Growth Times

As my previous posts show, Ontario’s current hub-centric model for promoting innovation and entrepreneurship is expensive, unfair, and ineffective. The Minister of Research and Innovation should take note and explore alternative models, rather than continuing to pour taxpayer’s dollars into an expanding bureaucratic network with high fixed costs and built-in inefficiencies.

The Chamber of Commerce in Ottawa has taken notice too and is criticizing the lack of oversight of OCRI and its expansion in activities it traditionally conducted, according to an article in the Ottawa Business Journal yesterday.

To explore alternatives and fuel a discussion, I have highlighted a menu of options below. As a disclaimer, I am not a policy expert on the matter of entrepreneurship, but a practitioner, so do please consider those as draft proposals for crowdsourced discussion and improvement.

Overall, propositions fall into 2 groups: clean up and downsize the current system (lots to do on that end , to compensate for the unbridled expansion of the innovation bureaucracy in recent years), and replace it with tax refunds for commercialization investments and (possibly) loan guarantees for entrepreneurs.

Proposition 1: Let active entrepreneurs design the system

Conduct a public consultation with active entrepreneurs or, probably better, let’s put together an objective, wide-ranging group of entrepreneurs and task them with proposing changes to the system. Give the floor to a good range of start-ups and early-stage ventures.

Entrepreneurs are the true actors of commercialization, they are the only ones who ultimately take new ideas and turn them into reality. However, the system so far seems to have been designed and run with limited inputs and influence from those, and I personally noticed an assumption at hubs that entrepreneurs don’t know what they are doing when it comes to commercialization – which is far from the truth. As “clients”, they should be listened to: that’s Commercialization 101.

Proposition 2: Cut executive compensation at innovation hubs

This one is a complete no-brainer — assuming we do not suppress the positions of CEOs and executives at innovation hubs, another proposition worthy of consideration. If you want to restore trust in the public system, you need to rationalize compensation at innovation hubs, and that means slashing it at the top of the pyramids.

There is nothing in what hubs do that justify such salary levels for their CEOs and top executives. If one is going to receive a check every month with no correlation between pay and contribution to the economy, then that pay should be the minimum that’s needed to fill the position. $400K+ is by no means the minimum needed to fill up the position of CEOs at institutions with less than 100 employees like MaRS, Communitech or OCRI. This is true in this period of economic uncertainty, and it will remain true afterwards.

Proposition 3: Eliminate grants and special funds

Governments contribute more to economic growth with tax cuts than with increases in spending. It’s not me saying it, it’s Canadian CEOs, according to a recent poll in the current issue of Canadian Business.

Direct spending by the government is less effective than tax cuts for a number of reasons, primarily having to do with the government not being as careful with its money as companies and consumers. As a result, money is often handed out based on relationships rather than expected performance. That in turn distorts the market, fuels taxpayer’s resentment, and generally does not deliver the expected results.

Hubs love innovation grants and special funds. MaRS, in particular, is pushing very hard to control those, because it has understood that they constitute the key source of discretionary power. As a local entrepreneur emailed me: “Whenever there is government pot of money involved, you get a bun fight and everyone trying to control the supply of buns.” And as the end result, only a small portion of the buns actually reaches the intended recipient.

MaRS apparently took full control of the Investment Accelerator Fund this month. Of course, that calls for hiring more people, so on April 20 they issued this job ad for an Investment Accelerator Fund (IAF) Coordinator, just to help the “IAF Managing Director and Investment Team”. Only entrepreneurs “already engaged with program Entrepreneurs-in-Residence (EIR) or MaRS Advisors to access specialized advisory services” qualify. Since you need to be selected to work with those, paying lip service to the institution is not optional. In business I believe that would be called Tying, also known as Forced Bundling, and it is illegal. Not to mention Dumping of services, too.

