KEY CONVERSATIONS ABOUT CANADA’S INNOVATION STRATEGY

Innovation Strategy Canada

In June, the Canadian government announced its vision to build a more innovative Canada, and in July the Minister of Innovation, Science and Economic Development,Navdeep Bains, provided some additional insight into Canada’s Innovation strategy in an interview with The Globe and Mail. This post highlights our perspectives on some of the key topics that promise to play an important role in shaping these consultations and the future of the Canadian technology sector.

The SR&ED Effectiveness Debate

There has been quite a bit of press recently on the SR&ED program, including some general criticisms of its effectiveness. Many commentators group the estimated $1.3 billion in refunds received by CCPCs (effectively SMBs) with the estimated $2.2 billion in tax credits to larger corporations, and point to Canada’s global R&D productivity rankings in making the case against SR&ED. While generalizations make for good headlines, they don’t make for good policy. It is important to set the record straight as these misinformed criticisms could have a long-lasting adverse impact on government policy.

The fact is that Canada’s technology SMBs outperform their global counterparts. If you look at exits as a proxy for commercialization success, Canada ranks fourth globally in exit activity (according to CB Insights), trailing only the United States, United Kingdom, and India (which has forty times our population). Interestingly, Canada ranks ahead of larger global economies, including China, Germany, and France. Given the SR&ED program’s critical role in funding SMB R&D, the evidence shows that this segment is clearly punching well above Canada’s global economic weight class.

Direct (Grants, VCAP) vs. Indirect (SR&ED) Investment Debate

The detractors of the SR&ED program suggest the Federal Government should shift funding from indirect to direct investment, effectively pitting SR&ED against a future VCAP.  We believe such an outcome would represent a setback for the technology ecosystem as a whole.  By some estimates, non-venture-backed companies probably represent 95% of all technology companies, and if we extrapolate CB Insights’ global exits data to Canada, this group is responsible for generating two-thirds of all exit activity.  In addition, non-venture-backed companies play a critical role in driving innovation in our economy, provide critical mass to the industry, and help foster the experienced talent pool from which venture-backed companies emerge.

Indirect investment is also highly democratic and market driven.  Tax credit refunds can be earned by any company performing R&D work that meets objective eligibility criteria.  In contrast, direct investment is by definition a more selective and therefore subjective process, be it by granting agencies or VCAP-backed venture capital funds.  We believe Canada needs another VCAP (more on that below), but the VCAP is not a substitute for the SR&ED program.  VCAP-backed funds follow the classical venture capital model of investing in a select few companies with “home run” or $1 billion exit potential, which most VCs would tell you would represent less than 5% of all Canadian technology companies.

Canadian technology companies, both venture-backed and non-venture-backed, are underfunded relative to their US counterparts, making the SR&ED program a critical funding source for both.  A growing and thriving technology ecosystem is key to Canada’s long-term prosperity, and SR&ED has proven effective in helping Canadian technology SMBs become world class.  Of course, there is scope for improvement on how the SR&ED program is administered.  However, direct vs. indirect funding is the wrong debate.  Experience tells us that SMBs are key to driving innovation.  If we truly want to improve Canada’s global innovation ranking, we should examine shifting SR&ED incentives from large public and private corporations, which should be able to access capital for R&D through more traditional sources, to the next generation of companies that will grow to become our future technology leaders.

Expanding the Venture Capital Action Plan (VCAP) Mandate

The VCAP attracted $900 million from Canadian institutional investors and family offices into the technology ecosystem, due in part to the attractive investment framework developed by the Federal Government.  We believe a second VACP program should help accelerate interest in this asset class among Canadian institutional investors who have lagged behind their US counterparts in venture investing.  A second VCAP is needed to help fund scale-up stage companies to make the necessary investments to play on the global stage.  However, limiting the program’s mandate to late stage equity investing (as some proponents would have it) or to equity investing generally unduly limits its impact to a small subset of the broader technology ecosystem.

To foster a healthy and sustainable technology sector we need to support more than just the small number of companies that have unicorn potential and therefore the ability to attract traditional venture equity.  Such an approach ignores the other 95% of companies, many of which have enormous potential, but due to their market focus, business model, or other reasons cannot attract traditional venture capital.

We believe that if the Government wishes to maximize the impact of a future VCAP program across the technology sector, its mandate needs to include venture debt.

Venture debt plays a critical role in supporting technology companies that don’t fit the venture capital mold, providing capital that bridges the risk continuum between bank financing and shareholder equity.  This large segment of the technology sector, which employs the majority of workers and which is also the most underfunded, deserves the Government’s support in making capital more affordable and more broadly available.

Your Voice Counts!

These are important issues with the potential to have broad and long-lasting impact. Whether you agree or disagree with our perspective, I urge you to speak up and make your voice known, so as to ensure the Government adopts a balanced and effective policy to foster innovation here in Canada. Please share your perspectives in the comments below or contact us to see how you can get involved.

Download our template letter and send an email to Minister Bains, your local MP. Include us in your correspondence by copying ajivraj@archive.espressocapital.com.

About the author: Alkarim Jivraj, CEO

In a finance career spanning 20 years, Alkarim has helped raise over $1 billion for more than 100 early stage and growing technology companies and has made over 50 direct investments. Before joining Espresso, he was the Founder and Managing Partner of Intrepid Business Acceleration Fund. Alkarim started his finance career at Yorkton Securities, a boutique investment banking firm, eventually leading its information technology investment banking practice and co-managing two investment funds. Alkarim sits on the Board of SCI Marketview.