Your First Year Service Plan

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Technology, Media & Telecommunications

Time to stand up and be counted. Services to an Emerging Technology Company

Table of Contents Introduction ................................................................................................... 1 Fees ........................................................................................................ 1 Other Work .............................................................................................. 1 Contents of the Document.......................................................................... 1 Your First Year Service Plan ............................................................................. 2 Business Plan ........................................................................................... 2 SR&ED Investment Tax Credits ................................................................... 2 Cash Flow Plan.......................................................................................... 3 Financial Statements and Disclosure............................................................ 3 Accounting Policies .................................................................................... 3 Financial Records ...................................................................................... 4 Financing ................................................................................................. 4 Review Corporate Structure........................................................................ 4 Quarterly Meetings .................................................................................... 4 ViaTech.................................................................................................... 4 Areas of Interest ............................................................................................ 5 Corporate Taxation: The Basics................................................................... 5 Scientific Research and Experimental Development (SR&ED) Tax Incentive ...... 5 Stock Option Plans .................................................................................... 6 $750,000 Capital Gains Exemptions ............................................................ 7

About Deloitte ................................................................................................ 8 Deloitte – Burlington Region ....................................................................... 8 Deloitte Canada ........................................................................................ 8 Deloitte Touche Tohmatsu.......................................................................... 8

© 2007 Deloitte & Touche LLP

Services to an Emerging Technology Company

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Introduction The purpose of this document is to outline briefly our service plan to an emerging technology company. In this regard, we believe that our service plan approach can add substantial value for you and your business. You will see from our approach that we are committed to you, and your business, and are prepared to make an investment to see you succeed. In short, if you succeed, we succeed.

Fees A common question or concern is how will I be charged for all of these services when I am dealing with a big firm. As indicated, we are prepared to make an investment in your business. Our first year fee quote covers all of the services outlined in our section entitled “Your First Year Service Plan”. At the end of the year we will show you the total costs incurred so that you can see the investment that we have made. We should point out however, that if you do an IPO or sell the business, we would like to recover this investment. This would be spelled out in detail in an engagement letter.

“We are prepared to make an investment in your business”

Other Work This document outlines in general terms the work that we will perform for our “base” proposed fees. There may be other projects however that we would propose and invoice separately.

Contents of the Document The remainder of this document discusses the services that an emerging technology company would typically require in its first year of working with us, and provides some level of detail on certain areas that are typically of significant interest to such companies. The topics are chosen based on our significant experience working with emerging technology companies in Waterloo region.

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Your First Year Service Plan Below is an outline of the services that we would normally provide within the first year of our relationship with a relatively new, emerging technology client. However, the actual services will of course depend on your unique business as well as your needs.

Business Plan There are many reasons why a business plan is prepared. Some of these reasons may include: •

Putting your plan on paper helps to get you focused.



The plan can help you share the vision for the business with other partners or employees in the business.



The plan can help to get employee buy-in and be a motivator if they participate in the development of the plan.



If any form of financing is required, a business plan is mandatory.

With respect to our role we will do the following: 1.

If you do not have a business plan, we will give you some guidance as to the construction of such a plan, as well as some initial input related to how you may wish to develop your plan in light of our understanding of your business and industry, or

2.

If you have a draft business plan, we will review this plan and meet with you to provide our initial thoughts and comments.

If you then require other specific work to help you with your business plan, such as market validation studies or preparation of cash flows, we would discuss with you what our fee arrangement would be.

SR&ED Investment Tax Credits If you are developing, adapting, or otherwise improving technology, then you may be eligible for scientific research and experimental development (SR&ED) investment tax credits. These credits, which may total up to 68% of your costs, are often fully refundable, providing significant cash inflows. If appropriate, we will discuss the SR&ED program with you in detail to ensure that you can take maximum advantage of the incentives that are available under the program. Further to the above, after discussing what projects you may undertake, we can also assist you in making contact with a number of other agencies, such as IRAP,, that can provide additional assistance, whether it be financial or otherwise, with respect to the development of your products. It is very common for research and development projects to be eligible for both IRAP and SR&ED funding, which together may fund nearly 80% of eligible project costs!

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Cash Flow Plan In a start up, or growing technology business, cash is king. Therefore, we will review with you a number of areas and strategies to either preserve or enhance cash flow. Some of these strategies include the following: •

Tax effective remuneration strategies.



Expediting scientific research and experimental development investment tax credit refunds.



Assistance in identifying other funding sources.



Expediting GST refunds.



Effective loss utilization strategy.

Financial Statements and Disclosure There are 3 levels of assurance that we can provide on a company’s financial statements: 1. Notice to Reader – we provide no assurance that the financial statements are correct but simply compile them from information provided by management. A notice to the reader explaining this fact is included with the financial statements. These financial statements only include a basic level of note disclosure. 2. Review Engagement Report – we provide negative assurance to the reader. That is, we indicate that in the course of our review we have not discovered anything that makes us believe the financial statements are not materially correct. These financial statements include full note disclosure. 3. Audit Report – we provide positive assurance to the reader that the financial statements are materially correct. These financial statements include full note disclosure. The appropriate level of financial statement assurance varies depending on the situation. Obviously the more assurance provided, the greater the scope of work to be performed. In many cases, Notice to Reader financial statements are sufficient and are prepared primarily for the purpose of tax filings. This typically changes when a company seeks third party investment. An angel investor or venture capitalist will likely demand a Review Engagement or Audit Report as a condition of their financing. One note of caution, if an Initial Public Offering is planned within 5 years, an Audit Report may be appropriate from the outset. In most cases, a 5 year history of audited financial statements is a mandatory requirement for an IPO.

