Canada’s declining position in the Global Competitiveness Index, the lower productivity of Canadian companies compared to U.S. firms, and the low ranking of Canadian companies in the Global Innovation Index despite the strengths of our scientific community and the quality of its research suggest that Canadians are adroit in transforming “money into knowledge,” but have difficulty mastering the alchemy of transforming “knowledge into money."
It is well established that high-growth small and medium-sized enterprises (SMEs) contribute disproportionally to innovation, productivity improvement, competitiveness and economic growth. Increasing the number of high-growth SMEs is a major focus of industrial policy worldwide. But in Canada, the trend is moving in the opposite direction. Since 1997, both the entry rate of new businesses and the proportion of high-growth companies in the Canadian economy have declined by more than 30 per cent.
The usual explanations of that sad state of affairs is a lack of managerial talent and the alleged propensity of Canadians to be risk-adverse. These are not satisfactory: A number of Canadian companies are world leaders in their industries and international comparisons of manufacturing-management practices place Canada at par with leading industrialized countries. The risk-aversion syndrome is belied by the number and high value of investments in junior exploration, mining, and oil and gas companies, one of the most risky sectors of activity.
There is no escaping the evidence that Canada is struggling with ineffective policies that hinder the growth of high-potential Canadian companies and promote pathways that lead to the sale of promising firms to foreign acquirers.
So, what should we do? Certainly more of the same policies would not produce different results. The analysis of successful policies in peer countries, as reported in two recent research papers, shows that there exists effective ways to solve our policy conundrum.
First, the tax regime that discriminates and penalizes innovative and high-growth companies that go public to raise equity capital must be corrected. SMEs that go public lose their Canadian-controlled private corporation status; they are penalized by a jump in the federal income rate to 15 per cent from 10.5 per cent and a substantial decrease in the federal scientific research and experimental development tax credit for R&D to 15 per cent from 35 per cent.
In addition, when they are listed on an exchange, companies are no longer eligible for a cash refund of the tax credit; instead, new technology-based companies must be content with almost worthless tax credits since, being in the development phase, they are not yet, or barely, profitable.
Second, the depth of Canada’s public and private equity markets must be increased in order to reduce the propensity of investors to sell to foreign investor companies that have reached the growth stage characterized by product maturity, rapid customer adoption and revenue growth and give these companies a better chance of remaining in Canada, either through a sale to a Canadian buyer or through an initial public offering.
Studies show that the U.S. Small Business Jobs Act of 2010, which provides for full exemption from federal taxation of capital gains realized on the sale of the shares of certain small businesses held for at least five years prior to sale, is an effective way to achieve this objective.
Third, we must make the acquisition and commercialization of intellectual property more attractive to Canadian companies.
Private equity capital investors have a strong tendency to exit through trade sales and, in most cases, they sell to foreign acquirers. During the 2013-18 period, private equity and venture capital firms completed 609 exits, of which just 43 were IPOs.
We also observe that half of private equity exits were effected through a sale to a foreign buyer and approximately 80 per cent of buyers in venture capital exits were foreign. The end result is the hollowing out of high-tech and innovative companies. To counter this phenomenon, we have the example of many European countries that apply a reduced tax rate on income generated by the commercialization of intellectual property for which the company has incurred expenses.
Fourth, there is an important societal motive to ensure that Canadians have the opportunity to personally benefit from the wealth created by high-growth companies during their early stage. To this effect, the capital-gains tax rates on shares issued by qualifying SMEs when listed on a Canadian stock exchange and held by individual investors for a reasonable period of time thereafter should be reduced. This measure would have the additional benefit of increasing individual investor participation in public equity markets.
Fifth, to help mitigate the impending shortage of talent, Canada should emulate Germany by establishing a network similar to that country’s "Steinbeis" system. The Steinbeis network groups around 6,000 technical professionals whose skills, experience and know-how can be put to use by companies across the country. It has proven to be very effective in helping German companies in their quest for technological leadership and innovation.
For entrepreneurs seeking liquidity or business growth, as well as private equity investors, the adoption of the above measures would create a more neutral environment for exit choice and make Canada a better place to scale-up and expand throughout global markets, which, to a large extent, is the crux of the matter.
Pierre Lortie is business senior adviser at Dentons Canada LLP. He is also the author of a pair of recent research papers: Nurturing Global Growth Companies: Time for a New Policy Toolkit for the school of public policy at the University of Calgary, and Entrepreneurial Finance and Economic Growth: A Canadian Overview for C.D. Howe Institute.