Monday, November 24, 2008

The Failure of Government Funding, or Why I Wish I’d married Buzz Hargrove

I promised the rest of my firm I’d go back to using this blog for posts about term sheets, and convertible debentures and the like, and I will. But I need one last riff:

I was comparing notes on the state of the start-up world last week with a U.S. colleague. (It’s important to note that since the dot-com meltdown of 2001, it’s become uncool for lawyers to use the term “start-up.” Instead, we call all of you “emerging growth companies” when we talk amongst ourselves.) We both are seeing very little investing in our regions, but my U.S. friend believes Canada is a far better place for emerging growth companies right now. After all, he told me, don’t you have all kinds of government subsidies available?

Here’s the truth about government funding for emerging growth companies in Canada: there is little, maybe none. No government policy or program in Canada today that provides meaningful, direct support for emerging growth companies. What exists instead are a number of job creation schemes that have been launched in the names of “entrepreneurship” and “innovation.” None of these programs have much impact on the economy, because they bet on universities and small businesses as the engines for economic growth.

Entrepreneurship” is really policy-wonk code for programs to assist first-time small business owners. I’m not going to go into further detail here. “Innovation” is the current buzzword of choice. As Russell Wangersky points out:

“Alberta has an Innovation Fund. Ontario has the Ministry of Research and Innovation. Saskatchewan? The Ministry of Enterprise and Innovation….In Ontario’s 2007 Throne Speech, the word “innovation” is mentioned three times. The 2008 Alberta budget? Seven times. Newfoundland and Labrador’s 2008 Budget? Three times — and Newfoundland has both a department of Innovation, Trade and Rural Development, and an Innovation Strategy. The last British Columbia budget? Seven times, along with the introduction of a $75-million Innovation and Integration Fund….The word is used three times in Alberta’s 2008 Climate Change Strategy, four times in the 2008 federal budget, and on and on.”

In government policy-speak, “innovation” refers to job creation money for pure research. In some provinces, it even extends to real estate development to provide facilities from which that research can be conducted, mentored and commercialized. The underlying rationale for this kind of government financial support seems to be that if academic researchers had more money or prettier labs, they would come up with better ideas. Or, people with better ideas will immigrate from other places to innovate here. (Or Saskatchewan. Or New Brunswick.) Immigration policies are interesting, but they don’t have anything to do with creating emerging growth companies or driving growth of an innovation economy, except in a very theoretical way.

What happens next? Because a focus on pure research does not yield near-term economic results, there is an inevitable policy shift. After all, researchers are not capable of commercializing the results of their new, improved thinking. And so a second layer of innovation-related funding inevitably follows: the creation of government- funded mentors and advisors to support early-stage rollouts of companies. In Ontario, there is even tax incentive legislation proposed to further incent the rollout of university-originated companies to assist.

But what if the ideas are, ultimately not fundable? Governments will move to a third cycle of innovation policy – job creation for investors. At the provincial level, it often starts with a direct government investment program. Form a crown corporation, staff it up and start spending. At some point, many tens of million of dollars later, the province will realize that it is not in the business of investing, and it will hand off its portfolio to an outside manager. Since many investment decisions were driven by political concerns and job retention, the portfolio is often not much of a prize for a manager to acquire.

At this point, the innovation policy cycle usually shifts again – to the fostering of a venture capital infrastructure to support local businesses. Why not allocate government dollars to professional investors like VCs, so that they can properly manage and nurture young start-ups? A fund of funds, like Ontario’s Innovation Fund, is then created to search out desirable VC funds and provide them with capital.

Of course, unless there is a mandate to deploy that capital immediately, it can be years before it makes its way into a VC fund and then to emerging growth companies. As far as I know, there have been no announcements of investment by TD Capital since assuming the management of Ontario’s Innovation Fund. And really, who’s to blame them? Every other fund of funds appears to be standing back from the market – if the Ontario government did not insist that their $80 million be deployed in a timely manner, why go against the market?

Now, with anecdotal evidence such as this as to the negative impact of “innovation” funding on economic growth, you might think that at some point government would look to providing some direct economic incentives to increase growth – things like tax breaks. But the cycle remains ghoulishly popular - Alberta and Saskatchewan currently are at various stages in the formation of their own fund of funds programs. Really, someone should take them out for a drink and speak with them. But will it make a difference? Saskatchewan is like your girlfriend who keeps dating married men even after you try and talk her out of it. Is she ever going to learn?

Where are emerging growth companies in the midst of this? Government seems to bet that the markets will take care of them – if enough venture capital is fed into the system, this and SRED will provide adequate stimuli. This may well work if there’s no market meltdown. Many of our clients have been the unintended beneficiaries of government programs that are intended to develop and drive growth in specific industry verticals such as nanotechnology, genome research and clean tech. There is a tremendous amount of money available, provided you can match government money with private sector funds. And it is here that the absence of capital grinds growth of emerging companies to a halt.

The one exception to Canada’s policy cycle grind appears to be Quebec (although recent revelations about the Caisse may suggest otherwise), where the government and its financing institutions seem to have determined that spending on high risk, high tech companies will provide more economic stimulus to the region. I grow fonder of the province each time I do business there. If Quebec were a man, I’d buy it a drink and flirt with it in front of my husband.

But, in the current climate, with innovation funding tied up in policies that bank on some distant future, emerging growth companies in the rest of Canada have few options. As the government considers an economic stimulus package for January, it’s time to ask whether innovation policies should be re-worked to preserve and stimulate growth for current innovators, rather than focus on developing possible future classes.

Of course, asking questions is a rhetorical exercise if one has no voice. And I’m not sure emerging growth companies in Canada do. We have relied on related bodies such as CATA and the CVCA to advance some kind of policy that will assist. We’d be much better off if we coaxed Buzz Hargrove out of retirement. Sure, the speeches would be longer, but we’d be heard.