Thursday, May 16, 2013

Strawman arguments against government support for startups still leave tough questions to answer

Last July, I mentioned that "there is increasingly a mood in Canada that we've been wasting too many resources on small startups that will never become large firms." In the months since, there's been a lot more written on that theme, much of it aimed at government policymakers.

There can be more than a touch of theatrical performance in these pieces. Often, the intended-but-not-explicit message is "why government needs to provide more funding for things we do ... and less for things those guys are doing"  (or, "why government should have funded what we do and not that tripe they chose to fund instead").

But, motivations aside, the ideas will stand or fall on their own. The pieces I've read have largely been rebuttals of strawman arguments for why startups are supported in the first place and come from a highly hands-on view of government's role in building businesses.

It's not unreasonable to question whether we should skew our limited resources toward startups per se. Most new businesses in Canada are in such sectors as local services, real estate, retail, and so on—many started by people who want to generate an income and run their own show (which is great—I've done it a few times myself) but aren't really looking to grow a business. They often don't sell to customers outside of their local region, let alone the province or the country. And they never will, and they have no plans to get much bigger than they are now.

In our little tech bubble, we hear "startups" and have in mind innovation-based companies like those at the Communitech Hub or the Accelerator Centre, but those kinds of startups are far from representative of new businesses in general. Tech startups don't even comprise 5% of business startups in Canada (that partly depends on how you define "tech", but by any common definition it's a small number).

In a report last year, the Toronto-based Institute for Competitiveness & Prosperity bemoaned that much public policy was based on "an exaggerated sense of the importance of all smaller businesses" and suggested a distinction between small businesses and "entrepreneurial businesses," which it defined as ones with an "ambition to grow." Y Combinator co-founder Paul Graham even tried to define "startup" as "a company designed to grow fast," saying that "being newly founded does not in itself make a company a startup." I can't go along with that, but within the tech field, the difference between new and growth-oriented is going to be less than in most sectors.

There are exceptions, but most tech startups at least have ambitions to grow, and—even better from an economic development perspective—hope to do so through sales in international markets. Other than some service businesses, it's difficult to sustain a tech business by selling only within your local area.

But that doesn't let tech startups off the hook. You could say that ambitions are nice, but as things turn out, many tech startups won't grow or will quickly plateau. These days, we tend to find that out more quickly and inexpensively than before, but it is usually the case that startups don't grow to be very big.

Daniel Isenberg, writing on the Harvard Business Review website, ("Focus Entrepreneurship Policy on Scale-Up, Not Start-Up," November 30) claimed that pro-startup policies are based on "a narrow conception of entrepreneurship as consisting primarily in the starting-up of an enterprise."

According to Isenberg, government has supported starups because they "equat[e] entrepreneurship with start-up"—something I don't think has actually been done by anyone anywhere. It's true that you'll hear the word "entrepreneur" tossed around a lot in discussions of startups, and there's no question that one way to support entrepreneurship is to encourage more people to choose that path—which begins with a startup. But no one equates the two. Governmement provides far more funding for established companies with growth plans than it does to startups—it's not even close.

Look at the Public Accounts of Ontario for the 2012 fiscal year and you'll see dozens of established companies receiving millions of dollars each (sometimes tens of millions). It's the same story at the federal level. Startups don't get that kind of funding—and they shouldn't and don't need it. When you look at the numbers, it's hard to see how anyone could reasonably conclude that government is equating entrepreneurship with startups. If anything, it's the long list of established companies receiving government funding that brings out the cries of "corporate welfare"—or corporate extortion as companies threaten to move jobs to whichever jurisdiction agrees to pay them.

It's an issue where different people will come to different, reasonable conclusions. Some will oppose direct government support of businesses of any size. I don't go that far down the hands-off path, but I have a much easier time justifying the relatively small amounts spent to support startups than the millions given directly to well-established businesses.

Most startups don't have cash and can't pay for expertise or hire a full management team. They may have nothing on the balance sheet other than goodwill and a few thousand dollars in computers and furniture, which makes borrowing money very difficult. They have ideas, but those aren't worth much in themselves.

