canada needs a thriving private sector that invests in new businesses. A strong environment for entrepreneurship creates jobs, drives GDP growth, and ensures economic mobility for all. In recent years however, entrepreneurship, and consequently private sector employment, has been slow despite an increasing population.

One factor driving this change is that Canada’s capital gains tax policies make it significantly less rewarding to start a business compared to other jurisdictions. To reverse this trend and reinvigorate our private sector, we must revise our outdated policies to align with global standards.

Our targets:

* Increase SMBs per 1000 people over the age of 18 from 33 to 62 to get half of the US rate of 124.

* Increase the number of early-stage financing rounds (Pre-seed, Seed, Series A, and Series B) for new businesses from 482 in 2024 to over 1000+ per year.

* Increase investments in new businesses through industry-agnostic venture capital financing to 0.5% of GDP, up from 0.35% of GDP, to get closer to the USA’s figure of 0.72% of GDP.

Background and Motivation

New business formation and growth relies on people taking huge risks with their time and money. However, today in Canada the people that take these risks – entrepreneurs, early stage employees, and investors – are rewarded less than in other countries.

As a result the country’s best talent is driven to leave and start businesses elsewhere, where they can find easier access to funding1 and keep more of the upside if they succeed.

We need to reverse this systematic issue. By rewarding investors that put their capital at risk and supporting entrepreneurs who put their livelihoods on the line to create new companies we can create a strong and resilient economy.

All companies begin as small and medium businesses (SMBs) and the formation and growth of these SMBs is essential to a country’s economic success both through driving the quality of the labour market and creating opportunities for productivity growth.

In Canada, SMBs accounted for ~64% of private sector employment and contributed to half of all net new jobs added last year2. These work opportunities support upward income mobility, lead to more capital being reinvested into local communities, and are particularly valuable for traditionally disadvantaged populations3 4 5.

In addition, SMBs represent a significant portion of the economy and have high potential for productivity improvements6. Between 2017 and 2021, SMBs contributed almost half of Canada’s GDP7. As these businesses grow and scale their operations they improve efficiency and drive productivity-led growth that can be equivalent in impact to roughly 5% of a developed nation’s GDP8 9.

Perhaps most importantly, SMBs turn into global winners. Growing these companies into sizable businesses is how a country can win an unfair share of global markets, by creating the large, export-focused corporations that contribute an outsized value to GDP and productivity growth. To ensure the next trillion dollar companies - the equivalent of Google, Microsoft, or Meta - are built in Canada, founders must be convinced to start their companies here.

So, having a healthy ecosystem of SMBs is essential to creating a strong economy, but the data shows Canada is falling behind our global peers. In the 20 years between 2003 and 2023, the total number of Canadian entrepreneurs decreased by ~100K, despite the population growing by 10 million10 11. Today, for every thousand people over the age of 18 the US has ~124 SMBs12 13. Israel, a country with less than a quarter of Canada’s population, has ~7314 15, while Canada has just ~3316.

A significant driver of this stagnation is outdated and uncompetitive capital gains policies that have low limits, exclude large categories of business, and contain many restrictions compared to global peers - especially the US. It is less valuable for investors to put money into Canadian businesses, making capital more scarce and it discourages entrepreneurs who know that in most cases they could receive more reward by building the same company elsewhere. This makes it difficult for any SMB to get started let alone scale.

Today, Canada has two capital gains policies, to try and encourage SMB creation, the Lifetime Capital Gains Exemption (LCGE) and a proposed Canadian Entrepreneur’s Incentive (CEI) announced in Budget 2024 but not yet implemented. Combined, the LCGE and CEI would allow shareholders to reduce the inclusion rate of capital gains from the current 50% down to a range of 33.3%-0% to a cap of $3.25M 17 18.

These policies simply can’t compete with the US. The USA’s Qualified Small Business Stock (QSBS) policy has a capital gains cap of $15M or ten times the original investment amount, five times higher than Canada’s LCGE and CEI limit. In addition the QSBS is active today, while Canada’s CEI cap has a phased approach only coming into full effect in 2029 if the policy is passed. Today in 2025, LCGE and CEI’s true combined cap is only $1.25M. And while QSBS shields 100% of gains up until the policy cap for individuals and corporations, Canada’s CEI would only shields 66.7% of gains for individuals.

To illustrate how restrictive this is, we could imagine a company where the business is owned between founders, early employees, and various investors (see the first example below). If this business was started in 2018 and sold 7 years later today in 2025 for $100M, these risk-takers would have to pay a combined $14.7M in taxes. However, that same business with the same structure would pay no taxes in the US.

The good news is that at larger scales of exit like $250m (see the second example below) the gap between Canada and the US decreases due to a more competitive basic capital gains inclusion rate in Canada. This means that if we match the QSBS’s capital gains limit it could actually give the Canadian policy an edge driving more investment in the country and supercharging our SMB ecosystem. However, if we leave the policy as it stands right now companies can never get started because investors and entrepreneurs are scared away.

