Introduction
I recently had the opportunity to discuss innovation policy with Charles Plant. Charles is an economist and serial entrepreneur, having led several ventures in medical and deep tech fields over an impressive career. On the side, he authors The Narwhal Project, a publication that provides evidence-based policy insights on a number of issues facing Canada today and advances hypotheses about what it takes to build and scale a company in the Canadian context.
If you are not already familiar with his work, I strongly suggest that you take the time to explore it. Charles’ research is grounded in statistically rigorous analysis of real data. Many of his conclusions challenge prevailing narratives about the issues holding back Canadian innovation, particular where private investment and startup performance is concerned. His thoughts should be required reading for public servants seeking to maximize the impact of the programs they administer.
In this interview, we explore a small subset of this work, examining and questioning the narratives around Canadian innovation and related policy.
Your email client will probably truncate this post. My key takeaways are presented at the end, so be sure to read the web version if you want to get the whole story. Many thanks to Charles for taking the time to share his insights.
Interviewer’s note: Charles Plant approved the final version of the section entitled “Interview with Charles Plant” and had editorial input on that section, with the option to rephrase and expand on the ideas discussed in the interview without changing or removing any intended meaning. The key takeaways presented at the end are my own commentary, and do not necessarily represent the views of Charles Plant.
Interview with Charles Plant
KB: Tell us about yourself and how you got to where you are today.
CP: I never know how to answer this, because it’s been such a long and winding path. Many years ago, I co-founded a software company and was its CEO. We built telecom software for phone companies in the US, England, and Canada, and I left after 15 years.
We’d built a moderately successful company. We were growing, we were profitable, but we weren’t a world-beater by any stretch of the imagination. And I realized I really didn’t understand how to scale a company to a large size. If you don’t work in one, you never see how it’s done. Remember, we started that company in the late 1980s. By the 2000s, companies were starting to scale, but it was a fairly opaque process, and it was hard to understand how people were doing it.
So I thought, okay, I have to learn how to scale a company. I deliberately set out to work with a bunch of different companies, and I acted as a fractional CFO for a number of them. I didn’t find the answers that way, because I never ran into any rapidly scaling companies.
I tried investment banking and saw a few moderate successes there, but nothing earth-shattering. I worked at MaRS and didn’t see any massive global companies coming out of Toronto through MaRS, although that was a few years ago and it may have changed a little since. I tried venture capital for a while too, and didn’t find it there either. I could figure out what it took to start a company, and what companies were doing right and wrong, but not what it took to scale.
So I scratched my head, and I ended up at the University of Toronto as a senior fellow at a new research institute. That gave me the chance to actually dig in, look at data on thousands of companies, figure out what was going on, and investigate. That’s when I really started publishing research.
Over the last 12 years or so, I’ve produced about 40 research reports, including a major one for the C.D. Howe Institute. I’ve written two books, with another on the way, and I’ve given tons of speeches. In that time I’ve talked to thousands more entrepreneurs, literally around the world. I’ve advised hundreds of them, and I’ve been an officer or director of about 25 companies. That’s given me a much better handle on what’s going on, and the work with entrepreneurs feeds the research. That’s where the latest batch of research you’ve seen came from.
Right now I’m co-CEO of a nanotech company, board chair of another, and CFO of a third. They’re all in quasi-medical, high-tech or deep-tech fields, and that’s proving interesting as well.
KB: Was deep tech part of the scope of companies you’d worked with before, when you were exploring the scaling question?
CP: If you call AI deep tech, yes. I worked with a couple of AI companies in the early days of AI, and I think it qualified as deep tech back then. Maybe not today. I never really thought of it as deep tech, though. It’s software. To me, deep tech means physical materials, medicine, drugs, things like that.
KB: In your research, you found that Canadian governments directly and indirectly contribute about 44% of the capital received by domestic tech companies, compared to about 4% in the US. Based on what you’re seeing, where are the actual gaps? How do we make more efficient use of the funds that exist?
CP: First of all, that 44% blew me away. I’d never considered it. You have to look not just at what governments are putting into venture capital, but at what they’re putting in through IRAP and SR&ED and all of these other programs. That’s really capital. It goes in different ways, but you still have to count it.
So the government has poured money into this, and people have been blaming the government for years anyway. I found one article from 1967 with a big headline: Canada introduces new R&D funding program because we trail the rest of the world in innovation. We’ve been telling the same story for nearly 60 years, as far as I can see.
What’s happened is that it’s become a mantra. Whenever productivity is low, everybody demands that the government do something, and as a result the government is spending billions. You mentioned $750 million, but when you add in SR&ED, they’re spending $5 billion a year trying to create an innovation economy in Canada. We’ll come back to that. But your question was about capital gaps.
