Introduction
For many Canadians, the COVID-19 pandemic represented a brutal start to the 2020s. Lives were forever altered, numerous companies collapsed, and the financial markets were in disarray. Remarkably, in this rather depressing economic state, Canada’s tech ecosystem reached its pinnacle. Dubbed the “Canadian Tech Boom”, 2021 was a record-breaking year in which venture capital investments were at an all-time high; tech giants, like Microsoft, expanded their Canadian presence, and new talent stayed local due to the restrictions limiting travel.
However, as the pandemic subsided and restrictions were lifted, the tech heyday fizzled out. It became glaringly clear that the flaws impairing this country’s tech industry resurfaced. The U.S. alternative proving once again why it is the mecca for success and growth in technology, as Canada continues to struggle with the lure of Silicon Valley poaching its STEM graduates, local startups looking to investors down south, and innovation thriving in the U.S. tech industry as Canada’s lags behind in R&D investments.
Nevertheless, this period of distinctive success proved that the country has the potential to be a dominant technology hub. Lamentably, the fact remains that in this post-COVID environment, Canada’s startup and technology ecosystem remains fractured and the country’s venture capital presence, founders, and new graduates are spilling through the cracks into the United States. If these realities are not sufficiently addressed, Canada risks losing a significant portion of its future position as a global leader in technology.
The article hopes to promote potential avenues in which the country can effectively grow its technology industry and address harmful insufficiencies in order to strengthen Canada’s position on the global stage while maintaining the characteristics that make the industry uniquely Canadian. These avenues include bolstering investment in R&D, collaborative action by Canadian universities and companies to invest in their talent and research, and addressing how local VC investors may play an active role in boosting the Canadian technology environment despite the risk aversion plaguing the asset class.
Bolstering investment in R&D
Research and development (R&D) is a critical driver of future economic prosperity as it stimulates growth through innovation, invention, and progress. Investment in R&D can result in breakthroughs that drive profits for companies and the well-being of consumers.
A study released in June from Boston Consulting Group’s Centre for Canada’s Future found that Canada ranked second to last on total R&D spending per capita among its international peers. According to the data, Canadian R&D spending per capita averaged US$700, with 52% of spending coming from business activity, while the remainder came from government or higher education. In comparison, the United States hit US$2,000 in R&D investment per capita, with 75% of spending coming from business activity, while the minority came from public institutions.
This has proven to be a trend as in 2021, U.S. firms spent almost 103x more than Canadian firms on R&D, with a total of $529 billion compared to Canada’s $5.2 billion, despite U.S. GDP only being 11.7x greater than Canada’s. Unfortunately, Canada’s science and technology organizational structure is severely outdated as it operates nearly exactly as it has since the 1950s. Over several decades, Canada’s economic policy objectives have remained vague, focusing mainly on the politics of “job creation.” The country’s capacity to take on research at scale is insubstantial, still relying heavily upon incremental innovation and safe bets. Realistically, Canada surpasses the majority of international competition in terms of public institutions disbursing experimental ideas to the marketplace. Yet, this is inconsequential as low business investment in R&D has resulted in low business demand for these ideas.
In order to establish its presence as a dominant tech hub, Canada must work diligently to institutionalize technology transfers from public R&D to industry. The country should consider the United States and its Defense Advanced Research Projects Agency (DARPA) as a model for transformative technologies that could be applied to complement the Canadian landscape. DARPA’s extensive resume is undeniable, consisting of generational innovations such as the internet, RISC, global positioning satellites, drones, etc. The DARPA model does not simply focus on early-stage idea generation and activation. Rather, it breaks down its role as follows: (1) catalyzing breakthroughs and (2) assisting them through the innovation process. Similarly, in the Netherlands, TNO, the country’s national applied research organization, provides significant contributions to the Dutch growth strategy by developing and transferring technologies that help companies boost their productivity and retain their license to operate.
Overall, rational companies will turn away from investing in breakthrough technologies, despite the rewards, if it involves high levels of risk and uncertain R&D timeframes. In turn, this requires governments to take a more hands-on approach. As briefly touched upon above, the internet, GPS, and touch screen are the direct results of partnerships formed between the public and private sectors in other countries to solve a problem. Canada’s technology industry would benefit from implementing this similar model within future and current organizations (i.e., Canadian Innovation Corporation) that would focus largely upon “use-driven” research directed at resolving practical issues utilizing breakthrough technologies which, in turn, also solves the market failure and cracks in Canada’s innovation ecosystem.
Universities need to incentivize companies to invest in their talent and research
The "Cali or Bust" mentality among Canadian STEM students, where many want to pursue opportunities in Silicon Valley as opposed to staying in Canada, is a concerning trend that reflects the challenges in Canada's science and tech ecosystem. According to Global Mail, Canada has been the worst-performing advanced economy in the Organization for Economic Co-operation and Development since 1976, with a significant brain drain of highly skilled tech workers heading to the U.S. annually, indicating a broken research and innovation ecosystem.
Currently, Canada is experiencing a loss of two-thirds of recent software engineering graduates and a third of computer engineering and computer science graduates to the United States. To combat this trend, Canada can look to successful models, such as Samsung's collaboration with South Korean universities. Samsung's partnerships involve a comprehensive five-year program that integrates graduate and undergraduate students, providing them with industry-specific academic training and internship opportunities in the semiconductor space. This collaborative approach fosters a direct link between academia and industry, nurturing talent and preventing the brain drain that Canada is currently experiencing.