Established companies don't have any of those excuses. We've seen companies with billions in the bank get millions from the government. Companies that could raise millions more if they needed to, but—understandably—would prefer the cheap money that government is willing to provide.

It doesn't take millions to help startups. The entire government budget to support the startup ecosystem is far less than many of the payments made to single established companies. A bit of coaching and networking through the early market validation stages can go a long way, especially with tech startups where the founders often have technical skills and a vision of a product but no experience in testing their ideas through interaction with their target market. The marginal cost per startup is very low. A little help goes a long way, which isn't true for established companies.

Returning to Isenberg for another strawman argument, he says that funding for programs to help startups is based on the common fallacy that "the most difficult and important task of the entrepreneur is launching." And again, I've never heard anyone say this—not even startup entrepreneurs, who would be the most likely suspects. I'm pretty sure we all realize that becoming BlackBerry (or your nearest 75-employee company, for that matter) is a lot more difficult than launching a startup.

One of the suggestions has been that, when it comes to early-stage companies, we should only support the ones that will grow to be big. That sounds good, but in some ways it's like saying we should only buy winning lottery tickets. That sounds good too.

Startups give you much better than 14 million-to-one odds, but in the early stages, it's not possible to know which will be big and which won't (some that won't may be fairly clear). You could always wait until companies are well on their way to growing big and then support them, but by then they will already had to have cleared lots of hurdles—including some that are much easier to navigate with a bit of mentoring and feedback. The longer you wait, the more likely you'll be "helping" companies that either don't need your help or shouldn't need it, if our expectation is that companies need to stand on their own two feet at some point.

The Institute for Competitiveness & Prosperity says people defending support for startups evoke "information asymmetry" as an argument (which it then tears down), but that's yet another strawman. The issue isn't that someone has better information than someone else, it's that nobody knows, and nobody can know at that point which startups will succeed and which won't. You can do all the "due dilligence" you want, and while you will be able to filter out some companies, it's still going to be a gamble. Too much of a gamble for banks or other sources of support that established companies can turn to. Those options aren't available to most startups.

So there seems to be no shortage of folks eager to misrepresent the reason for supporting startups—people who create simple-minded justifications that are easy to attack. Unfortunately, the pro-startup responses also tend to be simple-minded and easy to ignore. Some of the biggest offenders are those that talk about how "small businesses" (most of which are not startups) account for some very impressive percentage of something-government-cares-about. That may be a useful sentence, but now you have to fill up the rest of the page, and it's those other paragraphs that are going to make the difference in your argument.

In that blog post last summer I wrote that "the task ahead is to explain to policymakers and Canadians in general why having a thousand microbusinesses that few people outside of our little enclave have ever heard of is a sign of a healthy industry that is worthy of support and investment." That's still the big challenge.

Startup communities in Canada and around the world are full of tiny businesses that hardly anyone outside of that community has heard of. And there's dozens more with every graduating cohort of any of the who-knows-how-many Y Combinator-ish accelerator programs now operating. They'll all have cool names and logos and hardly any revenue. The majority of them will never have 10 employees, let alone 50 (which would still be considered a small business). Should we be concerned that only a tiny percentage of our startups ever grow to be even a larger small business?

I've seen hundreds of startups over the last 10 years—in one of the best startup communities in the world—and many of them are doing very well, but I'd guess that I could count on my fingers the ones that have more than 50 employees today. Is that a problem? There could be another 20 new startups in the next month. That's seems pretty good. Is it? Even if none of them grow to any significant size? Are we only supporting startups to catch the ones that will grow to 50+ or 100+ employees, or if we constantly have hundreds of microbusinesses, is that okay too?

These are the tough questions for startup supporters—at least for those relying on government funding (there are some trying to avoid that, but government-funded initiatives are a big part of the current ecosystem in Ontario). Without good answers, we may leave our fate in the hands of those who will come up with poor answers ... just so they can show how poor they are.

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