I see three capital gaps that are real and valid. The first is angel capital. There’s a lot less angel capital in Canada than in the United States, if we use the US as a comparator. The second is early-stage VC. There’s a lot less of it, and if you take the government’s money out of the VCs, the amount looks really bad. And the third is a lack of late-stage money.
So there really are three gaps. But the first two, angel and early-stage VC, have been filled by governments. You ask later on whether early-stage companies here are getting as much money as they are in the US. Yes, they are, and they’re getting it out of that 44% government funding. So we’ve solved the first two gaps. I don’t think we’ve solved them in a good way, but in terms of dollars, we’ve solved them.
That leaves late-stage funding. My belief is that this gap exists not because of a lack of funding, but the other way around: there’s a lack of good companies, so the funding isn’t flowing into the system. The funding doesn’t come first. The companies come first, and companies attract funding if they’re good. So if we’re not getting funding in Canada, it isn’t because of Canada. It’s because we lack good companies.
I said that once in Colombia (the country, not the university), where they were complaining about a lack of capital. I told them, stop complaining about a lack of capital. You have a lack of good companies. When you have good companies, the capital will find them, because that’s what capital does nowadays. It goes around the world looking for opportunities. If you can show investors a better return in Kazakhstan, they’ll go to Kazakhstan. Capital follows companies.
And sure enough, I went back the next year (I visited regularly and worked with the tech community there) and Colombia had two unicorns while Canada had none. People remembered what I’d said the year before, scratched their heads and went, well, I guess that works. A lot of places have figured that out. Singapore is one. So yes, there’s a lack of funding, but really it’s a lack of good high-growth companies.
KB: For the sake of clarity, when you say “early stage” and “late stage,” what do you mean?
CP: Companies have three problems to solve. The first is, is there a market, and is it big enough? The second is, do we have product-market fit? And the third is, can we scale efficiently? You can roughly line those up with funding stages.
Pre-seed capital answers the question, is there a big market here? Seed capital answers the question, do we have product-market fit? By the time you get to an A round, you should be at about $200,000 a month in revenue, and that’s enough to judge product-market fit.
Series A money lets you experiment with going to market and figure out whether you can get an efficient growth engine going. After that comes later-stage money to scale. Call it Series B if you like. But I think of it as three questions that have to be answered in order: large market, product-market fit, efficient growth.
KB: How do you see the influence of Canadian public funding for innovation showing up in the incentives, risk appetites, metrics, and behaviour of Canadian private money for innovation?
CP: I don’t know that I’ve been able to test that empirically. But I know from experience what happens. People chase grant dollars, and they skew their spending toward things that will get them grant dollars, because they think it makes the money go further.
I can think of lots of companies I’ve worked with (ones that don’t listen to me) that are getting massive amounts of grants and tax credits. They’re spending massive amounts on R&D and almost nothing on sales and marketing.
Now, I’m not sure whether that’s caused by the grants or just associated with them. I think there’s a bigger problem than the grants alone. But the incentives accentuate it.
KB: What’s your take on the relative risk appetites of Canada versus the US?
CP: I’m going to attack the premise of the question. Two weeks in a row, I read the Sunday column by the head of The Logic (I can’t remember his name) talking about risk aversion and risk appetite.
I don’t believe investors are risk-averse. I believe they’re not stupid. People run around blaming angels for not investing and asking for tax credits. They blame pension funds for not investing in venture capital. But put yourself in the place of a pension fund. You have a choice of assets, a mandated rate of return, and you’re personally rewarded for hitting it. You can go to the United States, invest in a venture capital firm, and earn on average, let’s say, a 12% return. Or you can invest in a Canadian venture capital firm and earn 7%. (We’ll come back to that 7%.) What are you going to do?
You can invest in an airport that gets you 18%, or in Canadian venture capital that gets you 7%. Is that risk-averse, or is it just smart money?
Now let’s look at that 7%. I just discovered something. I haven’t blogged about it, though I should have. It comes from a Business Development Bank of Canada report. That figure is supposedly the Canadian rate of return, but there’s a little asterisk, and the asterisk says it includes Canadian funds and American funds with heavy investments in Canada. What does that tell you?
I think the 7% is inflated. I don’t think we’re getting that return. If the number looked better with just the Canadian funds, they wouldn’t include the Americans. They make the number better by including American funds, because you can’t separate the Canadian returns from the US returns inside a US fund. So obviously the US funds that happen to invest in Canada have better returns, and they’re boosting the Canadian figure. We’re deluding ourselves about what our real rate of return is.
