Exploring Technology Innovation in Canada
Commentators have long criticized Canada’s inability to scale high-tech companies to world-class size. Although Canada has created an ecosystem that produces many startups, few of these companies grow to become Unicorns. Certainly, we have had world-leading companies such as Blackberry and Open Text, and more recently Unicorns such as HootSuite and Kik Interactive. But most of our successful startups are sold before they reach world-class size. Overcoming this growth hurdle is crucial to positioning Canadian companies favourably in global markets.
The Impact Centre is conducting research in order to discover the underlying factors that are inhibiting our ability to create world-class technology companies. Our objective is to understand how we can improve and how governments, companies, and academia can identify and adopt best practices in technology commercialization.
In several prior reports we looked at the impact that smaller VC deal sizes has on the slower growth of Canadian companies and on the availability of late stage capital. For this report, we wanted to look at whether smaller deal sizes may be as a result of any action that entrepreneurs themselves are taking.
To do this we looked in detail at 35 companies seeking financing. What we found that their forecasts expected, on average, a 160% compound annual growth rate in revenue. While aggressive, this in itself is not an issue. Their other expectations though are problematic in that they expect to achieve these results with very little capital while recording profits of 34% of revenue.
Clearly these expectations are phantasmagorical and problematic as their requests for capital would, under any scenario, be insufficient to propel growth at these rates. What we concluded was that as a result of seeking too little capital, entrepreneurs may be inhibiting their own growth and thus contributing to our challenge at scaling companies.
Canadian VC deal sizes continue to lag those in other countries and at the same time, the returns of Canadian VCs also lag American VC returns. Canadian VCs made a strategic decision to invest the way they did as they could just as easily have chosen to invest twice as much in half as many companies. This begs the question; does the smaller deal size result in smaller returns?
To figure that out we looked at the results of 587 US companies and 131 Canadian ones. What we found was that the more funding a company has, the faster it grows and the faster a company grows, the more funding it can get. This seems to be one reason why Silicon Valley based companies, who have the greatest levels of funding out-perform the rest of the US and why the US outperforms Canada.
We believe that Canadian VCs are inadvertently limiting their own returns. They are making strategic decisions to finance companies later, less frequently, and with less money than companies in the US, thus potentially generating low returns.
If Canada’s problem now is our ability to create large, public and industry leading world-class companies, then we thought it would be worthwhile to examine the ability of BDC’s venture capital division and MaRS Investment Accelerator Fund to pick and nurture world-class companies. What we found was that while they are effective at picking successful companies, they both lack the requisite funding at early, mid and late stages to turn these investees into world-class companies.
The goal of our current study was to examine and compare the quality of marketing leadership in Canadian and American tech companies. On the whole, we found that Canadian-based marketing leaders are less qualified and less experienced than their American counterparts but what worried us most about our findings was domestic brain drain. With foreign firms taking our best talent, and Canadian firms conducting marketing out of U.S. offices and being sold before they flourish, we have a severe problem. We are not developing a local talent base that will enable us to solve the marketing challenges our firms face. This has implications for public policy and the development of support programs aimed at accelerating the growth of Canadian companies.
The prevalent Canadian narrative is that as a country, we struggle to compete in the global innovation economy. One metric that is often cited as proof of this is the number of patents we are granted in comparison with other advanced countries. In this Brief, we have looked more closely at Canada’s performance in the numbers of patents granted.
What we found isn’t that we have a problem securing patents, it’s that we have a problem with the commercialization of them. Canada’s success in obtaining patent grants in the US has improved by 143% over the last ten years. The number of patents with one or more Canadian inventors climbed to 8,903 patents in 2015, placing us eighth on a per GDP basis against competitor countries in 2015.
However, of the patents granted to Canadian inventors by the US Patent Office in 2016, 58% were assigned to companies domiciled in other countries. This is up from 45% in 2005. This means that Canada earns a return through commercialization for less than half of the patents granted in the US to Canadian inventors.
Patenting is an international, not a local activity; and the nuances of the process must be considered before the numbers are aggregated into a single indicator for the purpose of policy making.
Anecdotal evidence suggests that many Canadian technology companies wait until their products are completed before raising and spending funds on crucial functions, including marketing and sales (M&S) and that this practice is delaying success in raising funding.
The goal of this study was to determine whether Canadian technology startups do in fact delay funding M&S activities. To this end, we looked at job classifications of employees at over 900 private Canadian technology companies that had received external investments. What we found was that in the startup phase Canadian firms have significantly fewer employees in marketing and sales than US firms do. Even among the best-funded firms, Canadians have 25% fewer M&S employees than US based Unicorns do.
In order to provide a tool to enable entrepreneurs and investors to gauge how attractive firms are from a financial standpoint, we are pleased to introduce a way to measure Financial Velocity. Financial Velocity is defined here as the amount of funding a firm has raised divided by the number of years it has been in existence. It is expressed in millions of dollars per year. This measure reports the rate at which companies raise and consume capital.
We have assembled a list of the top Canadian businesses based on Financial Velocity and are pleased to introduce the Narwhal List. This list shows Canadian venture capital backed companies with the highest Financial Velocity.
This study reveals three critical issues:
1. Canadian companies wait longer before they start raising funds.
2. They raise funds less often.
3. They raise less money over time.
And as a result of this pattern, even our best companies are not particularly attractive to investors as their growth rates fall well below that of the most successful US companies.
Our success as an “Innovation Nation” depends not only on our ability to come up with novel ideas or inventions but also on our ability to market and sell those ideas. Unfortunately there is a striking difference in the spending behaviour of Canadian and American on marketing and sales (M&S). While mid-sized US software companies spend, on average, 34% of their revenue on M&S, comparable Canadian firms only allocate 20% of their budgets to those expenditures.
The lack of venture capital in Canada has been denounced consistently in studies and think tank reports, and by the media, entrepreneurs, and even venture capitalists themselves. But while the general consensus is that Canada does not have enough venture capital, we somehow manage to rank #4 in the sale of technology companies.
How can we have too little venture capital funding but be so successful at selling companies? The answer lies in how we are funding companies and what stages we are able to fund.
While many commentators claim that Canada lags behind the United States in its ability to innovate, we found no evidence of this in our recent study on corporate culture. While these results may appear inconsequential, they allow us to eliminate a potential cause of Canadian innovation problems by highlighting the similarities in the Canadian and American beliefs about a culture of innovation.
Business expenditures on research and development have been under-reported by Statistics Canada for almost 20 years. While many reports bemoan Canada’s lack of spending on Innovation compared with the OECD, we haven’t been using the same definition of R&D and this has caused it to be under-reported.
The Impact Centre’s latest study has determined that Founder CEOs outperform Professional CEOs in both Unicorns and venture-backed Canadian companies. But in Canada we are 2.6 times more likely to replace a Founder CEO with a Professional CEO.
Our recent study on attitudes towards innovation found that there are 29% more Americans than Canadians who have a strongly positive attitude towards innovation. Americans outscore us in almost every dimension of attitudes towards innovation, among managers and employees, men and women, and among all age groups.