Grants and any selective attribution of money are the source of too many evils – they should only be considered a last resort to help entrepreneurs. With little transparency and many potential conflicts of interest, this is a scandal waiting to happen. As entrepreneur Stephen van Egmond commented in part 3 of this series, it is hard not to think of the Canadian eHealth fiasco. So I say let’s be smart and preempt it before we waste more millions: eliminate all grants and special funds all together. Good riddance.

Proposition 4: Eliminate consulting services delivered by public advisors

I developed this point in the previous posts, so I’ll summarize it here: the direct delivery of strategy and marketing services by public advisors is not efficient due to a lack of performance management “by design”; it also distorts the market and hurts the creation of a viable ecosystem of private providers; and finally, it leads to conflicts of interest when coupled with grants and programs.

Moreover, hub advisors paid by the taxpayer should not be allowed to maintain their own private companies on the side, a rule that is already enforced for any government employee. Assuming consulting services are still provided by the hub in spite of the recommendation not to, then there should be fair and competitive procurement policies and only private providers with no work association to the hub should be allowed to bid. Decisions should be fully documented. The people who are hired to make those decisions should come from diverse backgrounds (including minorities – see part 2), and should be tied by strict rules and independent oversight.

In any case, public hubs should focus on what a hub normally does: connecting and educating large number of entrepreneurs (assuming chambers of commerce and universities don’t do it). Not catering to the interests of a few select ones. The private sector does that better.

Proposition 5: Eliminate public incubators

I also talked about this before. In a nutshell: public incubators like the ones ran by MaRS and Communitech are not needed. They compete with viable commercial space and private incubators. Cancel the incubators program and sell the buildings to the private sector. Then use the money to feed tax refunds for entrepreneurs.

Companies primarily rent offices at those public incubators because of the proximity to public subsidies. The “chance encounters” and “creation of a global address” arguments are based on little more than hot-air theories with no fact to back them up. They do not justify multimillion-dollar investments. If I want chance encounters, I can easily go to one of the gazillion events organized by the entrepreneurship communities in those areas.

The hubs actually built those incubators to create endowments equivalent to a perpetual public subsidy. With 80% of the MaRS budget after real estate costs going to salaries, this subsidy is mostly used to add more bureaucrats. Few taxpayers I know would agree with that.

Note that with the extension of SR&ED to commercialization activities (as proposed below), private incubators and commercial office space would be indirectly subsidized, and they would still have to compete for that money with other commercialization activities. That’s a much healthier, market-based way to support entrepreneurs than creating public incubators.

Proposition 6: Require public reporting of all grant decisions and results, with independent third-party oversight

There should be detailed public reporting of the money given to hubs, and of the results delivered: not just on activity and effort (“we helped x companies” and “had x appointments”), or results that might have happened anyway, but on actual “performance improvement”.

This is notoriously difficult to measure, but there is an excellent proxy: the willingness of entrepreneurs to pay for your services at market prices (and without bundling those services with grants!). Hubs should drink their own medicine on commercialization and charge market prices for their advisors. Being in that business, I predict they would fail to cover even 20% of their disproportionate cost base. Only lean cats survive in the wild.

Assuming we don’t get rid of hub advisory services and grants all together (a shame), there are some alternatives, although mediocre:

• Require full disclosure of all program decisions: who applied for grants, who got selected, who completed the selection, and the rationale for the decision.
• Have a (truly) independent third party, paid by an independent body, conduct random, anonymous survey of client satisfaction. To that end, the audience should be defined as any start-up in the area of service, and not just companies that contacted the institution or were selected as a client.
• Have a third-party auditor also conduct random sampling of results for the recipients of those grants.
• Enforce a strict separation between the attribution of grants and the advisory services. Short of that, entrepreneurs will fear for their grant (as they do now) and not disclose their true evaluation of the services.

Note all of this adds to the red tape and costs to the taxpayer though, and since those advisory services and grants have terrible ROI by design, the best option remains scrapping them.

