A few years ago, the Canadian federal government asked me to explain the dismal performance of venture capital in the country. The 10-year average return of VC funds in Canada for the period 1995-2005 was 2.5%, compared with 20.7% for US funds — the various Canadian government-sponsored funds made even lower returns. In 2007, while almost US$30 billion was invested in US ventures, only about $2 billion was invested in Canada (bearing in mind Canada’s population of almost 33 million then, about 1/10th of the US).
Not much changed during the last 10 years. Median Canadian VC has delivered a 4% internal rate-of-return (IRR) versus comparable US returns of 12%, and the five-year numbers are 11% and 20%, respectively. This despite the mantra from all Canadian governments, federal and provincial — “innovations, innovations.” The word appears 212 times in the 280-page federal budget tabled this week by the Trudeau Liberals, with generous taxpayer-funded spending promised in the hope that something might stick. How come not much ever did?
The answer is not rocket science. First, you need a culture of disciplined, wide-ranging debate, and it’s better to start early – and certainly not prohibit it at universities. Innovation is a departure from customary ways of thinking and of doing things. Its execution is a matter of trial and error. But how do you recognize that you should go ahead with an idea and when to stop digging a deeper hole? This is best decided through debate on the merits of an idea as trials continue and debates with suppliers and potential suppliers about funding.
Asian countries can learn from repeated mistakes made by Canadian governments and institutions: drastically cutting the number of diverse sources of capital within Canada and with ill-conceived tax policies (capital gains taxes and high income taxes in particular), that reduce incentives to invest in Canadian startups. Avoid these mistakes and the countries will thrive. By taxing incomes heavily, Canadian governments helped lower the experimentation necessary for startups. High taxes prevent people from accumulating enough savings from discretionary income to become “angel investors” to whom budding entrepreneurs could turn for funding. The National Angel Capital Organization reported that in 2015 its members invested Cdn$134 million, whereas in the US the number was $24 billion.
No government officials, research centers and certainly not academics can stand in for “business angels,” private investors with experience in corporate settings, as entrepreneurs, or both. Along with capital, they offer the advantages of “smart money.” They are capable of vetting and improving ideas and plans entrepreneurs put forward. They evaluate the entrepreneurs: Do they listen to advice? How disciplined and determined are they? Can they delegate so that the business can grow?When “angels” take an interest in entrepreneurs, they bring their networks of contacts as well as their managerial, operating, and mentoring experience to the table on a daily basis — something bureaucrats and the vast majority of academics do not have.
Canada’s misguided tax policies prevent the emergence of a critical mass of “angels,” preventing the diverse sources of capital for startups. This doesn’t necessarily mean that brilliant young Canadian won’t become entrepreneurs. It only means they will likely move to the United States to realize their dreams. And with fewer startups and diminished financial incentives there are fewer opportunities to use venture capital and expand.
Indeed, total VC investment in Canada in 2016 was $1.7 billion, the same as 2015. To put VC numbers in context: Israel, with roughly the same population as Quebec (just over eight million), saw VCs invest $4.43 billion in startups in 2015. Taxes, regulations and Canadian federal and provincial governments’ misunderstanding of the “democratization of capital” and what roles governments could — and should — play are part of the problem.
The other part is the shallow debate in the Canadian educational system — universities in particular — a consequence of decades of throwing money at schools and universities while these institutions were giving up on proper selection of students and, in universities, faculty as well.
Jonathan Medved, one of Israel’s main VC investors in high-tech, noted that in his meetings in “India, China, [and] Japan, Israel is a top brand — BDS (Boycott, Divestment and Sanctions against Israeli handling of the Palestinian dispute) is important on college campuses, NGOs and some part of the church, but not in business … I was sitting with one of [the] top US hedge-fund managers and I asked him about BDS. His response? “Anyone with a brain cannot support BDS. If you do: get off Google, Facebook, your laptop, anything with an Intel chip.” Intel, Cisco, Apple, Facebook, Google, Paypal and Microsoft operations in Israel are major contributors to their companies’ product lines.
The dean of the faculty I am associated with recently told faculty members they “are free to criticize the university and publish your articles in any media outlet as you see fit. I am also free not to publicize it.” It appears that while business-school faculty is encouraged to do critical analyses of Wall Street, Main Street, the rest of academia (and this particular dean) are happy to publicize them. But this dean will not publicize research critical of universities — not something you would expect from the dean of a business school in a commercial society.
Her statements stand in sharp contrast to a former principal of McGill University, David Johnston, now governor-general of Canada, who is aware of the flaws in academia and universities concerning debates in particular. He has encouraged research on academic decline and has widely endorsed articles and debates on the subject both within and outside McGill. But that was 15 years ago.
True, the current McGill principal, Suzanne Fortier, issued a memorandum on Thursday emphasizing that disciplined debate is “the foundational principle of McGill University, as enunciated in our …statement of academic freedom.” The statement declares that: “The scholarly members of the university have the freedom to pursue research and artistic creation and to disseminate their results, without being constrained by political or disciplinary orthodoxies, monetary incentives or punitive measures as a result of their academic pursuits. They may exercise this freedom in the service of both the university and the wider society.”
But as her own communication attests, the faculty dean appears never to have read or thought about the stated principle as it applies to business education in particular. What do “foundational principles” imply? And if those principles are flouted what will Fortier and the McGill board of governors do? Doing nothing or mouthing platitudes signals a further decline in much-needed debates, with repercussions far beyond already weakened universities.
Reuven Brenner holds the Repap chair at McGill University’s Desautels Faculty of Management. The article draws on his testimony to Industry and Finance Canada, republished in Morgan Stanley’s Journal of Applied Corporate Finance (2010), and Force of Finance (2002)