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Financing Innovation—the Number One Challenge

February 01, 2013
Michael Bloom Michael Bloom
Vice-President, Industry and Business Strategy

Securing adequate financing is the single biggest innovation challenge that Canadian firms face, according to the Centre for Business Innovation’s recent survey of 1,000 innovating Canadian firms.

The financing problem isn’t simple to solve. In fact, corporate innovation financing has many sources—external and internal—and each comes with its own distinct characteristics, challenges, and advantages.

Sources for Innovation Funding

Most firms, large and small, find external funding so difficult that they prefer to use internal cash flow (including cash from headquarters) to finance innovation—if they have the cash.

Sources for Innovation Financing, by Firm Size

Many don’t. Young companies, especially, have a problem. They come up with innovative ideas (often the basis of their company), yet they lack adequate internal cash to fund their full start-up and commercialization costs and take innovations all the way to market. And external capital market sources often aren’t much help because they do not want to take on the risk.

It’s less of a problem for larger firms. They may be more bureaucratic and less nimble, but they are generally better capitalized and have more access to external funds at reasonable cost.

Government programs, at the federal and provincial levels, help by extending funding to undercapitalized young firms. This helps to explain why our Industry Survey ranks government programs as a more important source of innovation finance than the big banks.

The problem is not a lack of private capital or institutional funding to finance innovation in Canada. We actually have a very large capital market (mostly focused on mining and oil and gas).

The real problem is that the financial markets tend to overestimate the risk of equity investments and underestimate the value of the potential return on the innovation being funded. Companies need to do a better job of positioning and communicating their funding requests in language that resonates with the financiers so that the latter can evaluate the potential returns on new innovations more accurately—and become more bullish on innovation.

Making the Case for Capital

Companies do best when they communicate their innovation plans to financiers in language they can relate to. It starts with keeping in mind that financiers are really interested in profit, not innovation itself.

Since financiers are interested mainly in risk-adjusted returns on investment, innovators need to show the connection between their innovative activities and those returns. Its okay to speak about their research and development efforts, but they also need to build a “bridge” of metrics that link their R&D to commercialization, market entry, revenues, profit, and return on investment.

One of the biggest practical impediments to convincing the financiers is the lack of clear metrics that can empirically demonstrate innovation value and performance.

Otherwise, if firms are not prepared, or if they are unable to identify good evidence of their innovation value or show a good track record of innovation success (e.g., “company reputation”), it is difficult to get private or institutional investors to take the risk and provide funding.

You can hear directly from financiers about how to “speak their language” and find out about the in-depth findings from our survey on innovation at the Conference Board’s upcoming Business Innovation Summit 2013: Innovation for the Corporation.

 

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