R&D shakeup is good news for Canada's entrepreneurs

Canada’s been wasting money on R&D for too long. Time to fund the entrepreneurs.

Thank God Flaherty didn’t give the innovation money to the BDC. (Fred Chartrand/Canadian Press)

As Research In Motion slugs it out with the global handset Goliaths, and the Nortel carcass is picked apart by distressed debt investors, Finance Minister Jim Flaherty seems determined to put the full weight of the federal budget behind resurrecting Canada’s innovation sector. It comes not a moment too soon.

For more than a generation, successive Canadian governments have put most of their innovation funding eggs in the academic and scientific research basket, with the hope that the commercialization gods will eventually churn out high-value jobs and economic growth.That “trust the lab coat” public policy has created plenty of sinecures on university campuses and in government labs—but it has resulted in far too few actual tech and life-science spin-out corporations.

The big problem has not been the amount invested—after all the feds are spending $5 billion per annum on R&D funding—but that 17 different government departments and agencies are doling out the money. With that many cooks in the kitchen, it’s no wonder that Israel, with aquarter of our population, attracts more venture capital funding than all of Canada.

Luckily, Minister Flaherty, fresh from direct meetings with entrepreneurs here and overseas, seems to recognize that Canada doesn’t have a funding problem, it has an execution problem. So, after a multi-year decline in Canadian venture capital funding—hitting a low of just $1 billion in 2009, despite US$132 billion invested by venture capitalists south of the border over the past five years—the March budget finally screamed an end to business as usual.

The change that received the most attention was the decision to tighten the high-profile Scientific Research and Experimental Development (SR&ED) program, which gives out cash and tax credits for R&D spending in Canada. But it was the $400-million promise of new direct funding that could deliver the biggest bang for Mr. Flaherty’s buck. That’s because, rather than handing the capital over to any one of 17 government agencies with a finger in the innovation pie, or giving the money to the Business Development Bank of Canada, which deployed just $408 million of its $18.4 billion balance sheet to the venture capital industry, the Conservatives have decided to invest that money directly in entrepreneurs.

Some have concerns about this approach. Are the Conservatives looking to return to some 1950s idea of a planned economy? Will government officials take it upon themselves to pick winners versus losers? The simple answer is this: not if the government adopts the proven coinvestment model.

In such a model, when a Canadian venture capitalist invests $4 million in a Series A round, that private risk capital goes directly into new hiring and sales execution. These are high-valuejobs, right here at home, with companies that often already have revenue. If the government were to structure its new $400-million program as a coinvestment fund, as is available in several U.S. states and Canadian provinces, three important outcomes are guaranteed.

The first is that the private sector will end up leading the way, picking the winners and sitting on the boards of directors of the new corporations, with its own capital at risk. Second, Canadian entrepreneurs will have a better chance to execute their business plans, as the additional investment capital will give them more firepower to tackle their chosen markets. The third outcome is that—should the VC and entrepreneur succeed at creating the next Facebook or Research In Motion—the government’s coinvestment stake will earn the same handsome return as is being made by the private sector.

All three outcomes are crucial for Canadian innovation and competitiveness over the long term. The status quo is no longer an option, and Mr. Flaherty deserves credit for recognizing that it’s the entrepreneurs—not the antiseptic R&D departments—who create high-value jobs.

Mark McQueen is president and CEO of Wellington Financial LP