Private sector attention is shifting towards value of supporting scale-ups

It has taken a long time, and not all the needed pieces are yet in place, but the innovation debate is now paying much more attention to how we grow companies and scale them up to be global competitors, and not simply on how we start them.

While start-ups matter – there would be no scale-up companies without a constant flow of start-ups – the goal has to be to enable the start-ups with the greatest growth potential to scale up. Start-ups are the seed corn of the economy, but scale-ups are the enterprises that build the scale and scope for ongoing commercial success and the jobs and productivity that can result. While university research spending can have a variety of goals, innovation policy has to be focussed on commercial success.

“The growth of companies as they develop new markets is the main mechanism by which the economic benefits of inventors and innovation are realized,” a study on scaling up by the Industrial Performance Centre at the Massachusetts Institute of Technology stresses, arguing that the failure to scale up means that many of the potential benefits of public and private investment in start-ups are lost. “How well an innovation-oriented economy fares in this dimension of performance is no less important than its initial success in encouraging the formation of new companies in the first place,” it said.

This is an important message for Canadian policymakers who have tended to put the emphasis on start-ups and commercialization of university research. This is important. But there has been much less attention to the much greater challenge of growing the best start-ups into large companies. In fact, some of our policies, such as the lower tax rate for small business, actually act as a disincentive for growth.

The MIT study defined companies that had reached US$500 million in sales as “companies of scale” and those with annual sales of US$100 million-US$500 million as companies “on the pathway to scale”. What seems to matter is that companies on the pathway to scale have strong growth performance and potential. They have achieved “sustainable competitive advantage” through market validation with a strong customer base for their product or service. They have scale and scope.

Scale brings many advantages that small companies lack. A company with scale has access to superior distribution channels, can support stronger brand development, benefits from economies of scale that can lower costs and boost competitiveness, is able to produce new products or pursue new markets more quickly, can afford R&D, and has the resources to acquire young growth companies as part of its strategy to expand into new technologies or markets, as the MIT study finds. Scale “allows for investment in factors that drive competitive advantage such as the capability to innovate: the talent, technology and R&D needed to continually bring new products or new services to the marketplace requires significant resources that only scale can provide.”

Moreover, as the MIT study finds, there are advantages to economies and cluster communities as companies scale up. Growing companies create jobs and contribute to the overall economic growth of a region; they should improve productivity performance; they generate more tax revenue; they develop pools of managerial talent that can benefit new companies; they can be a role model for entrepreneurship and the training of entrepreneurs; they can boost opportunities for local suppliers; and they can be a source of investment for local start-ups.

Fortunately, there is now greater attention being paid to scale-ups, though more could be done. One example is the brainchild – and philanthropy – of Mike Lazaridis. In 2015 he donated $25 million to the Wilfrid Laurier business school, and the Ontario government kicked in another $15 million, to focus on the management issues facing young companies trying to scale up. Lazaridis recognized that one reason many promising Canadian start-ups were being acquired by foreign multinationals was their lack of management skills.

Hence the Lazaridis Institute for the Management of Technology Enterprises, launched in 2016, with two goals: to conduct an annual scale-up exercise for 10 promising firms with exponential growth potential; and to become a center of excellence internationally for research on scale-up issues and potential.  So far, the Institute has worked on scaling up with 20 Canadian tech firms, with work now underway to identify the next 10.

The other example is the launch in June of the Canadian $545 million (and promises to bring it to $1 billion) Business Growth Fund, an initiative of 13 financial institutions. Led by the major banks, it aims to take minority stakes in promising Canadian companies with at least $5 million in annual sales, a demonstrated growth trajectory and a clear pathway for accelerated growth. The funding is not just for tech companies, though they certainly would be candidates, but for any company that meets its criteria, says George Rossolatos, the fund’s president. The fund is modelled on Britain’s successful Business Growth Fund, with the idea coming from the federal government’s Advisory Council on Economic Growth early last year.

The hope is that with injections of $3 million-$20 million in equity or debt, companies can focus on achieving growth rather than worrying about their ability to make investments to achieve growth. The goal is to create more Canadian-owned and headquartered anchor firms. The focus will be on investments in the $10-$20 million range with $3-$5 million when there is a chance for follow-on investments, Rossolatos says. The “sweet spot” ultimately will be investments in the $8-$15 million range. A big test will be what level of risk the new fund is willing to take.

The attention to scaling up, largely led by the private sector, is long overdue. Success is more imperative than ever as Canada faces a fast-changing global economic environment and needs new foundations for growth that only more scaled-up companies can provide.