SME Financing in Canada, 2002 — Executive Summary

The Background

SME Financing in Canada is a report on the state of financing for small and medium-sized enterprises (SMEs) in Canada. This report is the first to include an analysis of three ground-breaking surveys from Statistics Canada and Industry Canada, and probes the complexities of SME financing in Canada. These surveys have been synthesized with a diverse body of existing public and private sector research to create this profile of SME financing.

The information gathered in this report is part of an ongoing process of understanding SME financing. As such, SME Financing in Canada is but one step in a five-year joint process that Industry Canada, Finance Canada and Statistics Canada began over a year ago. For further details on this initiative, see Part Three of this report.

While the data presented in this report will attract and inform a broad audience, this report was initially conceived as a resource for the House of Commons Standing Committee on Industry, Science and Technology. The research was first intended to provide parliamentarians with accurate and relevant information on the state of financing for SMEs, thus assisting them in forging timely and effective public policy.

A Glossary of Terms is provided in Appendix B.

Highlights of the Report

SME Financing in Canada presents its findings in three parts. Part One is an analysis of the research conducted on special instruments – including debt, equity, leasing and factoring. Part Two provides a general overview of the SME marketplace and details the specific conditions faced by women entrepreneurs, youth, Aboriginal and minority groups. Part Three offers a history of the SME Financing Data Initiative and explores how this project will be expanded in the future.

The recently completed Survey on Financing of Small and Medium-Sized Enterprises, 2000 and Survey of the Suppliers of Business Financing, 2000 conducted by Statistics Canada as part of the SME Financing Data Initiative, are data sets on the supply of and demand for financing in Canada. These summary tables are currently available on-line at the Industry Canada, Small Business Policy and Research Web site at: http://strategis.ic.gc.ca/fdi. In addition, the Université de Québec à Trois Rivières conducted a survey for Industry Canada, entitled Financing SMEs: Satisfaction, Access, Knowledge and Needs, 2001, which probed the attitudes and perceptions of SMEs regarding issues related to financing. A report produced from this survey will soon be published on the above-noted Web site. The results of these surveys, as well as data from several other sources, including the Canadian Federation of Independent Business, the Canadian Bankers Association, and the Conference Board of Canada, have been brought together to produce this report on the state of SME financing. All of the following results are from the Survey on Financing of Small and Medium-Sized Enterprises, 2000 unless otherwise stated.

Financing Stages of Growth

A firm's financing needs evolve with its growth. A capital structure that is appropriate at one stage may not be appropriate at another. This is not an area where there are "right" answers; rather, SMEs need to have a variety of options open to them to meet their financing needs. Table 1 is a snapshot of the sources of financing used by firms, according to size, in 1996 (note that multiple answers were accepted, making the total higher than 100). It shows that firms use a variety of financing instruments.

Table 1 – Sources of Financing Used by SMEs (in %, 1996)

Source of Capital	Fewer than 20 Employees	0-500 Employees
Retained Earnings	57.5	60.7
Personal Capital	59.1	54.8
Short-term Debt	58.4	61.9
Receivables	40.7	43.4
Long-term Debt	36.2	40.4
Leasing	23.6	28.1
Love Money (Debt)	17	15.3
Informal Investment	5.3	5.6
Love Money (Equity)	5.1	5.1
Venture Capital	2.6	2.8
Public Equity	1.1	2.8

Source: Orser, Gasse and Riding. Factors Relating to SME Growth: A Review of Findings. May 1996.

Start-up Capital

Typically the major challenge of firms starting up is to put together an equity stake usually consisting of the personal investment of entrepreneurs and of family and friends ("love money"). Firms without a track record may have difficulty raising debt, and if a firm has not yet begun sales, this might not be the most appropriate form of financing.

Financing Growth

Firms usually finance growth by re-investing their income in the business, in the form of retained earnings. Once a firm has established an equity base and a record of success, a number of other financing options usually become available, including a number of debt instruments. The financing challenge of growing firms is to match the instruments used with the growth prospects of the firm.