You’re an angel, right? Has an angel group ever told you your expected rate of return? Or the historical rate of return? Can you even get an angel group to tell you how much each company raised, and from how many angels? Not unless you’re in the tent, so to speak. I’ve been in the tent. One angel group asked me to do an evaluation, and I said, give me all your data on who you’ve invested in. I ended up having to use proxies, because I never got a list of who they’d invested in.
So we have a very, very immature, unprofessional angel community in Canada. And I say that as an angel who has been just as unprofessional and just as immature in my time. I now realize that was a real mistake.
So take somebody who has just sold their company and give them two choices. One: invest in a few angel deals with a 10-year horizon, no liquidity, and an unknown rate of return, because we really don’t know what you should expect. Two: buy an asset you can sell tomorrow that has earned 17.5% a year over the past 10 years. Which would you pick? And do you know what that 17.5% is? It’s the Royal Bank. So not investing isn’t risk-averse. It’s just smart. Totally rational.
And there you’re back to incentives, which gets to your question about how the state’s presence alters the risk appetite, target metrics, and behaviour of Canadian for-profit fund managers. People are now blaming pension funds and saying Canada should mandate that they invest here. But what they’re really saying is that we should mandate pension funds to accept lower returns. It makes no sense.
KB: According to your research, once a company crosses a “micro-funding” threshold of $100,000, its chances of going on to raise anywhere from $1 million to $100 million don’t look all that different from the United States. How should policymakers interpret that finding?
CP: Well, there are two things. Number one, we do have a lower startup rate, 24% lower than the United States. I don’t know why. And there’s a problem with startup-rate statistics, because there are two types of entrepreneurship: necessity-based and opportunity-based.
Look at a country like Uganda. It probably has a really high entrepreneurship rate, but that’s necessity-based entrepreneurship. People can’t get jobs. Have you ever spent time in Bogotá? It’s delightful driving down the highways, because there are people standing in the middle of the lanes selling things. That’s entrepreneurship, but it’s necessity-based, not opportunity-based. You can’t use the stats to tease out opportunity versus necessity, so I don’t know what the real rate of entrepreneurship is. There are studies, but they confuse the two. Still, we do have a lower startup rate.
So you have to adjust for the lower startup rate first, and then look at how many companies get to each size. Otherwise it looks like we’re not doing as well per capita. Well, of course not. We don’t start as many. The next question is: once companies actually start, how many get to different amounts of capital?
Most other research has been based on funding rounds: seed, A, B, and so on. I’ve done that too. But there’s no definition of what those mean. What’s a pre-seed round versus a seed round versus an A round? There have been 114 Series A rounds in the United States this year alone that were over $100 million. So what is an A round? You can’t do the analysis that way. You have to look at how many companies raised a given amount of money. And when you do that, we’re pretty equivalent to the United States.
That’s something people need to analyze more. I’ve done the other type of analysis multiple times, but for this one I picked a particular window, and it may be the wrong window. We should go back, look at different points in time, and keep doing this kind of analysis to see whether the finding holds up. Right now I’m working with a petri dish, and I don’t have enough data.
KB: When you look at the amount raised, are you referring specifically to private money?
CP: It’s anything registered in Crunchbase, however people choose to register it. Sometimes they register grants, but they’re not putting SR&ED in. So there might actually be even more funding in Canada if you include SR&ED tax incentives. Typically it’s angel money, venture capital, a whole variety of things. But it’s whatever is registered there, because I can’t tease out the different sources.
KB: As you alluded to earlier, one of your findings is that Canadian firms spend less on sales and marketing than their American counterparts. Is that why we struggle to scale in Canada?
CP: First of all, it’s one of the reasons, not the only one. Incentives play a part. But there are also three other things. I say three, and I’ll probably come up with four.
The first is virtue signalling. There’s a strong belief in Canada that intellectual property is the most important thing. You get that from the Jim Balsillie school of building companies, and from the fact that virtually all of the programs in Canada are oriented to research and development. Part of that is the result of international agreements, but be that as it may, there are ways around those agreements.
The government has promoted STEM education for many years, for instance. But it doesn’t take into account that someone in marketing and sales is probably earning more than the average person in STEM. If you can do marketing and sales, those are better jobs than software development or something like that. So that’s part of the virtue signalling: research and development is good, and marketing and sales is something other people do; you don’t really need it. I’ve had entrepreneurs say to me, “I don’t believe in marketing,” as if it’s a belief system. There’s scorn heaped on commercialization. In Canada, the definition of innovation usually skews toward invention rather than commercialization. But the two parts matter equally. To me, invention plus commercialization equals innovation.