Proposition 7: Require annual reports, financial statements, and full disclosure of all public salaries above $100K

Right now it seems that hubs like Communitech and OCRI escape any form of salary disclosure, even though they received large provincial grants. It’s also unclear whether the disclosed salaries for MaRS include all compensation. According to information I could not verify, the CEO’s annual compensation might be closer to $700K after bonuses. In any case, this all points to potential loopholes in the sunshine disclosure.

Requiring disclosure of all financials and salaries above $100K for institutions receiving public money (be it municipal, provincial or federal) would extend much beyond hubs and would be useful in adding some transparency to the public sector as a whole. This disclosure should include all of the money received, and offer detailed breakdowns.

Proposition 8: Drop the Ontario Network of Excellence initiative

The Ontario Network of Excellence (ONE) has been designed to be a MaRS-led province wide network that will affect every organization that supports entrepreneurs in Ontario. Organizations that submitted expressions of interests to ONE are being asked to prepare their business plans now.

The “access to expertise just around the block” – as mentioned on the page I referenced above – clearly points to a frightening expansion of this bureaucracy, with little in it for entrepreneurs. With the internet, I believe we’ve always had access to (actual) expertise, and we don’t even need to go “around the block”. This looks like more red tape and the fact that a large component of it will be coordinated by MaRS means they will apply their own “worst practices” to the whole network, i.e. no transparency and deficient result report.

Trimming down bureaucracies has always been a great way to fuel innovation, so let’s cancel that initiative.

Those 8 propositions is what it would take to clean up the current system. Having done that, we could move to provide actual support to actual entrepreneurs!

Proposition 9: Refund commercialization expenses through the tax system

I believe the most productive approach to channeling public resources towards entrepreneurs would be to extend the successful SR&ED tax refund to commercialization activities.

First, tax incentives are much fairer because they involve clear attribution rules, with much less room for subjective decisions. A startup in Huntsville would have the same “chances” of getting that money as one hosted in the MaRS incubator. The decision would not rely on whether you pay lip service to hub bureaucrats, and those bureaucrats would not need to be entrusted with picking winners – let’s leave that to venture capitalists.

Second, tax incentives are more efficient, because they feed less red tape: tax auditors conduct random controls, that’s it. That means bureaucrats take a smaller cut. The money goes directly to entrepreneurs, who get to decide independently how to invest it.

How would that work in practice?

Right now, SR&ED offers great tax credits of 35% up to $3M and 20% after that for R&D investments (broadly defined to cover most product development with some level of technological risk). It is controlled by Canada Revenue, anyone can claim the credits (with detailed documentation that makes fraud difficult), and even solo entrepreneurs can give themselves a salary and claim it to receive 35% of it back. My suggestion would be to simply extend that to commercialization activities for start-ups and early-stage ventures.

The key challenge would be to find the right selection criteria to restrict it to true innovation plays, but even that should not be a big problem. In fact, it would feed an interesting debate: what type of innovation, as a society, do we want to encourage? Is it just technological innovation? Not my pick, but you could do that by restricting the commercialization tax refund to SR&ED recipients, or to startups with patents. On the other end of the spectrum, it could even be extended outside technological innovation: after all, as Peter Drucker said, there are many sources of innovation, and I’d argue that a lot of it today takes place in business models and packaging existing technologies rather than from lab technologies. Think iPad and even Blackberry (or, to go farther in time, the banking system, which created lots of value even though it was not technological in nature).

Note there is already a program called the Ontario Tax Exemption for Commercialization (more details on OTEC here), however it provides a ten year tax exemption for new corporations that commercialize intellectual property that is developed by qualifying Canadian universities or colleges. Two problems: the tax exemption is of little use to startups in their pre-revenue years, and the requirement that the IP be developed at universities or colleges makes it very restrictive. So I think an extension of SR&ED would be easier.

But the acronym doesn’t really matter as long as entrepreneurs are in charge of their commercialization spend and the government refunds part of that to compensate for the higher risk in starting new ventures.