Accounting Policies Even for emerging companies, proper selection and a thorough understanding of accounting policies is critical. Nothing will tarnish a company’s credibility faster than errors in published financial statements. Some of the recent accounting rules under Canadian and US Generally Accepted Accounting Policies are extremely complex, particularly around the issue of revenue recognition. We will typically work with a company to ensure they establish sound policies right from the outset. Of course, if we provide a Review Engagement or Audit Report on the financial statements, we conduct a detailed reviewed of the accounting policies used in preparing the financial statements, and provide full disclosure of such policies in the notes to the financial statements.

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Financial Records Although mundane, it is critical that you set up an accounting system so that you can obtain timely financial information with which to manage your business, and to benchmark against your plan. In general, it is recommended that you do the bookkeeping and accounting work in-house, as it allows you to better manage and control your business. If you have a system, we will provide our comments. In some cases, you may simply not have the resources to do the bookkeeping work, or set up a system. In that case we can make an introduction to a local bookkeeper that would be cost effective.

Financing Your financing needs may be immediate or not for a year or two. Either way, we will arrange a meeting with our corporate finance group to discuss your business and your financing needs. Out of this meeting, you can expect the development of a plan of action that you would need to begin to follow in order to attract financing. Note that if you wanted to then pursue this plan of action, we would discuss with you at that time our fee arrangement to actively assist you in attracting financing.

Review Corporate Structure In many cases, your focus is simply on the business. However, we will discuss with you a number of options and alternatives related to the corporate structure to ensure that it is the most advantageous structure for purposes of raising financing or going public, as well as to ensure that the initial shareholders’ estate and tax planning opportunities are taken into account.

Quarterly Meetings Although we are accessible at any time, we like to initially diarize quarterly meetings to ensure that we get together to keep abreast as to the progress that you are making in your business. In some cases, it may be most efficient to discuss business over the telephone, however, we are certainly available for a breakfast or lunch in order to get caught up. Again, although we try to formally set up these meeting times, we are always accessible if you have an immediate need. If other thoughts or opportunities come to our mind, we would of course call.

“We get together to keep abreast as to the progress that you are making in your business”

ViaTech ViaTech is a group of professionals that work with growing technology companies. The purpose of the group is to be a sounding board for you and to provide general input or to assist you with any specific issues or concerns that you may have. This service is provided by the group free of charge. As a member of this group, we would be pleased to coordinate a meeting. At this meeting, it is typical that you would tell the group a bit about your background, where you are today and what your future plans are. At that point, you may either have specific issues or questions that you would like to discuss or alternatively the group can simply probe further into your plans and provide insights as to areas to consider.

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Areas of Interest The purpose of this section is to simply give you an overview of a number of topics of common interest to emerging technology companies.

Corporate Taxation: The Basics The following is a very brief overview of some of the taxation basics of a corporation that is a Canadian Controlled Private Corporation. •

Losses can be carried back three years and forward twenty years.



The first $400,000 (calendar 2007) of taxable income attracts tax at approximately 19%.



For taxable income in excess of $400,000, the tax rate is approximately 36%. Income taxed at this rate is effectively “double taxed” when withdrawn from the corporation.



Monthly income tax instalments are required. They are based on the lesser of last year’s actual tax, and your estimated tax for the current year.



In general, your final tax payment is due 3 months after the fiscal year end.

Scientific Research and Experimental Development (SR&ED) Tax Incentive Canada has one of the most generous tax incentive programs in the world for eligible SR&ED work. The Benefits For a qualifying Canadian Controlled Private Corporation, the benefits include the following: •

Federal refundable credit of 35%



Ontario refundable credit of 10%



100% write-off of certain capital expenditures

Eligibility It is important to note that there is specific eligibility criteria that must be met in order to obtain these tax incentives. If any of the following indicators are present, you may be doing qualifying SR&ED work. •

You are developing something faster, more efficient, stronger, etc.



You have successfully applied under the IRAP program.



You have a number of engineers or PhDs on staff.



You have tried several different approaches to solve a technical problem.

How to Claim The submission for eligible SR&ED is made with your annual tax return. There are essentially two components. The first is the technical write-up for each project, which is generally no more than 3-4 pages per project. 5

The second component is the accumulation of the costs attributable to each project. In general, the costs include wages and salaries, materials consumed in the development work, certain capital equipment and a portion of overhead. However, instead of calculating the overheads that would be allowed, you can instead choose to claim what is referred to as the “proxy” amount. The proxy is 65% of the eligible salaries and wages attributable to a project, and represents the notional overheads attributable to a project. Example If you have a project in which there is $100,000 of salaries and wages attributable to it, and no other costs, the SR&ED tax credits would be as follows. Salaries and Wages Proxy amount 65% Total eligible amount Ontario Credit ($165,000 x 10%) Federal credit [(165,000 – 16,500) x 35%]

$100,000 65,000 $165,000 $16,500 51,975 $68,475

Stock Option Plans The basic pros and cons of a stock option plan are as follows: Pros •

Helps to attract and retain talented people.



