Is Small Business Bad for B.C.?

Dominated by small, 
inefficient businesses, 
the B.C. economy needs 
for a few more champions.

This is what entrepreneurial success is supposed to look like. The decor is all blues, blacks and matte metals. The cubicles are all flat screens and headsets. The offices are all sports equipment and management books. The lobby’s triumphant corporate art screams entrepreneurial testosterone: a velociraptor skeleton, made of nuts, bolts and metal tubes, hind claw raised in full attack mode. “Leave all prehistoric ideas at the door,” its plaque commands.


Coastal Contacts Inc.’s east Vancouver base, near the Renfrew SkyTrain station and overlooking the company’s 25,000-square-foot assembly and distribution centre, is solid proof that not only can B.C. support a global operation; it can grow its very own from scratch. Founded in 2000, Coastal Contacts now employs 450 people in Vancouver and another 150 in Europe, and has filled more than 100 million orders for some two million customers in North America, Europe and Asia. Revenue in 2010 was just shy of $150 million.


The entrepreneur behind the operation is 41-year-old Roger Hardy, who founded the company with his sister, Michaela Tokarski. Of course, Hardy wasn’t always sitting this pretty. Growing an online contact lens retailer in the early 2000s among dozens of competitors was a painful crucible. It involved daily trips to the bank, he says, and he personally

didn’t draw a salary for years. At one point, he says, he learned that a U.S. competitor had secured a $40-million line of credit to fund its drive for market dominance. Coastal Contacts could only draw on Hardy’s $10,000 Visa limit. “That was in our first year,” Hardy remembers. “My sister and I kind of look at each other and go, ‘Are we sure we’re in the right business?’”


Coastal Contacts is one example of B.C.’s unique economic advantage: gutsy entrepreneurs like Hardy fuel Canada’s most dynamic small-business sector. However, while Coastal Contacts broke through to the big leagues, such successes are few and far between. In 2009, businesses with fewer than 50 employees provided 57 per cent of B.C.’s private-sector jobs, the highest proportion in Canada, according to B.C. Stats. About 18 per cent of the province’s workers were self-employed, the highest rate in the country. Together, these small companies accounted for about one-third of B.C.’s GDP. 


Depending so heavily on small business has its drawbacks. Productivity is linked to things like working conditions and wages, and those improve with economies of scale far beyond the reach of small businesses. Canada’s unimpressive labour productivity – a measure of wealth created per hour worked – has long been a topic of conversation among economists, and B.C. is dragging Canada’s score down, coming in at just below the national average. And we aren’t making any significant advances: a report released by the C.D. Howe Institute in June this year found that between 1985 and 2009 B.C. had the second-lowest labour productivity growth in the country, after Newfoundland.


“This is counter-intuitive to a lot of people,” explains Jock Finlayson, vice-president of policy for the Business Council of B.C., “[but] the larger the enterprise, on average, the higher the output per worker.” He explains that large companies are generally able to invest more in machinery, training and technology to max out the value created in every working hour. “This suggests that an economy that is highly weighted toward small businesses is going to have a fairly low level of productivity,” Finlayson says. “And this is what we see in B.C.”


And the bad news doesn’t end there. Exports and R&D are both crucial factors in a growing, dynamic economy, Finlayson explains, and these too generally suffer with small business size. Only Nova Scotia and PEI have a smaller portion of their GDP derived from exports, according to Statistics Canada, and B.C.’s spending on research and development per capita is below the national average. 


There is, however, an upside to having so many small businesses: the ones like Coastal Contacts that do grow quickly can contribute significantly to the economy. A 2008 study by Industry Canada found that while only four per cent of companies in Canada qualified as “hyper-growth firms” between 1993 and 2003, they were responsible for 45 per cent of the net jobs created by continuing companies. So if more of B.C.’s many small businesses could follow the lead of such companies as Coastal Contacts, they could transform B.C.’s economy from laggard to leader. 