Proposition 10: Extend the Canadian Small Business Financing Loan Program

This idea was put forward by Ian Graham of the Code Factory in Ottawa (thanks Ian), who foresees a challenge with tax refunds: an entrepreneur needs to spend money to get the credits back, so a kickstart would be great. With the Canadian Small Business Financing Loan (CSBFL), the government guarantees 75% of a loan and the entrepreneur 25%, working with the banks to do this.

The problem with CSBFL today is that it is only for capital expenses, which are used as collateral for the loan. A similar program for operating capital (salaries and opex) would be ideal.

I see risks of fraud if there is no tangible collateral for the loan, and I tend to think that entrepreneurs should find a bit of money to pay themselves before starting. However, assuming that the risk is addressed in the design of the program, it would indeed be a useful program that could get lots of entrepreneurs started.

Proposition 11: Make it more attractive for both Canadian and foreign private investors to invest in Canadian early-stage ventures

In the footstep of recent successes to lobby the federal government for the modification of section 116, which removed some bureaucratic obstacles to foreign investments in Canadian start-ups, we must continue to make it more attractive for foreign angels and VCs to invest here.

The proposed extension of SR&ED to commercialization activities would go a long way in making such investments more attractive. Other measures should be explored to reduce red tape and optimize incentives (through the tax system).

In parallel, we should also explore the successes of other regions, such as the Silicon Valley or Israel.

Proposition 12: Engineer an “Own the Podium” culture, again

Canada has a great immigration policy, a solid engineering base and long winters to keep us all working. It also has universal healthcare. This is great for entrepreneurs.

We have the key ingredients to create a real culture of entrepreneurship, to make local champions like RIM less of an exception and more like the norm. What’s missing is self-confidence and entrepreneurship-friendly policies.

We need to trust that Canadians can own the Podium, that they can win without social assistance. We need to accept failure and frown upon inaction. We need to stop wasting time applying for grants. The Silicon Valley wasn’t built on grants, it was built by attracting the best talent, the best companies, and setting up an environment in which they could freely use their skills, try things out, and try again until it worked.

We also need rules that are designed by entrepreneurs, not by bureaucrats. I’ll give you a tiny example, one that affects me personally: stock options are taxed differently for contractors and employees. And SR&ED does not refund money spent on contractors. Yet the best mode of delivery of my services is as a contractor, not as an employee. Now because of this, it is difficult to offer stock options payment to my clients, or leverage SR&ED when I get involved in product development work. Take many rules like that, put them together, and you have the basis for a system that is not as friendly to entrepreneurs as it could be.

So we are back to proposition 1:  the government should crowdsource its innovation policy-making to active entrepreneurs. An entrepreneur would not have given MaRS $130M to buy buildings and create a bureaucracy of smoke and mirrors.

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Canadian entrepreneurs bmep, communitech, ilse treurnicht, innovation policy, irap, mars advisors, mars discovery district, oceta, OCRI, Ontario Network of Excellence, public accountability, public support, ric, sr&ed, venture capital

In the first two installments of this blog series, I looked into the massive salary of MaRS Discovery District’s CEO, the vast deficit in public reporting in spite of over $130M in public subsidies, the lack of performance management, the systemically poor results and low ROI, the lack of transparency of grant decisions and the reliance on intimidation and ostracization to silence critics.

Yesterday I published a companion post with extracts from the feedback  I received so far, the importance of whistleblowing in a healthy democracy, and the direct impact those who get more than their fair share (like the CEO of MaRS) should know they have on others, like entrepreneurs  who have to work another full-time job to make ends meet.

Now I will take a look into the claims by MaRS that it constitutes a “public-private partnership”, and its expansion into the realm of private services.

But first, the 2009 salaries of MaRS employees were just published as part of the latest provincial disclosure, so below is a screenshot. The CEO made $436K in 2009, and MaRS continues to use public funding to add positions compensated over $100K – there are now 16 (out of 42 employees in 2008 – staff numbers for 2009 have not been disclosed yet):

MaRS salaries above $100K in 2009

What public-private partnership?

