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October 27, 2011

Jumping the innovation gap: Breathing life into life science startups

Innovation_Gapby Paul Krzyzanowski

Canada was built upon the inventiveness and resourcefulness of people who lived here. Why then, have Canadians long heard and read about being second best, sellouts, and in general not that great? Thinking we aren’t competitive has almost become a national mantra. But it’s more than a state of mind: the innovation gap has a $9,500 per year impact (as compared to the United States) on our standard of living.

In the last two weeks, two reports on Canadian innovation were released. Both were critical of Canadian capacity for research and inventiveness, and both suggested ways Canada could come out on top when it comes to competing with the best worldwide. The reports warrant some scrutiny, particularly with respect to a fledgling industry such as biotech.

The University of Toronto’s School of Public Policy & Governance released Canada’s Innovation Underperformance: Whose Policy Problem Is It, a report that examines the federal government’s current system of innovation support. Tijs Creutzberg, a public policy lawyer specializing in research innovation, suggests that the current system of Scientific Research and Experimental Development (SR&ED, pronounced ‘shred’) credits is not as effective as it could be. Creutzberg points out that it’s an expensive program, with the write-offs costing Canada $4.7 billion annually in lost tax revenue. Compare that with the CIHR’s expenditures which run around $1 billion, or with the $1.8 billion that Genome Canada has spent in the last decade.

Shortly thereafter, another report released by the Institute for Research on Public Policy emphasized the need for increased competition amongst industries in Canada. Tom Jenkins, the outspoken chairman of Open Text, argued that Canadian firms suffer from poor innovation due to limits on competition (and therefore innovation) in key “enabling sectors” of the economy, like telecommunications, banking, and transportation. Simply put, inferior services by companies in these sectors act as a headwind against entrepreneurs and can even dissuade Canadian companies from becoming multinational yet retain head offices here. Hence, the lack of a Canadian equivalent of Roche, Genentech, or Qiagen.

The press responses to Canada’s Innovation Underperformance were variable, ranging from a muted wait and see what happens response to a vociferous defense of the SR&ED program. Now a little over a week later, it’s become clear the federal government will give the R&D tax system a critical look.

Supporters of government targeting specific research activity point to the ineffectiveness of the SR&ED program to identify research efforts above a critical level. As Barry McKenna wrote in the Globe & Mail, “Ottawa wants to build world-beating companies, but it’s giving away millions [of dollars] to $10,000 R&D projects. That’s less than two months’ salary for one engineer.”

What impact, if any, does this have on biotech and regenerative medicine startups?

Dr. Michael May, CEO of the Centre for the Commercialization of Regenerative Medicine (CCRM), emphasizes the difficulty for any group to pick successful companies or sectors in advance. Venture capitalists, for instance, have a hard enough time choosing promising companies despite having extensive business experience: “Remember that only one in ten VC-funded startups usually succeed.” 

The success of a government body in selecting winning companies to fund would likely be even lower.

“We really do need winners to rally around in the biotechnology and regenerative medicine sectors,” said May, “but I’d rather see incentives in place for entrepreneurs, businesses, and investors to put their own funds into play.”

One major challenge with any startup company is to address the lack of funds after initial formation and the first infusion of venture capital: the so-called “valley of death.” “Canadian startups suffer from a lack of local risk capital support for new venture financing”.

It’s clear that policies to encourage raising venture capital funds in Canada for life sciences companies are needed. “One tax policy that would likely work for biotech would be to allow flow-through shares,” suggested May. Common in the mining industry, flow-through shares are a type of investment vehicle that allow companies to pass tax credits on to investors. “These types of shares have attracted a lot of funding for Canadian miners.”

This preferential tax treatment of investments in the mining, oil and gas, and renewable energy industries suggests that investors would likely place risk capital in those startups over ones commercializing regenerative medicine and stem cell intellectual property. It’s very likely that Canadian biotechnology startups lose out on initial investments in this uneven playing field.

The CCRM was created to fill the commercialization gap between the early start-up stages where intellectual property has been created to meet a market need. “Our ultimate goal is to attract a billion dollars of risk capital,” says May with a confident smile. “As long as we strive to create companies that have great products and are excellent investment opportunities, the necessary capital and expertise will follow and take them to the next level.”

That’s the kind of energy government policies should be designed to support. Without changing policies to strongly encourage calculated risk taking, Canadian startups will remain satisfied with the status quo.

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