Supply-side innovation: An American view of Canadian conservatism

Ah, Canada. I have a jillion relatives in the Maritimes who talk like me. It’s refreshing. The conversation usually turns to technology and opportunity, such as why does the Canadian innovation rate per capita fall below the USA? Why do artists migrate to Hollywood to achieve success?

The answer is simple: because Canada deals with the demand side of engineering and not the supply side of the innovation process.Large organizations specify the direction for the innovators and are the major beneficiary of the work done. So why would we want to invest or work in such an environment?

I am not alone in this opinion. Several years ago, the City of Toronto asked an assortment of venture capitalists (including myself) to talk about startups and innovation investment. Two Venture Capitalist (VC) firms and two large angel firms attended. We presented our experiences and statistics to the audience who was enthralled with the portfolio success of innovative startups. Worldwide, eight percent of the VC deals succeed in making “real” money. The US usually fares much better than that. Have you ever met a poor venture capitalist? They exist, but are as rare as an impolite Canadian.

Most of real growth, not reallocation of assets, comes from technology. Some pundits suggest that the only way to increase (not redistribute) wealth is with innovation in technology.

In Toronto, our panel ran into a brick wall. We had a lot of questions focusing on the startup process and almost none on failure or the folding issue. Poker is a strategic game of folding, not betting. Most poker hands don’t win – the same is true for new companies in an untested market. Our audience did not want to hear this. Folding is the name of the game, and it should be emotional and quick.

In the United States, we do not have an implied contract between employee and company. Custom suggests that we try to give two weeks notice but this is not necessary. Most of the startup employees are underpaid with the understanding that, if successful, the early employees will have a “;piece of the action.”; No formal social contract or guarantee normally exists. Many in the Toronto audience felt that this is unfair to the employee and that their jobs must be protected and managed by the government. This may be reasonable for large (over 500 employees) companies, but not for small enterprises.

Most European countries penalize failure when failure needs to be encouraged. Investors do not want a prenuptial agreement on the first date. If someone repairs your toilet, for example, are you guaranteeing an annual fee? As Edison stated, “I have found a thousand ways not to build a light bulb.” The idea that need drives innovation is flawed – remember no one wanted Google or Windows.

The established organizations want cheaper, better and faster products, but not disruptive products. Trying to specify the direction for startups is not innovation, it is engineering. Most of engineering is needed improvement (95 percent), but don’t confuse engineering with innovation.

Why does Canada fail to foster disruptive innovation? Here are some possible reasons:

• The belief that academics and PhDs can help – I don’t think so. In the US, we avoid them as company presidents;
• No real understanding of cash;
• The tax structure;
• The belief that big is good;
• Money available only for managed projects.

How can we overcome these religious issues and stay within the governance of Canada? I suggest we need to keep Canada as is and develop a strong small business environment. The US has some interesting programs that work.

One in particular is the Small Business Innovation Research Program (SBIR) run by the Department of Defense. It provided half-a-billion dollars in early stage R&D funding for small technology companies. From 0.1 percent to 2.0 percent is allocated from government programs into the SBIR – a substantial seed mechanism deserving analysis.

Another interesting recommendation comes from the California left and right wing sides. (So seldom do they agree that it might work.) The right wants unlimited rewards for intellectual property, and the left wants to know what intellectual property is.

The suggestion is as follows: Capital gains tax is prorated across five years. The first year has a punitive 100 percent tax to suppress the Wall Street dealmakers. A linear annual decline occurs in the tax over five years to zero in the sixth year.

The tax would be 100 percent in the first year, 80 percent in the second year to zero in the sixth year. Only “;real”; investments would benefit and the time scale matches most startups. Entrepreneurs would blossom along with VC dollars, and a tax free return.

Would we here in the States migrate to Canada? Canada has the people, the attitude, the challenge and the resources. Canada has everything but the courage. So stop specifying what is needed and instead need what is innovated.