SME Financing in Canada, 2002 — Part I: Debt Financing

Conditions for Accessing Financing: Collateral

Collateral is any asset that a borrower must pledge as security for a financial arrangement. Lack of collateral, for start-up firms or those in KBIs for example, can create a major obstacle to accessing debt. Anecdotal evidence suggests that SMEs often believe lenders are excessive in their demands for collateral. Of course, for lenders the amount and type of collateral available are often key considerations in the financing decision. Business owners are often asked to use personal assets for collateral when tangible business assets are not available. In general, goods-producing industries use business assets as collateral more frequently than the personal assets of the owner, while the opposite is true for service industries. Size of business is also a key factor in determining the type of asset used as collateral. These factors, along with types of suppliers, are most likely the influencing factors affecting regional variations. Overall, for debt approved in 2000, 39 percent of SMEs used personal assets as collateral, and 41 percent used business assets¹⁶ (see Table 8).

The following are key findings with respect to collateral:

• Smaller Businesses: Firms of fewer than 20 employees are equally as likely to use personal assets as collateral as they are to use business assets, while larger firms are much more likely to use business assets rather than personal assets. This is not surprising, as larger firms are also more likely to have such assets to pledge and are most likely to request term debt. Term loans are usually used to finance fixed assets, as those assets can be used to secure the loan.
• Agriculture-based SMEs: 56 percent of these firms used business assets as collateral. This is the highest rate of any sector, which is as expected given that these businesses tend to be asset-rich (equipment, land and buildings).
• Wholesale/Retail and KBI Sectors: 45 percent of firms in these sectors used personal assets as collateral – the highest rate of any sector. These are also the sectors that most frequently requested short-term debt, which is usually used for operating capital. Possibly these instruments have a lower collateral requirements, though more study would be required to make this correlation.
• Rural-based SMEs: 54 percent of these firms pledge business assets as collateral as compared to 34 percent of urban-based firms – consistent with the findings for the agricultural sector.
• Alberta / Northwest Territories: 49 percent of firms in this region used personal assets as collateral, more than in any other region in Canada. This is a higher level than realized within the various ranges for size of business, or for industry breakdowns, therefore another factor must be at play, such as the lending practices of suppliers in this region.
• Manitoba/Saskatchewan/Nunavut: 53 percent of firms in this region used business assets as collateral, and this reflects the fact that 45 percent of SMEs located here are classified as agricultural, which is an influencing factor on type of collateral used, as stated above.
• Quebec: Only 28 percent of firms based in Quebec used personal assets as collateral – the lowest of any region. Although the size of the business and the industry are influencing factors on collateral requirements, they do not seem to account for Quebec's low levels of collateral usage, therefore further study will be required on this issue.

16. Note that in this study firms could have used both personal and business assets as collateral.