The reason is that the QSBS rewards smaller exits - the majority of SMB outcomes - with the maximum capital gains tax value. This makes it easier for entrepreneurs, early employees, and investors to take on the risks of building a business. In fact, early-stage US investors are currently increasing their investments into new Canadian businesses, and adding in clauses that would require the Canadian business to reincorporate in the US simply to become eligible for QSBS. This means the best Canadian entrepreneurs and companies are leaving the country simply to take advantage of these rules. This decreases the health of our SMB ecosystem, prevents large companies from growing in the country and ultimately reduces tax revenue.

If we want to keep our entrepreneurs, Canada’s capital gains policies must become competitive with US policies.

‍Beyond better gain caps and exclusion rates, the US’s QSBS allows a wider range of businesses and stakeholders to benefit from the policy, with no minimum ownership requirements, increased asset value caps, and a tiered inclusion rate approach that incentivizes long-term business building. Meanwhile, Canada’s CEI excludes companies in healthcare, food and beverage, and service businesses19. CEI’s minimum ownership rules also exclude early employees and investors who own less than 5% of the business at the time of sale.

Most importantly, while LCGE and CEI’s $3.25M cap applies over a taxpayer’s entire lifetime, QSBS’s limits are per issuer or business. In other words, entrepreneurs, early employees, and investors can use the QSBS more favourable policy again and again for subsequent companies. This discourages repeat entrepreneurs in Canada, who statistically have a higher chance of building successful businesses, from creating a second or third company, as Canada’s LCGE and CEI don’t extend to new issuers20 .

What Needs to Be Done

To properly reward risk takers, Canada can fully solve our capital gains policy problems by combining the LCGE with the CEI into a simple, powerful capital gains policy that supports entrepreneurs. In particular, the new policy could become competitive by adopting three major changes:

1) Expand the eligibility requirements to ensure Canadian entrepreneurs and risk takers are supported. Eligible business types should be expanded to include all industries of national interest, including healthcare clinics, clean energy, technology, etc. We should also eliminate 5% minimum ownership requirements to enable any individual or corporate entity to claim CEI deductions in accordance with the tiered approach that is used to support early-stage employees and investors.

2) Improve the capital gain exclusion rate system to be globally competitive, supporting entrepreneurs and increasing investment. To prevent the draw of foreign jurisdictions and ensure that we have just as much incentive to start companies as peer countries, we should start by raising the exclusion cap to $15M gain or 10x adjusted cost basis per taxpayer, whichever is greater.

3) Make structural changes to ensure these new policies scale appropriately. Amend the capital gains limit from applying per lifetime to per business to incentivize repeat entrepreneurs to continue building in Canada. Additionally, ensure that common investment structures, including Simple Agreements for Future Equity (SAFEs) and Convertible Notes, become eligible, with the holding period commencing from the date the investment is signed, not when the shares are priced and converted. So, there are no major discrepancies for startups choosing to operate in Canada compared to the US.

Common Questions

Will this only benefit tech startups?

No. Canada’s LCGE was originally created to support all small businesses and increase competition, which includes non-tech businesses such as fisheries and farmers. Our memo recommends expanding eligibility to all industries deemed essential, including non-tech ones, that the current CEI proposal omits, such as healthcare practitioners. In the US, SMBs of all sectors, including manufacturing, retail, wholesale, consumer, and packaged goods, benefit from the QSBS policy21.

Wouldn’t corporate tax breaks reduce tax income for social programs and only benefit the wealthy 1%?

No, this would encourage investment in Canadian small businesses, essential for increasing corporate tax revenue that funds social programs. Businesses that receive investment can generate more jobs, pay higher wages, which help increase individual income tax revenue, and reduce withdrawals from crucial social assistance programs, such as Employment Insurance, as more companies and workers stay in Canada. This helps reduce the burden and improve access to social programs, rather than removing them.

What stops foreign investors from abusing this and using Canada as a tax-sheltered haven to enrich themselves at the expense of Canadians?

Maintaining Canadian incorporation, assets, residency, and operating requirements, combined with a minimum 2-year waiting period before benefits kick in, will ensure that new businesses maintain a presence in Canada, creating skilled job opportunities for Canadians and contributing to local economic growth.

Why should we invest in SMBs? Aren’t they risky and likely to be shut down in a few years?

68% of SMBs in Canada survive and operate into their fifth year, and a further 49% of SMBs survive and operate for more than a decade22. SMBs around the world, including Canada, contribute significantly to economic output, job opportunities, and increased competition for consumers.

Conclusion

Canada needs to create an ecosystem that supports entrepreneurs at the earliest stages. We have one of the most educated countries globally, with the largest college-educated workforce among G7 countries23. Canadian universities are consistently ranked among the top institutions globally, world-renowned, with research labs led by leaders like Geoffrey Hinton, dubbed the “Godfather of AI,” who was recently awarded a Nobel Prize for his work in AI and ML24 25.

Not only is our population talented, but they are also resourceful and hardworking. Rather than punishing them, we should reward them for taking the risks to build Canada’s economy. To start, we should implement a modern capital gains policy that rewards investors, entrepreneurs and early employees.

Read more here: https://www.buildcanada.com/en/memos/reward-the-risk-takers

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