Should government invest in private companies?

For Josh Sookman, the founder and chief executive officer of Guardly Corp., a Toronto-based mobile startup, a recent $237,500 interest-free loan from the federal government is a much-needed investment that will help jump-start his business with new hires and faster deployment.

"We can hire more people, and we can have them efficiently working together," Mr. Sookman says.

Not everyone is so enthusiastic about such investments.

Critics see funding like this as an example of the government playing investor beyond its qualifications, of "picking winners," and of using tax money from some businesses to give a head start to others.

To say that the practice of subsidizing small businesses is polarizing would be an understatement.

The fact that governments have for years been funding what they perceive to be promising ventures – whether by way of grants, loans, export assistance, consulting, or assistance lumped under the umbrella of economic development – has not bridged an ideological divide about the practice.

It's an long-running debate, but one that's come to the fore again with the recent release of a federal report from a panel of experts, which urged the government to help provide more businesses with capital, and to provide more subsidies "to help SMEs grow into larger, competitive firms."

Mr. Sookman's company, whose product puts users in one-touch contact with emergency responders, is just one example of how these programs can work.

Guardly was given a "repayable contribution" from the federal government – essentially, a zero-interest loan, with a years-long repayment time frame – matching the money he was able to raise from angel investors and accredited venture capitalists.

The contribution was one of two announced in September by FedDev Ontario, the federal agency created in 2009, and operating under the banner of the Conservative government's "economic action plan" stimulus package.

But the idea of the government acting as an investor in small business ventures still raises hackles, both within the small-business community and without.

"What politicians want to do is create a huge plethora of niche programs" catering to specific sectors, says Dan Kelly, vice-president of legislative affairs at the Canadian Federation of Independent Business.

The result, he says, is an ecosystem that revolves around grants. But "as soon as the subsidies dry up, so do the jobs, and so do the companies. There have been far more failures than success stories."

Mr. Kelly says that governments are more effective with programs that backstop businesses through existing channels.

He points to Industry Canada's Small Business Financing Program, which works through existing banks to extend loans to small business that might not otherwise have qualified.

Others are doubtful of the government's ability to single out successful investment prospects.

Stewart Thornhill, associate professor of strategy and entrepreneurship at the University of Western Ontario's Richard Ivey School of Business, says that, as eager as politicians are to create jobs, the economy is better served when governments reduce hindrances to small business – things like regulations, taxes, and filing requirements – than by acting as investors.

"That does tend to come down to picking winners, and I think governments are just genetically poorly disposed to do that," he says.

A bureaucrat, he believes, does not have the same incentives to invest as carefully as a private citizen would.

For all that, Canada doesn't subsidize promising sectors nearly as much as other countries do – and advocates say it should boost the practice.

Federal programs put more emphasis on tax credits than subsidizing businesses, especially through the $3.5-billion Scientific Research and Experimental Development (SR&ED) tax incentive program.

This makes Canada an "extreme outlier" on the world stage, according to a report published this month by the University of Toronto's Mowat Centre for Policy Innovation.

The report argues that tax credits encourage short-term R&D, as getting to market quickly lets firms take advantage of tax breaks on earnings. Subsidies, on the other hand, help offset the risk of long-term R&D. Focusing subsidies at regions and sectors (rather than specific technologies) is a more effective way of encouraging innovation in the long term.

"The whole Asian development model is all about picking sectors, and very strategically so," says Tijs Creutzberg, the report's author. "It's very aggressive, and it's worked."

His report coincides with the release of recommendations from an expert panel commissioned by the Conservative government to evaluate the way Canadian governments support R&D. The panel recommended that the tax-credit program be simplified, that funds saved on tax credits be directed to direct subsidies for businesses, and that the government provide risk capital for high-growth ventures.

Unlike private investors, who look for a straight return on their investments, governments are looking for other kinds of payoff as well.

First among them: the holy grail of job creation, followed by sector growth in desirable areas like technology.

The Ontario Media Development Corp, a provincial agency that administers a variety of assistance for both traditional and new-media enterprises, uses industry juries to select recipients of some of its grants.

"The rationale that our juries use is about the economic impact. What is the job impact going to be in this province?" says Karen Thorne-Stone, the OMDC's president and CEO. "What's the impact of our relatively small investment going to be?"

One of the OMDC's success stories is Toronto-based Capybara Games Inc., which the agency took a gamble on shortly after its founding in 2005, providing less than $10,000 in export funding to a company that didn't even have offices yet. This helped get the company's founders to an industry convention, where they signed their first contact.

Today, Capybara employs 24 people, developing games like "Sword & Sworcery," an innovative iPad game that garnered international acclaim on its 2010 release.

Nathan Vella, Capybara's co-founder, says that early-stage assistance helps get game makers past the point of work-for-hire arrangements with foreign developers, under which the development is done locally, but neither the intellectual property nor the profits stay in Canada.

"It's small-risk, extremely high-reward stuff," Mr. Vella says of goverment subsidies. "I could list 12 local companies that have received small support that have made best-in-class games already."

In the technology sector, governments are also eyeing the frequently cited (though not universally acknowledged) lack of venture capital in Canada.

A spokesperson for FedDev Ontario, the agency that provided the interest-free loan to Mr. Sookman's startup, noted that Ontario venture capital deal activity dropped from a peak of $3.5-billion to just $424-million between 2000 and 2010. The program, introduced by Stephen Harper's Conservatives in the 2009 budget, aims to help early-stage companies it identifies as having high potential for growth.

Canadian high-tech companies that need more capital from angel investors often wind up moving to California, says Mr. Sookman, and often stay there, reinvesting both their human and financial capital in that ecosystem instead.

"That drain has left a funding gap for early-stage companies," he says. "For government to stimulate that is hugely important."

Like many programs, FedDev has its sights set on growing a specific sector of the economy.

As the travails of Toronto's MaRS Discovery District complex suggest, this isn't always easy. Construction of the second phase of the two-tower facility, assisted by tens of millions of public funds and designed to spur the city's entrepreneurial biomedical research sector, recently resumed, having been stalled for years. However, its original moniker – "Medical and Related Sciences" – has been dropped, in favour of a more generic focus on science, technology, and social entrepreneurs.

"It's really hard to grow a cluster, although, Lord knows, a lot of government dollars have been spent in trying," says Eileen Fischer, a professor of marketing at York University's Schulich School of Business, and the director of its entrepreneurial studies and family enterprise program.

One of the fundamental problems with subsidizing small business, Prof. Fischer says, is that governments persist in confusing small business with micro-businesses that might never grow past the point of sustaining one person – especially when creating jobs is the biggest rationale for government investment in the first place.

Government assistance has a place, she says, but advocates should keep their boundless optimism in check: There is a pervasive hope that any given startup will become "the next RIM," and a corresponding fear that failing to invest might cause the country to miss out on it. Combined with the political salability of supporting small business, this makes for a potent cocktail.

"Small business is good for the economy – that's the first mantra," Prof. Fischer says. "All small business is good business, is the second mantra."

Which means that, for good or for ill, the idea of government subsidizing small business isn't going anywhere soon.

Special to The Globe and Mail