As Finlayson explains, “the challenge is to have an environment where these rapidly growing small firms will take root and actually grow and reach their potential.” So what’s stopping them?

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Energy Aware Technology’s UBC beginnings

The home base of Energy Aware Technology Inc. is a far cry from the Coastal Contacts head office. A team of seven is snuggled into 1,000 square feet of office space on the top floor of an aging Gastown office building. The tiny kitchen is stacked to the ceiling with shipping boxes. A hand drill rests on a square of cardboard in the boardroom. President and CEO Janice Cheam jokes that every room here is a “slash” room: office/storage, boardroom/workshop, and so on. 


But the humble office belies the young company’s early promise. Energy Aware makes an elegant palm-sized wireless display that’s designed to promote energy conservation by showing people, in real time, how much power their home is using. The company was named 2009’s most promising startup by the B.C. Technology Industry Association, it has development partnerships with several smart-grid developers and, although it is not yet profitable, it has sold some 5,000 of its gizmos to clients around the world.


Energy Aware was conceived as part of an entrepreneurship course at UBC, and Cheam admits that at first she never intended to turn it into a real company. Instead she applied for jobs at Vancouver’s biggest consulting firms upon graduating in 2006. But her early experiences with Energy Aware kept coming up in the interviews, and after a particularly in-depth three-hour session, she recalls, her interviewer pulled her aside and levelled with her. “When we did our one-on-one, he was like, ‘I don’t think what we can offer you is going to be on par with what you’ve already just experienced.’” It was a classic moment of self-discovery, and Cheam quickly called up her old classmates and convinced them to help build a real company.


These kinds of origin stories happen continually in entrepreneurial B.C., but what happens next presents the real challenge: how to transform that tiny germ of a company into a money-making, job-creating, export-generating international corporation. Energy Aware’s struggles early on make for a good case in point. Cheam faced two problems common to most new entrepreneurs: obscurity and lack of funds.


Energy Aware’s starting funds came from family members, angel investors and a single VC firm, Renewal Partners Co., all of whom together pitched in about $600,000. But raising the money necessary to continue improving the product and court potential clients and partners remains a challenge. It’s not that there isn’t capital to be had in the world; it’s just tough to convince it to come to Vancouver. Hardy and others contacted for this story confirm that even in these days of supposedly mobile capital, investors are likely to put their money close to where they live. Cheam recalls one meeting with a potential American investor: “His question to me, straight up, no apologies: ‘When are you moving your company to California?’” 


There are some advantages, however, to being north of the border. Cheam’s reason for staying here comes in the form of a few choice letters: IRAP and SR&ED. The federal government’s Industrial Research Assistance Program provides funding to pay salaries associated with research projects, and its Scientific Research and Experimental Development Tax Incentive Program is a tax credit for money spent on R&D. Energy Aware’s access to those programs ended the conversation about moving the company, Cheam says.


Energy Aware has sold products to utilities in Australia, Finland and North America, but so far only for pilot projects. The company’s goal is to score a system-wide contract with a major utility and outfit millions of homes, instead of thousands. If and when that lucky day comes, the company will explode in size – which will, of course, bring on new problems. Cheam will need engineers familiar with modern smart grids and business-development managers who know the global utility industry. To find that specialized talent, she’ll likely have to recruit internationally, which means lengthy searches, big salaries and struggles with Canada’s immigration system.

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Small business challenges

All of these challenges are nearly universal in the world of startups. Roger Hardy’s story, for one, hits all the same notes. He credits much of Coastal Contacts’ success to having been able to attract those specialized senior managers. Before founding Coastal Contacts, Hardy was a manager with Loomis Courier Service, and he lured several of Coastal Contacts’ managers from his old workplace.


But while Hardy had success on the talent side, he had none when it came to government support. Since his wasn’t a research operation, Hardy approached the Business Development Bank of Canada rather than seek government-funded research grants – with absolutely nothing to show for it. “We didn’t get any kind of government-funded support,” he says. “I can’t imagine the thousands of hours I’ve wasted chasing them down.”


