John Shepherd

Innovation and Capital (Part Two)

By John Shepherd

The fusion of technological innovation and private capital is the key to productivity growth and to the success of the National Innovation Strategy. Unless and until there is a huge shift in capital flows into the innovating sector - bringing with it the ability to foster R&D, to attract management and technical skills and to support sustained global marketing activities - the productivity gap will persist and the innovation climate in Canada will continue to be sub-marginal. The population of Canadian innovating companies, drawn from the SME sector, must be increased by achieving ready access to start-up and expansion capital.

The problem be-devilling this fusion of capital and innovation is the poor risk/reward equation. Innovation is high cost, problematic in result and long term. Risk is inherent in innovation. At the same time risk is anathema to financial institutions. The longer the process the greater the nervousness. In Canada, there is a major disconnect between capital and innovation, because of the different perceptions of risk and reward.

RISK/REWARD & TAXATION

To resolve this dichotomy in Canada, which has no ingrained culture of technological risk, the risk/reward ratio is going to have to be changed to reduce the risk for the capital provider and to increase the reward for both provider and innovator.

In order to meet the targets of the National Innovation Strategy, we must modify the national tax system to stimulate large flows of private sector capital into innovating enterprises. Although we claim to enjoy a favourable tax environment for innovation, the hard fact is that this environment has not served its intended purpose of rapidly increasing the flow of investment funds into innovating enterprises. SR&ED tax credits may help somewhat, but they will not fill the capital gap.

A much broader tax approach is necessary, one which reduces risk and makes innovation profitable to the investor from the very start-up of the process.

FLOW-THROUGH SHARES

Let’s take a lesson from the Canadian mining industry. The creation of flow-through shares has proved to be extremely successful in this sector. Its application to innovating companies would have similar results.

Flow-through shares are 100% tax deductible investments for the private investor. An innovating company flows through its innovating costs to the purchaser of the shares, thus reducing the investor’s taxable income. The results are a huge reduction in risk to the investor and a large flow of funds into the innovating enterprise. In the mining sector more than $900 million dollars of investment have been channeled since the year 2000 into mining primarily through that mechanism, creating a powerful stimulant for Canadian mining exploration.

The stimulation proposed would revolutionize the financing of Canadian innovating enterprises, simply because it would become profitable to invest in them at and from the start-up phase. If we can finance holes in the ground we can surely support the commercialization of technology.

INNOVATION AS A CULTURE

Innovation is not just high tech and it is not just R&D. Innovation is improvement in both product and process; it is the imaginative commercialization of an idea. It is above all a culture of entrepreneurship wedded to new ways of doing things. It is the only route to closing the productivity gap in Canada.

For tax incentive purposes, therefore, the flow-through share should be available to the innovating community on as wide a basis as possible. At first approximation, innovation expenses would encompass R&D costs typically covered by the SR&ED program, as well as pre-production and sales and marketing costs over the first five years. The latter is crucial to commercialization and is typically the hardest capital to access from existing programs.

There is the concern about foregone taxes. But the current amalgam of “bit and piece funding”, while well intentioned, can never be adequately funded to drive and sustain the innovative engine that the Canadian economy requires to meet its strategic goals. These programs are little more than inadequately funded,artificial minimal stimulants.

We have to stop pushing programs and start pulling ideas into a well-funded private sector using a low risk, high reward scenario. It is fitting to note that the US as the most dynamic economy in the world has no innovation strategy, precisely because it already has an innovating culture.

Only with this total change of culture and practice will the vision of the National Innovation Strategy be realized.

John Shepherd is chairman of Gemprint Corp, a member of the Council of Science and Technology Advisors and founding chairman and current member of the Defence Science Advisory Board. He was also founder and chairman of the board of Leigh Instruments.