The second thing is that there isn’t a great base of experience for people to draw on. We’re at the early stages of developing a community here, and there just aren’t many people who’ve spent their lives in sales and marketing in the tech sector. So there’s nobody saying, hey, you’ve got to do more of this. The people giving advice typically don’t have that experience. The government isn’t saying it, and the entrepreneurs don’t have it. All of that adds up to people not thinking of sales and marketing as important.
Now, I did one really interesting piece of research in the last couple of weeks. I was looking at scale-up efficiency, trying to find what drives growth, and I found a 0.76 correlation between the rate of increase in sales and marketing spending and the rate of increase in revenue. General and administrative expenses and research and development aren’t correlated nearly as highly. So it’s pretty clear, and you can experience it in any company: if you want more sales, you spend more on sales and marketing, not on research and development. But we don’t have that conversation here, we don’t have that base of experience, and the government isn’t promoting it. All of those things, along with incentives, feed into this lower rate of spending on sales and marketing. And I’ve run that test multiple times. It comes back the same way every time.
KB: Is that a stage-independent finding?
CP: Yes. Now, it could partly be a result of the amount of capital we get, too. If you get less capital, you still have to build the same product, and if that costs the same in both countries, you have less left over for sales and marketing. That could be a factor. But the funding data says it isn’t true at the early stages. We’re actually close in dollar funding.
KB: Is that correlation as strong if you look at the American ecosystem?
CP: Oh, the 0.76 is from America. It’s from 160 software companies that went public.
KB: How would you approach remedying the issue? Is it a question of restructuring incentives, deprioritizing certain areas of grant funding, cutting grant funding, incentivizing talent retention, or something else entirely?
CP: Those are all little tweaks, and I don’t think a tweak is going to work. I think we have to go back to fundamental strategy.
First of all, we should stop comparing ourselves to the US and start comparing ourselves to France, England, Germany, Singapore, and places like that. The reason is that the US is special. It’s a country with an enormous amount of power in the world, and we’re all dealing with that power imbalance right now. But when you look at the opportunity for starting a tech company in the US, they have three things we don’t.
Number one, they have a large local market. Same regulations, same language; all of those issues are already dealt with. In Canada, we have to get big by exporting, and that’s a much more complex problem to solve. We watch the same TV shows, but that doesn’t mean we buy the same way or for the same reasons.
The US also has a higher degree of competition, and because of that, American companies tend to buy more innovation. We’re an oligopolistic country with a low degree of competition, and that doesn’t drive innovation. So these are very different markets. Their size, their nature, and how they work are substantially different.
I remember that most from the first sales call I made in the US. It was to the CTO of Cingular (at least, I think it was Cingular). He was a Texan, in an office in Baltimore, I think, with an enormous Texas flag behind his desk. And he practically jumped across the table and devoured me while I was trying to sell to him. I thought, oh my God, this is totally different. In the US, you don’t have to sell to them. They buy. They want innovation. Canada is different. So that’s the first issue: the market is different.
The second issue is that the talent is different. There may be one school in Canada that teaches sales. They all teach marketing, but not sales. A lot of people in the US see sales as an honourable career, and they have really talented people with lots of experience. In the early days of the tech industry, they didn’t have much experience either. Nobody gave salespeople big budgets, and nobody expected them to burn through a hundred million dollars from a Series A round. But starting about thirty years ago, the US began developing that talent base, and it’s now been a full generation. It’s replacing itself: the people who were young then are now retiring, and all of that knowledge has accumulated.
We don’t have that base of knowledge. We don’t have enough people here who’ve spent their lives selling high-tech products to build an ecosystem around. And if you’re trying to get big, you have to sell in foreign countries, so you should be hiring your salespeople locally in those markets. So we’ll never build that talent base here. We’ll never have the big market, and we’ll never have the big talent base.
The third thing is capital. They have enormous pools of capital, absolutely, that can write billion-dollar cheques to back wacky ideas. They didn’t have that thirty years ago either. They had small amounts. Look at how much money Apple got initially. We’re talking two to six million, that kind of thing. Not six hundred million. They built those pools of capital up through success.
We’ll never have those pools of capital, because of power-law distributions. To get a narrow range of outcomes on a large investment, you have to make lots of investments, say a hundred of them. We don’t have enough investments here for people to get a consistent rate of return, so the math is working against us. We’ll never have the capital. And besides that, capital here has all sorts of other places to go: oil and gas, mining, forestry, natural resources. Those sectors soak up large amounts of capital because the world needs what we’ve got, and they draw people away as well.
So fundamentally, what I’m saying is that our economy is structurally very different from the US economy, and because of that, we don’t have the raw materials to create what the US has created. When it comes to government policy, you can’t make tweaks to try to make us look like the US, because we will never, ever succeed at that.
