For Canada’s tech to thrive, startups must grow up

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When Microsoft Corp. offered to buy his software startup for more than $10-million (U.S.), Carl Rodrigues agonized about the decision for three days.

It was 2006 and his firm, SOTI Inc., had nine employees and $800,000 in revenue. Friends and family urged him to sell, convinced the giant from Redmond, Wash., would crush him if he said no. Saying yes would have made the Pakistan-born Canadian immigrant a multimillionaire – but he wanted to keep building.

Today, SOTI has 700 employees and helps 17,000 government and business customers manage their mobile communications. It is on track to hit $100-million (Canadian) in revenue this fiscal year; the Mississauga business has never raised venture capital nor had a losing year. The offers haven't stopped – only now, the ones Mr. Rodrigues rejects value SOTI at more than $1-billion (U.S.).

"I really care about creating a Canadian company," says the 55-year-old Mr. Rodrigues, who plans to break ground this fall on a new SOTI campus that could eventually house 3,000 people. When asked what his "exit strat-egy" is – a common question for startup entrepreneurs – he retorts: "Does Google have an exit strategy? Does Microsoft? Do you become a world-class multinational company with an exit strategy? We have to educate our people [to think], 'Hey, you can do something bigger.'"

Years after Canada's last global technology champion, BlackBerry Ltd., began its long decline, Canada's pipeline of tech innovation has rarely looked more promising. Canada boasts several $100-million revenue "scale-ups" like SOTI, and domestic early-stage technology firms are attracting a lot of buzz and money. Canadian tech companies raised $3.7-billion (Canadian) in venture capital last year, the highest since the dot-com bubble, and more traditional Canadian corporations and asset managers including banks, insurers, mutual funds and pension funds are increasingly getting into the startup-financing game.

"There's a lot of excitement about the pace of innovation … and investors really want to start getting exposed to [startups] at an earlier and earlier point in the life cycle of the capital markets," said Laura Adams, managing director of institutional equities with Morgan Stanley Canada, which hosted an investing symposium in Toronto last week on Canadian growth companies. The event attracted 160 institutional and high-net-worth investors, three times the expected crowd.

In June, eight-month-old Montreal artificial intelligence firm Element AI raised $102-million (U.S.) from a swath of global investors, making it the hottest startup in the globe's hottest technology sector, thanks to the work of Canadian-based academics, including the University of Toronto's Geoff Hinton and Yoshua Bengio of the University of Montreal. Canadian scientists and startups are leading in emerging sectors such as quantum computing, smart robotics and cleantech and developing technologies that would disrupt fields ranging from banking and auditing to DNA testing and textbook publishing.

Provinces are starting to add coding to their education systems, and post-secondary institutions are increasingly focused on STEM (science, technology, engineering and math) and entrepreneurship programs.

But while Canada has never lacked for world-class research scientists, many of our top innovations have been commercialized elsewhere and this country has rarely produced global technology giants. Canada has had just one breakout success in the past decade – Ottawa retail commerce platform provider Shopify Inc., used by 400,000 merchants to run their online and bricks-and-mortar stores. The company, which is on track to top $615-million (U.S.) in revenue this year, went public in 2015 and now has a market value of $8-billion. Given that Shopify's quarterly revenues are on track to surpass fading BlackBerry within a year, it is only fitting that the Prince of Wales and Duchess of Cornwall are set to visit the company on Canada's 150th birthday.

But uneasy lies the head of a Canadian tech giant that wears the crown, particularly given the fates of BlackBerry and Nortel Networks Corp. They often seemed to hold up a tech industry that was otherwise pretty thin; information technology (IT) stocks account for less than 3 per cent of the S&P/TSX composite Canadian index, which remains heavily weighted to financial and energy stocks; in the U.S., IT firms account for 23 per cent of the benchmark S&P 500 index. Consider that the market value of all 186 Canada-listed technology companies add up to $96.4-billion (Canadian). That's equal to one-sixth the size of Amazon's quoted market value or one-third of the cash and marketable securities sitting on Apple Inc.'s balance sheet.

"I obviously hear the lamenting about BlackBerry and Nortel a lot," says Mike Serbinis, a Toronto serial tech entrepreneur whose latest venture, League Inc., is attempting to upend the health benefits business. "It's on top of everybody's mind – how do we get more global champions?" Unlike years past, "there are now thousands" of emerging tech companies in Canada, "and you've got to believe the volume of shots on net today as compared to five years ago" will yield more winners.

The future of Canadian innovation thus depends less on inventors and more on people like Mr. Rodrigues – business builders who not only create and expand thriving tech companies but who also choose to remain independent and Canada-based, outsmarting the giants in their way as BlackBerry once did. Too often, companies sell out early – a 2015 PwC survey found that 58 per cent of Canadian tech startups expected to be acquired within six years – or go public only to be gobbled by predators who take advantage of Canada's low dollar and weak regimes for fending off unwanted suitors.

"We need more of these companies to get to scale so we develop leaders for the next generation of innovators," says Tom Liston, managing partner with Toronto's Difference Capital Financial Inc. and a former technology equities analyst. "Canada will not be viewed as a leader in technology without a few more multibillion-dollar companies that largely grow organically."

Now the predators are also coming from China, with giants such as Baidu Inc., Alibaba Group Holding Ltd., JD.com Inc. and Tencent Holdings Ltd. (an investor in Element AI) "starting to ramp up North American investment activity" in recent years, says Alison Nankivell, a vice-president with Business Development Bank of Canada in Hong Kong.

"Suddenly Canada is on the radar" because it's cheaper and less competitive to get in on deals here compared to the U.S., she says. Chinese firms are filing patents at a torrid pace and crowding on to global standards-setting committees to ensure their homegrown technologies become the norms in emerging fields like clean technology.

All of this has created dynamic challenges for the federal government, led by self-described "geek" Prime Minister Justin Trudeau. His innovation-friendly government has introduced policies to help domestic startups compete for foreign talent and sell their wares to government. Ottawa is investing in venture capital, committing nearly $1-billion to fund "superclusters" built around Canadian innovation strengths and promising to help Canadian companies more effectively protect and commercialize their intellectual property.

At the same time, the government has also warmly welcomed tech giants that have set up shop in Canada – including Google, Microsoft and Amazon.

Many tech leaders also publicly welcome the foreign interest, saying it validates Canada as a thriving hotspot of tech talent. But those foreign giants are also buying up Canadian tech companies and muscling in to hire the same coveted developers and data scientists that Canadian tech startups are struggling to hire themselves – sometimes aided by government incentives aimed at wooing foreign direct investment.

Why does it matter whether an engineer works in Canada for a foreign tech giant rather than a Canadian one? Because the benefits created by that engineer support head office jobs and related benefits including corporate taxes that flow to the parent company's home jurisdiction. If Canada's tech sector is expected to meaningfully improve the economy – a key expectation – those impacts will be limited if Canada's best and brightest stock foreign branch plant operations.

"The challenge for Canada is how do we stop this incessant focus on branch plants and creating pre-revenue startups that are 'built to flip' and instead build an ecosystem that allows proper innovators – our most successful, revenue-generating entrepreneurs – to quickly get their revenues to $100-million and then go beyond?" said former BlackBerry co-CEO Jim Balsillie.

Mr. Rodrigues is equally blunt. His company, like other Canadian tech firms, has qualified for federal research and development tax credits. If those taxpayer dollars ultimately benefit U.S. companies that buy Canadian startups, "we're funding the U.S. economy," he argues. "We have to stop."

Sean Silcoff writes about innovation for The Globe and Mail and is co-author of Losing the Signal: The Spectacular Rise and Fall of BlackBerry.