On its website, MaRS claims that a “combination of private and public funding allows MaRS—a charitable organization—to offer these services.” While MaRS spins its communication to imply that private donors generously contribute to the budget, and thus that taxpayers’ dollars acted as a catalyst, the reality is very different. Almost all of the revenue (over 90% in 2008) comes from government grants and rental / meeting room income from buildings purchased with public dollars.

If you think much private capital went into MaRS, think again. In an interesting 2006 Powerpoint presentation by the hub, the numbers already showed that only $16M came from private sector donations – while government subsidies amounted to $79M. There were loans too, but those qualify as much as private “investments” as the money credit card companies lend us every month. Overall, a far cry from the catalyst effect we were sold on.

From a planned $79M, the subsidies actually reached $130M by 2008. But the private contributions did not increase – the sure sign of a good public-private partnership. I would also be curious to learn what the private donors got in return for their money. Private companies do not tend to give away money for nothing.

Tell me again, why do we need a taxpayer-funded incubator, when there is plenty of office and private incubator space in the city?

I met MaRS CEO Ilse Treurnicht once in 2007 as I was seeking support for TagOver, a web startup I was working on at the time (an app to replace folders with linkable tags – a technology Gmail recently introduced). I think she was looking to hire people for MaRS, and I was looking to get some help with my venture. The discussion, although courteous, ended quickly given that my little operation was of no interest to her.

See, Ilse was busy presenting MaRS as a public-private partnership to the public. Take a look at this 2008 video (or its transcript). In it, the CEO pulls all the stops to introduce MaRS as a trendy catalyst of private investment.  She talks about “the unique public-private partnership nature of MaRS’ (2:26 in the video), and then in even more epic ways at minute 5:40. The key argument supporting this partnership model was phase II of the MaRS center, which was to be built by a private U.S. developer.

While phase 2, unlike phase 1, might have been a partnership of sort, the developer pulled out of the project during the crisis (see David Crow’s write-up at the time).

But now that the crisis is apparently behind us, it is likely that there is appetite from MaRS to resume the plans, if they haven’t yet proceeded with that. I suspect that the government might be asked again to contribute. After all, the provincial authorities gave Waterloo-based Communitech $26.4m last year for the creation of a “Digital Media & Mobile Accelerator” (a $107-million project, with the rest coming primarily from other levels of government and “some private sponsors”). It looks like the bureaucrats think the main problem of start-ups is to find offices, and that private incubators don’t cut it – so why not take advantage of that flawed belief while it lasts?

Which leads to the real question here: why is a non-profit organization like MaRS in the business of hosting companies using taxpayer’s money, when there are plenty of private office buildings and incubators in the city? And when so many in the entrepreneurship community don’t think it is a good idea (I’d love to call for an independent professional survey here). The extravagant building of the hub goes against the very essence of entrepreneurship and all the advice about bootstrapping. Do you picture Steve Jobs starting Apple from those buildings?

MaRS charges high rates for booking meeting rooms and hosting companies, and one key reason clients go along with it is preferred access to public money and connections (remember the very reason the U.S. selected Washington D.C. as their capital city was to distance it from the business interests in N.Y. and Boston). The claims of creating a “global address” as MaRS puts it is highly debatable. Most people in Toronto don’t know what MaRS is, let alone people internationally. If we spend those millions for awareness, then it’s not clear that it worked – we could achieve better results with much less money. VCs and investors I know also tend not to look at delegations led by a public-sector institution as a sign of dynamism.

The bottom line: our taxes should not help create bureaucracies that replace a more efficient private sector.

It’s not just real estate

MaRS, a non-profit organization, and the other hubs in the region increasingly offer private-sector services like business planning,  sales and marketing, financing and funding strategy, human resources, financial management, product development and marketing, customer relationship management, strategic partnerships. Now, I may be biased, since many of those are services I offer through my private practice, but I think my experience both as a private provider who also saw MaRS “in action” (or inaction) – and has to be deliberately retained by clients based on performance -  is relevant.