We need a completely different approach to developing the innovation economy, built on a different set of premises. Instead of requiring a large market, maybe we figure out how to build big companies out of analogous small markets. Maybe we go into areas that depend less on great sales and marketing and lean more on the technology, deep tech being one. And we figure out how to be more capital efficient.
Shopify, for instance, is a great Canadian company and remarkably capital efficient. The average US company has $2.18 of capital for every dollar of revenue. That may be an old stat, but Shopify was one to one, and that’s why its stock has done so well. We need to create a different style of company in Canada, not keep doing it the same way. We have to stop comparing ourselves to the US and figure out what we can do with our resources that somebody else can’t. Why are we special?
I say to people, it’s like Japan deciding one day that it wants to be an oil and gas powerhouse. You smile, because that’s a stupid idea. Japan doesn’t have any oil and gas. How could it ever be an oil and gas powerhouse? Yet that’s what we’re doing. We’re being totally stupid about this.
KB: Have you seen ecosystems with a similarly structured economy to Canada’s that have been able to overcome this?
CP: Well, no. We’re doing better than France, Germany, and England in this game. We aren’t doing as well as Singapore or Israel. Singapore is a great case. They rely on partnerships; they’ve developed a way of partnering with everybody, I think. I don’t know enough about Singapore, and I should really do a bit of research before I talk about it, but from what I’ve learned, they took a different strategy.
Israel has a completely different set of issues. It has a highly educated population, which works to its advantage. It also faces an existential threat that forces it to make sure it has a local supply chain of innovation, and it has promoted that. So there are countries that have developed different philosophies from the US. But the first thing an Israeli company does when it goes big is open an office in Boston or New York. The number of Israeli companies with offices in Massachusetts is quite astounding.
The point is, we’re all looking at the US and going, I’ve got to be like the US. But the countries that have succeeded have succeeded for other reasons, because they’ve done something else. Now, I don’t have that thesis completely tested, so take it with a grain of salt, but that’s where I’m heading.
If you go back to economics (I don’t know if you’ve ever taken any), it always starts with: what resources do you have, and how are you going to capitalize on them? An analysis of countries might use Porter’s Five Forces or something like that, and it all starts from the premise that you have to build on your strengths. You can’t fix your weaknesses. In Canada, we’re trying to fix our weaknesses instead of building on our strengths.
KB: On the question of missing sales and marketing talent: is this talent we train that then leaves, or does it never develop in the first place? It sounds like you’re saying it never develops, because the kind of sales and marketing talent that has driven success elsewhere just doesn’t develop in a market with low competition that’s export-dependent from the get-go. Am I understanding that right?
CP: I did a piece of research a couple of years ago, which you can find online, that surprised me. It’s old, so I don’t know how well it applies today. Everybody talks about the brain drain to the US. But there’s more of a brain drain of sales and marketing people than of technical people, and it happens early in their careers. Once you’re pretty good at sales and marketing and you want a good career, you go to the US.
KB: In some of your writing, you posed a series of questions, some of which we’ve touched on already. The first is whether grant-heavy firms take longer to reach meaningful revenue. Do you see a causal relationship between easy access to grant money and delays in actually taking steps to commercialize and scale?
CP: I don’t know. I haven’t tested that. It’s logical. But I asked some of those questions precisely because I really don’t know why people do what they do, or exactly what they’re doing. That leads into something we’ll get to toward the end.
KB: What data do you actually need to answer these questions? And who should be collecting it?
CP: I’ve tried to research these things, and the only way to figure them out is by talking to entrepreneurs directly. Talk to the founders, ask them what they’re doing and why, and do a lot of it. I tried to get research money to do this and failed. Maybe I went about it the wrong way, but there’s no one in Canada who’s incented to research this area, and research follows the dollars.
This would be non-academic research. There is academic research on these topics, but it’s done by people who each see only one part of the elephant. If you have real experience, it leads you to the research. You know the problems you’ve had, and you can go look at them. Academic researchers aren’t doing that. They theorize about what the problems are and then research those.
Meanwhile, the entrepreneurs who have the problems don’t know what their own problems are. If they did, they’d have fixed them and they’d be doing better, right? You see it all the time in academic and government research that asks entrepreneurs what’s wrong. That’s a completely invalid way to do research. They don’t know. If they knew what was wrong, they’d fix it and nothing would be wrong. The fact that they’re saying something is wrong means (and we’ll get to this in your last question) that I need to go out and actually talk to entrepreneurs.
And there are some great sources of them. IRAP provides money to all the right companies. You could just go through IRAP and start asking questions, but IRAP isn’t funded to do that research. BDC isn’t funded to do it either, and it also has access to all of these companies. So you could go through government agencies to reach the people, but nobody is spending money on it.
