Free market an ‘illusion’ in world of innovation

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By Peter van der Velden, Special to Financial Post  
Governments around the world, including those in Canada, have been offering funds and tax incentives to spur innovation, but is it enough?  
Being one of the world’s great resource rich nations is both a blessing and a curse with respect to Canada’s innovation agenda. We weathered the recession of 2008 far better than most developed nations but unfortunately that success and the vast amounts of wealth generated by exploiting Canada’s natural resources has often made it far too easy to neglect the need to focus on creating a next generation, knowledge-based economy in this country.  
The rationale for nurturing the environmental, medical and information technology sectors is at its most basic level reinforced by the simple realization that our capacity to learn, create and innovate is limitless, while our natural resources are not.  
Given the nature of global competition in the innovation sector it is clear that from China to Brazil and from the European Union to the U.S. that the “free market process,” at least at it relates to innovation, is simply an illusion. Virtually every major economy in the world has recognized the role venture capital plays in fostering innovation-centric growth, and has enacted policies to cultivate investment in these businesses with the goal of building high-growth, globally competitive businesses that create high-value, knowledge-based jobs at home. The approaches may be different (direct investment, direct subsidies, favourable tax policy, targeted procurement policies, grants for fundamental science and research) but the goals are the same.  
Virtually every major economy in the world has recognized the role venture capital plays in fostering innovation-centric growth. As a result, in order to compete and succeed at home, our government must remain fully engaged, recognize the global nature of the innovation economy, and use all the tools at its disposal to ensure that the innovation fields are cultivated and ready for planting, growing and harvesting. This means continuing to fund basic academic science, supporting research establishments like the SDTC, ensuring that post-secondary education thrives, facilitating high value immigration (Startup Visa is a great example), and continuing to build on successful programs like the SR&ED tax credit and IRAP.  
It also means doing more. It means engaging in procurement policies that favour domestic innovation and that provide Canadian companies with validating first orders and customer interactions. It means streamlining and organizing our regulatory agencies, like the Health Protection Branch, so that they are not followers, but rather leaders in approving medicines and tools that will enhance patient outcomes and lower the total cost of healthcare. It also means using policy tools to affect the funding equation when domestic funding for innovation is not synchronized with market needs and global realities.  
During the past six years, we have seen provincial governments across Canada come to understand the competitive nature of venture capital financing. This has resulted in many jurisdictions implementing thoughtful, private sector-based solutions that have increased the amount of capital available. These provincial funds, in parallel with the Business Development Bank of Canada, have reinvigorated venture capital investing in Canada. In 2012, these efforts resulted in six-year highs for both new capital formation ($1.8 billion with the vast majority in private independent funds) and investments in Canadian companies ($1.5 billion for 395 companies).  
The venture restart is great news, to be sure, but the sector still lacks meaningful engagement from large, sustainable sources of capital such as domestic pension funds and insurance companies. Fortunately, the federal government has recognized this need and is looking to address it as part of its Venture Capital Action Plan. The one true cloud on the venture funding side results from proposed changes in the 2013 federal budget which would eliminate the federal incentives for labour-sponsored venture capital corporations (LSVCCs). Given the substantial investments by LSVCCs in under-serviced regions of the country, and their emergence during the past six years as one of the few truly stable, committed, long-term sources of capital for private independent venture funds across the country (approximately $900 million) these changes appear to pose a real threat to the venture capital ecosystem. It is vitally important the government continues to work closely with stakeholders to find a mutually acceptable solution that aligns with its objectives of building a next generation economy.  
Canadian companies are thinking big and competing globally, and the innovation system is meaningfully deeper and wider today that it was 10 years ago. In addition to the re-emergence of the venture funding ecosystem, it is also important to note the broadening and increased capacity of the rest of the funding continuum. At the earliest stage we have seen tremendous growth in publicly and privately sponsored accelerators and incubators (more than 40 by the Canadian Venture Capital Association’s last count). These initiatives build on the experience and networks that exist within our broader Canadian ecosystem and many graduates of these programs are in turn attracting significant financing from U.S. and Canadian VCs. But what happens to the rest? Some (perhaps even many) will fail, either because there wasn’t sufficient follow-on capital or because the idea or business simply wasn’t competitive. Regardless, failure is also an important part of a healthy ecosystem, provided that it allows the lessons learned to be leveraged by the entrepreneurs for their next startup.  
Angel and family office investing has always been an important part of the funding continuum in Canada and while still small relative to U.S. investment levels it has certainly become more sophisticated and organized. As a result, successful entrepreneurs are returning to the ecosystem as funders and equally importantly as mentors. Government programs have certainly helped form some of the organized angel organizations, but more enablement is needed, potentially in the form of continued tax reform that incent and reward investment in private, innovation-centric businesses.  
The reality we face in 2013 is that much has improved, but more work must still be done. Venture returns are improving, Canadian VC funds more than picked up the slack when U.S. investment in Canada slowed in 2012, innovative Canadian companies are thinking big and competing globally, and the innovation system is meaningfully deeper and wider today that it was 10 years ago. In fact, six of the 25 largest venture capital financings in North America in 2012 were for Canadian-based companies and five of these financings were led by domestic firms. We are certainly on the right path, but long-term success will require all pieces of the innovation-funding puzzle to be aligned and working together in a synchronized fashion.  
Peter van der Velden is the president of the Canadian Venture Capital and Private Equity Association and the managing general partner at life science and healthcare venture capital investment firm, Lumira Capital.