Canada excels at startups but struggles to grow companies

Peter Josty is Executive Director of the Centre for Innovation Studies in Calgary.

Canada has a thriving startup sector but has a hard time growing these startups into viable ongoing businesses.

The graph below shows the growth of startup activity in Canada over the last 10 years. The data are taken from the Global Entrepreneurship Monitor reports for Canada. These reports measure the “total early-stage entrepreneurial activity” (TEA) calculated as a percentage of the population ages 18 to 64. The data contain two components – those people who are actively planning to start a new business, and those who are running a new business less than 3.5 years old.

Because the information is expressed as a percentage of the adult population it is normalized for population growth. The graph shows steady growth in TEA from about 12 per cent in 2013 to about 20 per cent in 2023.

As the graph shows, a rising share of the population has been involved in startup activity over the last decade.

Established businesses declining

Now look at the graph below from a recent Business Development Bank of Canada report, showing the total number of self-employed people with employees. This is the BDC definition of “entrepreneurs,” as their mandate is to create jobs and wealth for society.

This graph (Source: Business Development Bank, Statistics Canada LFS) shows a decline between 2000 and 2022 of 100,000 entrepreneurs (the total number of self-employed). This graph is in absolute numbers, so as a proportion of the Canadian population the decline actually would be steeper, as the population has risen during that period. This is consistent with Statistics Canada data that shows that in 2000 about 16 per cent of the labour force was self-employed, and by 2022 that number had declined to 13 per cent.

What is going on?

The reasons why Canada has a declining number of businesses as a proportion of the population are not well understood.

If you dig into the TEA data some more, it becomes clear that of every 100 people who are planning to start a business, only three-quarters actually go ahead and start one. And of the businesses that do get started, the Global Entrepreneurship Monitor data hints at some of the reasons why they don’t continue. These reasons include an opportunity to sell the business, the business was not profitable, and challenges in recruiting and retaining skilled employes.

The BDC report identifies four skills needed for entrepreneurial success: grit and relationship skills, leadership and people skills, marketing and finance skills, and operational administration skills.

There are some positive hotspots. Deloitte’s Technology Fast 50  lists 50 technology companies in Canada that have a three-year average growth rate of 300 per cent or greater. However, a three-year growth spurt doesn’t necessarily predict a stable future.

Some insight can be found in a report by McKinsey & Company. They analyzed the life cycles of about 3,000 software and online services companies from around the globe between 1980 and 2012, and claimed to have found a recipe for sustained growth, based on four principles:

• Growth happens in phases – growth stories typically unfold as a prelude, act one, and act two.
• In act one, there are five critical enablers of growth: market, monetization model, rapid adoption, stealth, and incentives.
• The drivers for growth in act two are different.
• Finally, successful companies master the transition from one act to the next

It could be that Canadian companies have difficulty transitioning from one phase to the next. The McKinsey report suggests that a company has to re-invent itself for each stage of growth.

Software and online service companies may not be representative of the whole market, but they do represent a significant driver of growth. However, just how unusual these two sectors are is indicated in a quote from the report: “If a health-care company grew at 20 per cent annually, its managers and investors would be happy. If a software company grows at that rate, it has a 92 per cent chance of ceasing to exist within a few years.”

Conclusion

Canada has a very high rate of startups by international comparisons, but has difficulty growing them into established businesses. The reasons for this are not well understood.

McKinsey’s research suggests some reasons, but it is not clear how well indicator factors developed for software and online service companies would apply to the rest of the economy. The BDC report identifies skills needed for entrepreneurial success.

Unless something changes it looks as if this trend will continue. As the saying goes, if you do what you’ve always done, you’ll get what you’ve always got. We need to better understand the reasons why startups don’t scale up to become successful larger companies.

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