May help to motivate employees and executives.



May be a way of making up for salaries and wages that are below market due to cash flow constraints.



It may be a way of raising capital.

Cons •

The set up and administration of a stock option plan can take time, and money.



The value of the shares of a privately held company may be very hard to determine.



You now have other shareholders to be accountable to.

The Valuation Issue In general, if you are planning on doing an IPO in the future, or are planning to quickly grow and then sell, the pros of a stock option typically outweigh the cons. Canadian Taxation for Options •

No tax implications when the option is granted.



No tax implications when the option is exercised.



When the shares are sold, there is a taxable benefit calculated as the difference between the exercise price and the fair market value of these shares at the date of exercise.



There may be a 50% reduction of this benefit in certain circumstances. 6



When a share is sold, there may also be a capital gain calculated as the difference between the selling price and the fair market value of the share at the date the option was exercised.



The company will not receive any deduction in respect of the options.

Alternatives There are alternatives to a stock option plan that can be implemented that avoid the introduction of new shareholders yet provide employees with similar incentives. The viable options depend on the particular situation. We would discuss these alternatives with you prior to establishing a stock option plan.

$750,000 Capital Gains Exemptions Every Canadian individual taxpayer has a $750,000 capital gains exemption available. The exemption is only available to be used against gains realized on certain qualifying property. Shares of a qualifying small business corporation (QSBC) qualify for the $750,000 capital gains exemption. In order to be a QSBC, the following, simplified criteria must be met. •

The company must be a Canadian Controlled Private Corporation.



You (or someone you are related to) must have owned the shares for 24 months.



During the last 24 months, at least 50% of the assets of the company must have been used in an active business carried on in Canada.



At the date that the gain on the shares is realized, at least 90% of the fair market value of the assets must be used in an active business carried on in Canada.

Tax Savings and Proliferation of Exemptions Each $750,000 exemption can save you as much as $172,500 in income tax. As such, it is very important that you gain access to the exemption. In addition, with proper planning you can also access the exemptions of your spouse and children. What to Watch For In terms of ensuring that you gain access to your $750,000 capital gains exemption, the following are a number of areas to watch out for. •

Ensuring that you meet the 50% and 90% rules where you have done a financing and, therefore may have excess cash in the company.



Again, ensuring that you meet the 50% and 90% rules where you have set up foreign subsidiaries or branches. Note that these foreign assets are not assets of a business carried on in Canada, and therefore not eligible assets in determining the 50% and 90% thresholds.



The manner in which you incorporate your business can have an impact on the 24 month holding period rules.



How the business has been financed can have an impact on the availability of your exemption. In addition, your other personal investments may have an impact on the availability of the exemption.

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About Deloitte Deloitte – Burlington Region Our South Western Ontario operation has over 500 professionals located in five offices in Kitchener, Burlington, Windsor, London and Niagara. Locally in Burlington, Deloitte has a complement of 116 professionals: Total Assurance and Advisory

47

Tax

32

Consulting

16

Enterprise Risk Services

11

Financial Advisory Services

2

Administration

8

Total

116

Deloitte Canada Deloitte, Canada's leading professional services firm, provides audit, tax, financial advisory services and consulting through more than 7,600 people in more than 52 locations. Deloitte & Touche LLP, operates in Québec as Samson Bélair/Deloitte & Touche s.e.n.c.r.l. The firm is dedicated to helping its clients and its people excel. Deloitte is the only professional services firm to be named one of the 50 Best Companies to work for in Canada for 2007 by the Globe and Mail’s Report on Business Magazine and Hewitt and Associates. "Deloitte" refers to Deloitte & Touche LLP and affiliated entities. Deloitte is the Canadian member firm of Deloitte Touche Tohmatsu.

Deloitte Touche Tohmatsu Deloitte Touche Tohmatsu is an organization of member firms devoted to excellence in providing professional services and advice. We are focused on client service through a global strategy executed locally in over 150 countries. With access to the deep intellectual capital of 135,000 people worldwide, our member firms (including their affiliates) deliver services in four professional areas: audit, tax, consulting, and financial advisory services. Our member firms serve over one-half of the world's largest companies, as well as large national enterprises, public institutions, and successful, fast-growing global growth companies. Deloitte Touche Tohmatsu is a Swiss Verein (association), and, as such, neither Deloitte Touche Tohmatsu nor any of its member firms has any liability for each other's acts or omissions. Each of the member firms is a separate and independent legal entity operating under the names "Deloitte," "Deloitte & Touche," "Deloitte Touche Tohmatsu," or other related names. The services described herein are provided by the member firms and not by the Deloitte Touche Tohmatsu Verein. For regulatory and other reasons certain member firms do not provide services in all four professional areas listed above.

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