KB: If you were given control of the $750 million envelope of funding right now, what would you do differently from what’s currently being done?
CP: I probably have some ideas, but I should say that I really don’t know, because I don’t have enough data to make decisions. And that’s part of the problem. I’ve advised provincial, municipal, and federal governments on exactly these issues and programs, and there’s no data being used to develop programs. Well, “no data” is a little loose. There’s a limited amount, frequently of the wrong type, being used to evaluate which programs are needed. Most of the time they’re just responding to the noisiest voices. So I don’t know what I’d do with $750 million. I’d probably hit pause, take the time to research what the real problems are, and then build something around that.
KB: Is there anything you’d like to get into that I didn’t ask about?
CP: The blame game. We’ve touched on it. You read in the press that people blame the government for not spending enough in Canada, and there are always articles saying the government should do more. It should be the first buyer. The hospital system is terrible; it doesn’t buy from Canadians. So the first complaint is that we’re failing because buyers aren’t buying.
Number two is that we’re failing because the right people aren’t here. Nobody has really said what to do about it. Oh yes, they have. This one really got me. Recently, people have said we’ve got to change the tax system to allow greater inequality, so entrepreneurs can keep more of the money they make and won’t leave for the US. Have you seen that one? So there’s the pattern again: blame the government; the government can fix this.
The third is that we don’t have enough capital. Everybody fights over that one. We don’t have enough capital; government, you must give us more.
What’s happening is that people are blaming external factors for the lack of success instead of looking inward and asking, what could I have done better? If I have limited resources, what could I do with them? We really have to stop the external blame game and have a serious internal conversation about what we’re doing and why it isn’t working. It’s not the government’s responsibility to buy our products. It’s not the government’s responsibility to make sure the right people are here. It’s not the government’s responsibility to provide capital.
Now I’m sounding like a rabid right-winger, aren’t I? I’m actually a highly woke, very left-leaning person. I believe in putting money in regular people’s pockets and cutting taxes for lower-income people, not making the wealthy wealthier. So this is partly a reaction to that, and I don’t want to come across in the article as a rabid right-winger, because I’m the complete opposite. It’s just that we’re being greedy in a lot of what we’re asking for.
We have to look inward and ask why we’re failing and how we can succeed in a different way, and have a serious conversation based on serious research. I may have done more research on this topic than anyone in the country. I haven’t found anybody with more, particularly longitudinal research. And that’s sad, because I do it for fun, on the side.
We need a much more serious conversation. The institutions sitting around blaming everything but themselves, and the entrepreneurs blaming everyone but themselves, need a kick in the pants. That’s not the way to succeed. It’s like the Maple Leafs blaming the crowd for their performance.
Key takeaways
It isn’t the amount of money
While Charles did not comment on it directly, the results of his analysis land awkwardly for the federal government, which last week announced the allocation of Growth VCCI funding into precisely the stage his data suggest is least in need of it. Adding up all of the programs run on public dollars, he finds that 44% of the money going into Canadian innovation comes, in one way or another, from the government, 10 times more than the equivalent figure in the US.
Despite this, the Canadian private sector keeps asking for more. As Charles puts it:
“[T]he government has poured money into this, and people have been blaming the government for years anyway […] We’ve been telling the same story for nearly 60 years.
What’s happened is that it’s become a mantra. Whenever productivity is low, everybody demands that the government do something, and as a result the government is spending billions.”
Clearly, the issue is not the amount of capital being spent by the government on innovation.
Funding gaps
Charles identifies three gaps in Canadian private capital: angel investment, early-stage VC, and late-stage VC, but he is careful to distinguish between them. The first two, he argues, have already been closed by the public sector, at least on paper:
“The first two, angel and early-stage VC, have been filled by governments. You ask later on whether early-stage companies here are getting as much money as they are in the US. Yes, they are, and they’re getting it out of that 44% government funding. So we’ve solved the first two gaps. I don’t think we’ve solved them in a good way, but in terms of dollars, we’ve solved them.”
The funding exists, but the way it is delivered determines who can actually use it and the impact it ultimately has. I’ve written extensively about the structural problems that divert public funding away from its intended recipients, or that are designed, through revenue minimums, matching requirements, and reimbursement after the fact, to prevent access by the pre-revenue companies that could make the most efficient use of them. A dollar that arrives as a tax credit eighteen months after it was spent, or that requires a cash match the company does not have, counts toward Charles’ 44% without ever reaching a company at the formation stage.
The late-stage gap is a different animal. Here Charles rejects the premise that more capital is the answer:
“My belief is that this gap exists not because of a lack of funding, but the other way around: there’s a lack of good companies, so the funding isn’t flowing into the system. The funding doesn’t come first. The companies come first, and companies attract funding if they’re good.”