Financing Rapid Growth

Occasionally, firms are able to grow at exponential rates. Although they are a small minority, they are vital for the economy because they become the large firms of tomorrow. Their financing needs vary significantly from those of other firms. Generally they require outside equity from a relatively early stage in their development to support their expansion. This might mean seeking informal (or "angel") investment, venture capital and listing on a public stock exchange.

Debt Financing

Figure 1 provides an overview of recent debt financing activity in Canada.

Figure 1 – Debt Financing Overview

In 2000, 23 percent of SMEs made a request for debt, with an overall approval rate of 82 percent; approval rates increased as the size of firms increased. Of all debt instruments that SMEs applied for, term loans were the most sought after, followed by new lines of credit, and increase in current line of credit. The majority of requests for debt (66 percent) were made to chartered banks.

At 88 percent, credit unions / caisses populaires had the highest overall approval rate.

Only 1.3 percent of SMEs saw a reduction in their credit limit in 2000. Nineteen percent of SMEs experienced automatic renewal of their credit in 2000.

Business credit of less than $1 million^{Footnote 1} extended by the chartered banks in 2000 represented 22.8 percent of total business credit extended by them that year, compared with 26.8 percent in 1996. This represents a nearly 16 percent decline. However, it may reflect increased use of personal credit instruments by SMEs or improving financial conditions facing SMEs. More study would be required to determine the cause.

Lease Financing

Figure 2 provides an overview of recent lease financing activity in Canada.

Figure 2 – Lease Financing Overview

In 2000, 9 percent of SMEs made a request for a lease, with an overall approval rating of almost 98 percent. More than 80 percent of leasing was provided by leasing companies, manufacturers' dealers, or suppliers. Demand for lease financing varies somewhat by size of SME, industry or region, but little in approval rate. While larger businesses were more likely to apply for a lease, the Canadian Finance and Leasing Association says that about 60 percent of SME owners used lease financing because it allowed them to finance the full value of their leased assets, without tying up their operating capital.

Risk Capital

Figure 3 provides an overview of recent activity in risk capital in Canada.

Figure 3 – Risk Capital Overview

Only 2.4 percent of SMEs reported that they made a request for risk capital in 2000. Nevertheless, risk capital, especially in the form of equity, is a vital element in financing, especially for growing SMEs. Figure 3 shows that the institutions most commonly approached for risk capital are governments, Crown corporations, banks and credit unions. These results are somewhat anomalous, given that these institutions typically do not make risk capital investments. It may be a reflection of the survey methodology. For example, the survey question grouped venture capital with government grants, as these forms of financing are often treated similarly for accounting purposes. Future surveys will include separate questions about venture capital and government grants and will also attempt to discern whether SMEs that report securing risk capital at banks and credit unions were actually securing funds, or advice about how to raise funds.

In 2001, the total amount of venture capital invested in Canada was $4.9 billion in a total of 818 companies. This was down by 27 percent from the $6.6 billion invested in 2000, but was still well above 1999 levels. Venture capital investment in the United States dropped by 65 percent in 2001. One of the major trends observed in 2001 was the growing importance of foreign venture capital investors in the Canadian market. Their share has risen from 19 percent in 1999 to 24 percent in 2000 and 33 percent in 2001.^{Footnote 2}

Early-stage equity investment in companies not traded on stock exchanges, also known as informal or angel investment, is an important source of risk capital at a crucial stage in a company's development. Previous research on investment patterns of informal investors suggests the combined annual investment made by informal investors in Canadian SMEs ranges from $1 billion to as much as $20 billion. The Survey on Financing of Small and Medium-Sized Enterprises, 2000, which found that 18 percent of majority business owners have invested privately in other companies. As part of the SME Financing Data Initiative more data will be gathered to determine their total contribution to the financing of SMEs.

Other Sources of Financing

Supplier Credit

• Twenty-nine percent of all SMEs made purchases using supplier credit in 2000.
• Larger firms and those in the manufacturing sector were most likely to use supplier credit.

Quasi-equity

• In 2000, 347 companies (about 0.024 percent of all SMEs) received a total of $117 million in quasi-equity; in the first nine months of 2001, the market grew by 9 percent (in terms of value of transactions) compared to the same time period for 2000.
• Expansion-stage firms were more likely to use quasi-equity: 83 percent of such transactions were directed to such companies.
• The vast majority (94 percent) of quasi-equity transactions were $1 million or less.