To counter this trend, universities must incentivize companies to invest in talent and research, by creating incentives such as increasing salaries, enhancing co-op placements with Canadian firms, and boosting government funding for research and development. By enhancing funding through programs like the federal government's Research Support Fund, universities can play a significant role in bridging the gap between research and industry, ultimately stabilizing Canada's position in the global technology landscape. This attracts Canadian students while making these institutions competitive on a global scale. When students have opportunities to participate in cutting-edge research projects, they are more likely to stay local to be part of these initiatives.
Without urgent measures to stabilize the technological skilled-labor market, Canada risks losing its technological future to global competitors.
To ensure that the government and universities receive a return on their investment in the innovation ecosystem, several strategies can be considered:
Public-Private Partnerships (PPP):
Governments can encourage collaboration between public institutions, such as universities, and private companies through PPPs. These partnerships can involve joint funding for research projects, shared resources, and a commitment to leverage outcomes for mutual benefit. This allows students to engage in collaborative industry-related projects with companies locally rather than seeking these opportunities abroad.
Skills Development and Talent Retention:
By investing in educational programs that align with industry needs, universities can contribute to the development of a skilled workforce. This not only addresses the talent drain issue but also ensures that graduates are well-equipped to contribute meaningfully to the workforce, making them attractive to Canadian companies. A skilled workforce attracts businesses, leading to economic growth, increased tax revenue, and reduced unemployment, resulting in a positive economic impact for the Canadian government.
Global Competitiveness:
Governments can position their investments as strategies to enhance the country's global competitiveness. If governments invest in new Canadian graduates, it would contribute to the country's reputation as a problem solver, attracting partnerships, and opening opportunities for economic growth. A thriving research and innovation ecosystem can lead to the development of cutting-edge technologies and solutions to future problems.
The role Canadian VCs need to undertake
Gone are the days of the investor “FOMO” that ran rampant when VC funding hit its peak in 2021; venture capitalists are now far more comfortable sitting on the sidelines. This strong inclination towards risk aversion is the result of multiple factors, such as rising interest rates, public market valuations restricting VC-backed exits through IPOs, and more. This has contributed to venture being the sole private investment strategy that produced a negative one-year return on a global scale. The distinctiveness of this outcome is substantiated by venture having topped the global charts within private investment strategies for three and five-year returns, and ranked second behind only private equity for ten-year returns. From a positive angle, this establishes that VC has a storied history of behaving as a pivotal driver of economic growth and progress in countries across the world, Canada undeniably included.
Nonetheless, the recent international trends plaguing the industry have been blatantly apparent within the country. This is clearly depicted in the first half of 2023, in which VC disbursements to Canadian companies amounted to ~$3 billion, representing a roughly 60% decrease from that same period in 2022. Yet, while the lack of funding is unquestionably concerning, this is plausibly not a pressing long-term issue. In fact, an argument can easily be made that the following current market conditions make a rather convincing argument for continuing to invest in Canadian technology startups:
1. Valuation multiples have considerably decreased, causing entry multiples to decrease. This regression helps investors enhance confidence regarding a company’s ability to exit at similar valuation levels, thus setting less risk upon the exit-multiple.
2. Pursuing profitability has become the main priority for tech companies, as the lack of funding discourages them from operating in “cash burn mode”. Ultimately, producing fundamentally sustainable and reliable businesses for investors to diligence.
Regardless, it appears that international investors are far more intrigued by these investing conditions than their Canadian counterparts. In H1 2023, U.S. VC firms provided the majority of the ~$3 billion in funding, accounting for 44% ($1.43 billion) of total VC investments. International investors, outside of North America, totaled 16% of investments and the remaining 40% was provided by Canadian investors. These results have extended from 2021 in which 72% of investments in Canadian firms were made by foreign investors, with 56% coming from the U.S. alone. To the country’s benefit, the diversification in the regional source of capital in Canada shows increasing international recognition of the competitiveness of Canadian startups and the attractiveness of the local venture capital asset class.
However, these statistics also raise valid concerns regarding the probability of keeping Canadian startups local in order to continue reaping the economic benefits that come with their exits and continued success. When analyzing Canada’s tech heyday, of approximately 400 VC-backed companies involved in M&A between January 2019 and February 2021, over half were acquired by foreign investors. Of those that stayed local after being taken over, 71% had a majority of original Canadian investors, suggesting that a greater share of domestic owners is a decent predictor that a company’s post-takeover owners will also be Canadian. Overall, this illustrates the need for Canadian investors to be active and majority investors in our local startups, as their participation bolsters economic progress and the tech landscape from the early-stage startup to exit.
Conclusion
Canada’s technology ecosystem suffers from a number of critical flaws that are creating opportunities for international competitors to swoop in and extract startups, emerging talent, and the significance of local venture capital investors. Paired alongside a dreary macroeconomic environment that overshadows the country’s strengths, the days of the “Canadian Tech Boom” could not seem further away. However, this sentiment does not negate from the fact that the country’s technology industry is brimming with potential. From world-class universities to a storied history of successful local startups and technology investments, Canada has the ability to right the ship and cement itself as a top technology destination. The many statistics that afflict the prosperity of the country’s tech sector are clear and the individual industry and institutional roles that can be enacted have been outlined. The overarching theme is that these varying groups will not maximize innovation and success if they work in isolation. Canadian suppliers, customers, investors, universities, research and government institutions need to band together to mend the fractures within the country’s technology industry.
