The federal government recently unveiled the new “supercluster” program to the tune of $950 million dollars towards 5G networks, clean tech, self-driving cars and more. The thinking behind this was straightforward: The government should choose and support the development of specific technologies where Canada can win globally.
Contrast this thinking to the $4-billion SR&ED program that supports almost any small company willing to invest in new technology development, regardless of a proven market need or path to market. In the middle is IRAP, a relatively small program of $175 million that’s part of the NRC’s budget, in which advisers provide grants to companies with good technology ideas and a high likelihood of successfully bringing them to market.
While the supercluster concept and IRAP are both great programs, they have a feel of a planned economy rather than free market, with government ultimately choosing where the money goes. On the other hand, no venture capitalists would hand out money to startups without a proven business plan, which is kind of what SR&ED does.
So how is this working for Canada? We have an enormous number of tiny startups, a declining number of mid-sized Canadian tech companies, and very few large Canadian tech giants. You could argue the distribution of Canadian tech companies parallels the programs in place.
Suppose there was a way for the government to automatically direct support to clear market winners that are doubling down to take their companies to the next level. How do you pick a winner?
How about companies that export a high percentage of their sales? It’s one thing to sell locally; it’s quite another to successfully sell around the world against global competitors.
Direct subsidies to exporting companies are obviously off the table as they violate the WTO and a whole host of other agreements. But there’s a loophole: R&D grants.
Governments are still permitted to invest in corporate R&D development however they see fit. If the government chooses to help companies that are successful exporters and are investing in R&D, that’s within the rules of fair play. Interestingly, the extra R&D money would free up cash inside those companies to invest in global sales and international marketing to sell even more abroad.
We can do this without creating any new programs, hiring additional bureaucratic overheads or allocating extra funding. Simply add a term to the SR&ED refund equation to decrease the “grind down” of the funding eligibility of companies in proportion to the percentage of sales they export.
“Grind down” refers to a mechanism in the SR&ED program that decreases the cash returned to companies as they grow or become mildly profitable. The original idea was to spark innovation and startups, but looking at the stats we don’t have an innovation problem – we have a commercialization of innovation problem.
Perhaps we should be redirecting some (not all) of that funding to mid-market winners with proven track records that are reinvesting in R&D rather than endless startups. These mid-market companies have a proven business plan with a proven path to export markets. Additionally, the increased exports shift the balance of trade and bring foreign money into the country to help further pay for the program. This is a more efficient use of the existing SR&ED budget and lets the hand of the free market pick the winners.
Understand that as a company grows it needs cash to fund that growth. When startups transition to become medium-sized companies, the SR&ED cash rebates plunge and the search for alternative funding begins, often urgently. If these companies are cautious and have some cashflow, the Business Development Bank of Canada will offer (expensive) sub-debt support, which is far preferable to equity investment but not nearly as appealing as SR&ED cash rebates.
The rest have to find equity funding and the best valuations come from American equity funds with exit time frames of three to seven years. By the end of that period, the new Canadian darlings we tout in the press are almost always sold to larger American companies and become R&D outposts, with the “business” jobs going to the United States in addition to the financial rewards.
It doesn’t have to be big American companies that buy up our Canadian companies. It can be big Canadian tech giants, but we have to create them first. You don’t get large companies without them transitioning from small, to medium, and then to large.
Canada desperately needs more government backing to encourage our mid-sized companies to scale and compete on the global stage that we are joining. Decreasing the SR&ED grind down in proportion to company exports is an easy yet powerful mechanism to make this happen.
David Ross is the CEO of Ross Video.
A version of this column first appeared in the Globe and Mail