Coastal Contacts’ biggest challenge in its early years was raising the capital needed to build a robust IT system, outfit a crack call centre and maintain a large stock of product, Hardy says. To fund its early growth, the company was forced to accept a subordinated-debt bank loan at nearly 20 per cent interest. Then it took a major step with an IPO in 2004, which gave the company the capital to acquire similar online contact lens retailers in Europe and Asia.


Hardy argues that B.C.’s growing startups are mostly held back by lack of money. As a result, very few B.C. firms founded around the same time as Coastal Contacts are as big as Hardy’s company is today. As he explains, “The ones that were on the right trajectories got bought out and moved.”


So why has Coastal Contacts not sold? Not for lack of offers, Hardy says. He dutifully argues that growing the business is a better deal for his shareholders than selling it. But there’s another force at work here: Coastal Contacts has remained a B.C. company simply because that’s the way Roger Hardy wants it.


No two small businesses are alike, but the stories of the early days of Energy Aware and Coastal Contacts highlight some important themes: money and talent are consistent challenges for growing startups, government support programs can be a huge boost (or not) and the route to success is different for every operation. The challenge facing B.C. is to decide what we can do to help struggling startups beat the odds.


Business lobbies and think-tanks have a fairly standard wish list they present regularly to government: tax credits for angel and VC investment, more entrepreneurship education in the post-secondary system, improvements to R&D support programs, a more streamlined immigration system and a continued focus on reducing barriers to foreign trade.


But while there’s always room for improvement in these areas, the B.C. and federal governments are already doing a lot of the right things, according to Jock Finlayson. Business taxes are low, R&D spending is subsidized, capital gains taxes have decreased and B.C. has Canada’s most generous tax incentives for VC investment. So the uncomfortable truth is that there may be little more government can – or should – do.


According to UBC business professor Thomas Hellmann, regions around the world wishing to become the next Waterloo or Silicon Valley are struggling with the same question of how to help home-grown entrepreneurs. And compared to most, Hellmann says, B.C. has been comparatively successful in fostering a healthy entrepreneurial environment. But he identifies a lack of local talent as a major roadblock, and it comes from a shortage of large, established companies: “If you look at where the entrepreneurs come from, the guys who really build these high-growth companies, they normally come out of these technology anchor companies.”


Silicon Valley, for instance, has companies such as Cisco and Oracle that regularly churn out managers with, say, five years’ experience in global sales or high-growth business development. They often go on to start their own companies or join other startups – and tend to want to stay close to home. There’s a crucial shortage of these seasoned managers in B.C., Hellmann says. While the province is blessed with a steady supply of entrepreneurs with fresh ideas, ideas are just the beginning. Implementation is at least as important, which means business management, market development and, yes, actually selling things. And, as the business school instructor admits, these skills can’t be fully taught in the classroom.


So talent and money tend to remain concentrated in a few major hubs. This leaves B.C. in a bind. We know we need more fast-growing companies, but there’s no way to simply create that kind of critical mass. As Finlayson explains it, no government can force small businesses to grow; all they can do is prime the pump and wait. In the end, he says, “a lot of it does come down to the goals, the talents, the ambitions of the entrepreneur.”


So after all is said and done, the real challenge falls to such people as Roger Hardy and Janice Cheam, who have made the tough decisions to start their own businesses, and to keep them in B.C. And perhaps one day, more upstarts will break through to a global scale and we’ll see that success compound itself, spinning off local skills and money that allow yet more startups to grow.


But this much is clear: while there’s always a role for governments and business groups to play, their efforts are not the main event. The real catalyst for growth is the sum of thousands of individual decisions by the entrepreneurs willing to go through all the hardships of building something new.


Five years down that difficult road, Cheam admits that it has been terrifying at times. “I’ve probably experienced greater highs and greater fears than anything I’ve ever done in my life. But in the worst of times, I’ve always been able to step back and know that this is exactly where I want to be,” she says. “Even when it’s terrible, I still recognize the fact that I love this.”