This is where last week’s Growth VCCI announcement should be closely examined. The program is explicitly designed to address the late-stage gap: larger cheques for companies that are ready to scale. If Charles is right, that is the one gap in the Canadian capital stack that is a symptom rather than a cause. The shortage of late-stage capital reflects a shortage of companies worth funding, and no amount of growth-stage public money will create them after the fact.
A shallow pool
There is a mantra in Canadian innovation that Canada is great at starting companies but bad at keeping them. While Charles’ analysis certainly supports the view that Canadian companies have trouble scaling in Canada, it challenges both the first half of that idea, and the usual causal attribution to insufficient capital: he finds that on a per capita basis, Canadians start 24% fewer companies than Americans. Once he adjusts for that difference, he also finds a “micro-funding threshold” of $100,000: a Canadian company that crosses it is no less likely than a US startup to raise $1M–$100M in follow-on capital
Charles is as always careful to caveat the generalizability of his findings:
“I picked a particular window, and it may be the wrong window. […] I’m working with a petri dish, and I don’t have enough data.”
My own diagnosis differs slightly from that of Charles, but they are complementary: my assertion in much of my writing is that public money arrives early but in a form that excludes pre-revenue firms, while his is that it may skew survivors toward R&D over sales and marketing. The best investor on the planet will be unable to realize good returns in an ecosystem that does not produce a deep pool of investment opportunities from which to choose, and Canada’s pool is shallow. As Charles puts it:
“We don’t have enough investments here for people to get a consistent rate of return, so the math is working against us.”
No amount of government funding will change this if the money is delivered early in aggregate but structured so it doesn’t reach formation-stage, pre-revenue firms (and, per Charles, so that it distorts spending toward R&D).
Rational versus risk-averse
I have written often about risk aversion in Canadian innovation. Charles attacks the premise and highlights a critical nuance:
“I don’t believe investors are risk-averse. I believe they’re not stupid. […] You can go to the United States, invest in a venture capital firm, and earn on average, let’s say, a 12% return. Or you can invest in a Canadian venture capital firm and earn 7%.
[…]
You can invest in an airport that gets you 18%, or in Canadian venture capital that gets you 7%. Is that risk-averse, or is it just smart money?
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[You can] invest in a few angel deals with a 10-year horizon, no liquidity, and an unknown rate of return [or you can] buy [RBC,] an asset you can sell tomorrow that has earned 17.5% a year over the past 10 years.
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So not investing isn’t risk-averse. It’s just smart. Totally rational.”
He is right, and my own research backs it up: the earlier in a company’s lifecycle we look, the greater the disincentive for for-profit investors. Apparent private sector risk aversion is a symptom of rational investing in an ecosystem with a shallow pool of opportunities, and it is through taking steps to increase the quality of the pool of investable companies, not through further funding for late stage growth, that Canada can incentivize private-sector participation in Canadian private markets. He goes further, challenging the purported Canadian rate of return in venture capital:
“Now let’s look at that 7%. […] It comes from a Business Development Bank of Canada report. That figure is supposedly the Canadian rate of return, but there’s a little asterisk, and the asterisk says it includes Canadian funds and American funds with heavy investments in Canada. What does that tell you?
I think the 7% is inflated. I don’t think we’re getting that return. […] US funds that happen to invest in Canada have better returns, and they’re boosting the Canadian figure. We’re deluding ourselves about what our real rate of return is.”
I’ve previously written that to address this, we must embrace risk, recognizing that in the pre-revenue stages, before it makes sense for private capital to get involved, it is too early to pick winners. At first glance this contradicts Charles’ point, but this is not the case: my position is that the risk at the earliest stage can’t be carried by for-profit capital, so it has to be carried by public or venture philanthropic capital designed for that stage, strengthening the pool of opportunities so that it makes sense for private capital to get involved.
Context matters
A further issue he identifies relates to market structure and the importance of building policy for the context in which it will be applied:
“[W]e should stop comparing ourselves to the US […T]hey have a large local market. […] In Canada, we have to get big by exporting, and that’s a much more complex problem to solve.
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The US also has a higher degree of competition[…] We’re an oligopolistic country with a low degree of competition, and that doesn’t drive innovation. So these are very different markets. Their size, their nature, and how they work are substantially different.”
I have summarized this idea in other articles simply as “context matters”. We cannot simply import American practices and expect them to work here. His prescription follows from that:
“We need a completely different approach to developing the innovation economy, built on a different set of premises. Instead of requiring a large market, maybe we figure out how to build big companies out of analogous small markets. Maybe we go into areas that depend less on great sales and marketing and lean more on the technology, deep tech being one.