Factoring

• Only 0.4 percent of SMEs used factoring in 2000.

Profiles of SMEs and Entrepreneurs

See Figure 4 below for the demographics of business ownership.

About half of SMEs were wholly or partly owned by women (about 15 percent of businesses were majority owned by women). In comparable sectors and sizes of business there was no variation in approval rates of female and male entrepreneurs who applied for debt financing. SMEs owned by women tended to operate in the wholesale/retail and professional services sectors, and they tended to be small businesses growing slowly.

Young entrepreneurs accounted for 9 percent of SMEs and were concentrated in the knowledge-based industries (KBIs). Aboriginal entrepreneurs owned about 1 percent of all SMEs and were concentrated in agriculture and primary industries.

Visible-minority entrepreneurs owned 7 percent of SMEs, most of which were larger than the average SME. They were concentrated in the wholesale/retail and KBI sectors. There was little variation in approval rates for financing businesses owned by visible minority entrepreneurs and businesses owned by others with comparable sizes and in the same business sectors.

Figure 4 – Demographics of Business Ownership, 2000

Majority Female		Majority Male
34%	French Speaking	66%
23%	English Speaking	77%
18%	Non-Official Language	82%

Source: The Research Institute for SMEs, Université du Québec à Trois-Rivières, Financing SMEs: Satisfaction, Access,Knowledge and Needs, 2001, commissioned by Industry Canada, 2002.

Note to Readers on Sources and Uses of Data:

Many statistical findings presented in this report were collected by Statistics Canada in two surveys: The Survey on Financing of Small and Medium-sized Enterprises, 2000and The Survey of the Suppliers of Business Financing, 2000, conducted during the summer and fall of 2001.

The Survey on Financing of Small and Medium-sized Enterprises, 2000 was completed by over 11,000 firms across Canada with 0 to 499 full-time equivalent employees. Financing and leasing companies, co-operatives, subsidiaries of other firms, not-for-profit organizations, government offices, schools, hospitals and other public sector organizations were excluded.

Information was collected from SMEs based on their financing practices and experience during 2000. Only firms in operation at the time of the survey were surveyed. The accuracy of the results diminishes as statistics for sub-groupings of the total SME population are broken out (e.g. regional, size of business and industry categories are less accurate than estimates for the entire Canadian SME population, as defined above)

The Survey of the Suppliers of Business Financing, 2000 was based on a sample of financial service providers with assets of $5 million or more in selected financing and leasing industries. Enterprises providing venture capital financing and federal Crown financial institutions were also surveyed. While some crown corporations were included, the survey excluded other government and public sector organizations (e.g. Atlantic Canada Opportunities Agency), not-for-profit organizations, informal suppliers such as business angels and family members, and foreign suppliers.

A third survey by Université de Québec à Trois Rivières (UQTR) conducted for Industry Canada, Financing SMEs: Satisfaction, Access, Knowledge and Needs, 2001, probed the attitudes and perceptions of 2000 SMEs over the summer of 2001 on issues related to financing of their firms. The data produced from this survey will soon be published at http://strategis.ic.gc.ca/fdi

All results in this report are from The Survey on Financing of Small and Medium-sized Enterprises, 2000 unless otherwise stated.

Note on Interpretation: First it is important to note that all data reported here relate to firms that were operating at the end of the calendar year 2000, therefore it does not capture any data on those businesses that failed or on those entrepreneurs who planned to start up a business but failed to do so, whether because of problems accessing financing or for other reasons. In many places in this report, correlations and observations are made of data by region, industry, gender of business owner, etc. Given the relatively small sample sizes related to some of these correlations, one needs to be very cautious in drawing strong conclusions about them. The purpose of this report is to provide some initial observations and interpretations of the data. Likewise, it is not possible on the basis of one observation to say anything about trends. This is the first of a regular series of reports, and these issues will be examined in more detail as more data is collected.

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1. Loans of less than $1 million is a proxy definition that the Canadian Bankers Association uses for loans to SMEs.

2. Macdonald and Associates Limited.