Currently, consultants or contractors in strategy and marketing are seen as “generally not as effective in dealing with the needs of emerging companies as people with more specific background”, as I was told last year by the head of the Market Readiness Program, in spite of the projects I was referred and complimented for by MaRS advisors (and a specific background of dealing with the needs of emerging companies!)… Yet the publicly-funded institution has no problem partnering closely with lawyers and accountant, even co-organizing events with selected private practices like Deloitte and Ogilvy Renault, and welcoming several as tenants in the MaRS building, so it looks like a clear case of rejecting competitors to the hub – and to the private practices that multiple advisors support or run on the side.

But, if the private sector is that efficient, why can’t it simply out-market the non-profit institution? We often do, actually. But it’s hard to beat free. Free creates a culture of free – entrepreneurs who received free help from hubs are not only less prone to paying for commercialization services, but they also end up more suspicious of the added value, since the institution frequently falls far short of the expectations.

MaRS’s selective give-away advisory services disrupt the marketplace, harm a perfectly viable private sector and prevent the creation of a viable, sustainable ecosystem for start-ups and early-stage ventures. With the right tax policy and less red tape (congratulations to the Federal government for repelling section 116), I’d argue that the private sector is best equipped to provide commercialization support.

After all, the essence of commercialization is about making people pay for a solution to their need: if hubs can’t do that for themselves, they should not be in the business of teaching it to others.

We don’t need no start-up bureaucracy – give the money to start-ups instead

Start-up evangelist David Crow pointed out the expansion of those public hubs in this post. There is now a myriad of agencies each with their own “advisors” and “entrepreneurs-in-residence”, competing for power and funds, and increasingly venturing into activities that are perfectly viable for the private sector.  The expansion of those bureaucracies seems insatiable (MaRS alone added another 10 positions in 2008) and anyone in that space knows that there is a clear power struggle at play, along the attempted institutionalization of commercialization activities.

What’s clear is that MaRS so far has been little more than a public play. It operates an incubator using public money and competes with perfectly viable private interests. It does not have the private sector efficiencies and built-in performance management. It would fit right in Dubai but does not get us closer to a Silicon Valley.

We all agree that a public “oasis” acting like a forum and meeting space for entrepreneurs downtown is a good idea. But taxpayers in Toronto pay $50 each for this oasis, now taken over by a group that by all account is using these resources to further their own interests. As a Toronto venture capitalist recently told me: “this is a honey pot, and parasites are going to take advantage of it until the last drop.”

There are other hubs running mostly with volunteer professionals as advisors, and the help they provide is not subpar compared to MaRS with its highly-paid professional staff. Their ROI is likely much higher. With the rise of commercial hubs based on the Y-incubator model and the growing number of highly-experienced commercialization consultants with a clear incentive to perform, there is no need for public advisors, and with the money we save from their salaries we could help many startups. So give the money to start-up founders instead – and through tax breaks.

We could also make use of an organization with the clout to represent entrepreneurs’ interests in the political arena, but MaRS isn’t even well equipped for that, since it is paid for by the government. That’s something professional associations are best equipped to do, as NACO and CVCA have recently shown.

Even if the hubs’ generic advice and select grants help some start-ups, overall it distorts the playing field and hurts our attempt to create a self-standing, sustainable innovation economy based on sound market principles. Overall, the MaRS model costs too much and does not work.

In my final post, I will make suggestions on how to improve public support to entrepreneurs in Ontario.

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• Background Note on Whistleblowing (in Context of the Series on MaRS Discovery District) (growthtimes.com)
• Troubling Facts about MaRS Discovery District (Part 1 of 4) (growthtimes.com)

Canadian entrepreneurs commercialization, entrepreneurship, incubators, mars discovery district, marsdd, Ontario, performance management, public accountability, public policy, public-private partnerships, toronto