[…]
Shopify, for instance, is a great Canadian company and remarkably capital efficient. The average US company has $2.18 of capital for every dollar of revenue. […] Shopify was one to one, and that’s why its stock has done so well. We need to create a different style of company in Canada, not keep doing it the same way. We have to stop comparing ourselves to the US and figure out what we can do with our resources that somebody else can’t.”
His offers insight into where we should direct our effort:
“You can’t fix your weaknesses… In Canada, we’re trying to fix our weaknesses instead of building on our strengths”
[...]
“[I]t’s like Japan deciding one day that it wants to be an oil and gas powerhouse. […] Japan doesn’t have any oil and gas. How could it ever be an oil and gas powerhouse? Yet that’s what we’re doing.”
Canada is a natural powerhouse in many areas: we are among the world leaders on quantum technologies, we have vast natural advantages in agriculture, and the recently announced Defence Industrial Strategy is an opportunity to establish a strong defence sector, to name just a few. Doubling down on these areas will do more work for us than yet another attempt to buy our way past structural weaknesses with late-stage capital.
Invention is not innovation
Having debunked risk-averse culture and a lack of capital as the source of the issue, Charles offers two further explanations as to what does contribute.
The first issue he identifies is that we over-index on invention over commercialization:
“There’s a strong belief in Canada that intellectual property is the most important thing. You get that from the Jim Balsillie school of building companies, and from the fact that virtually all of the programs in Canada are oriented to research and development.”
This has been the subject of lamentation in the Canadian ecosystem for some time: the idea that we are great at inventing things but poor at commercializing them. What differs between Charles’ take and the usual one is that the usual take concludes that we need to do a better job protecting IP. Protecting IP is a first step, not an end goal. In his words:“invention plus commercialization equals innovation.”
Funding only half of a commercialization strategy
The second issue he identifies revolves around sales and marketing. Canadian companies do not spend as much on these areas as their American counterparts, and the talent that does develop leaves early. Charles’ research found a larger brain drain of sales and marketing people than of technical people, concentrated early in their careers.
Part of the issue stems from the R&D focus of our public spending. By providing funding for research and IP but not for sales and marketing, our public contributions to private innovation only provide half of a commercialization strategy. While Charles is careful to note that it is not clear if there is a causal link between public R&D incentives and the under-spend on sales, his findings certainly warrant a more careful look.
Charles’ research points to the lost opportunity:
“I was looking at scale-up efficiency, trying to find what drives growth, and I found a 0.76 correlation between the rate of increase in sales and marketing spending and the rate of increase in revenue. General and administrative expenses and research and development aren’t correlated nearly as highly. […] if you want more sales, you spend more on sales and marketing, not on research and development. But […] we don’t have that base of experience, and the government isn’t promoting it.”
While he notes that this is specific to a set of American software companies and that this is a correlation rather than a causal attribution, it certainly suggests that we should be considering sales and marketing when providing public funding intended to help Canadian firms succeed, or at the very least, collecting the data to make it possible to disentangle the effects in play.
Conclusions
Taken together, Charles’ findings suggest a change in strategy. However, he is careful to note that many of the questions that we need to answer simply do not have enough data to allow the required analysis:
“I’ve advised provincial, municipal, and federal governments on exactly these issues and programs, and there’s […] a limited amount [of data], frequently of the wrong type […]. Most of the time they’re just responding to the noisiest voices. […] I’d probably hit pause, take the time to research what the real problems are, and then build something around that.”
Among the many things that Charles’ analysis makes plain, it is clear that addressing Canada’s innovation challenges will not come from pointing fingers, nor will it come from repeating, or making incremental changes to, that which has not worked in the past.
Charles objects to demands for more of the same public funding, and he is right to do so. There is no shortage of public capital for innovation, and no shortage of evidence that it is not working in aggregate. The issue is at least in part that it is delivered in a form that cannot reach the earliest stage, and for only half of what commercialization requires.
Growth VCCI is a case in point. It is a well-intentioned answer to a gap that Charles’ data suggest will close on its own once there are enough good companies to fill it. If the public servants administering the program take one thing from this interview, it should be his instinct to pause and ask whether the gap being filled is the one that matters.
Above all, his final thoughts ring true:
“We really have to stop the external blame game and have a serious internal conversation about what we’re doing and why it isn’t working.
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We have to look inward and ask why we’re failing and how we can succeed in a different way, and have a serious conversation based on serious research.
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The institutions sitting around blaming everything but themselves, and the entrepreneurs blaming everyone but themselves, need a kick in the pants. That’s not the way to succeed. It’s like the Maple Leafs blaming the crowd for their performance.”
Thanks again to Charles for taking the time to do this interview. You can find more of his work on The Narwhal Project.