SME Financing in Canada, 2003 — Part I: Financing Conditions for SMEs in 2001

2. Commercial Debt: Application and Approval Rates

The primary objective of the Survey on Financing of Small and Medium-sized Enterprises, 2001 was to measure the effect of the economic slowdown on SMEs' access to financing. This section examines whether SMEs changed their behaviour during 2001 as a reaction to the market context. To evaluate this issue, this section presents results pertaining to request and approval rates for debt on a national, regional and sectoral basis.

2.1 National Overview

The Survey on Financing of Small and Medium-sized Enterprises, 2001 found that debt instruments were the most common forms of financing used by SMEs. The most commonly used debt instruments in 2001 were (in order of requests):

• term loans (33 percent)
• new lines of credit (31 percent)
• mortgage loans (16 percent)
• demand or short-term loans (8 percent)

Debt: SMEs Behaviour Highlights in 2001 Demand for debt: 18 percent of SMEs requested debt in 2001 Approval rate for debt: 80 percent of SMEs' requests were approved Financial institutions: 66 percent of SMEs requested debt from chartered banks; 20 percent requested debt from caisses populaires and credit unions; 10 percent from Crown corporations and government institutions Sectoral Findings: Agricultural SMEs had the highest approval rates for debt in 2001(94 percent); similar to the results from 2000 Wholesale and retail industries SMEs secured 15 percent more debt in 2001, compared with 2000 Regional Findings: Ontario SMEs had the lowest approval rates in Canada in 2001 (78 percent)

The Survey on Financing of Small and Medium-sized Enterprises, 2001 found that 18 percent of SMEs requested some form of debt in 2001, and 80 percent were approved (see Table 3). These figures are down from 2000, when 23 percent of SMEs requested some form of debt and 82 percent were approved. Although it may appear that the economic slowdown resulted in a fall in the demand for debt in 2001, two observations do not constitute a trend. More data collection and analysis will be needed to determine whether this is a long-term trend or a short-term aberration.

The fall in demand for debt is a well-documented phenomenon and these findings are consistent with other research studies.¹⁰ According to a Conference Board of Canada study, loans outstanding under $1 million accounted for 69 percent of authorized amounts in 1995 and 67 percent in 1999. The report also suggested that during periods of economic upswing, SMEs were probably more focussed on repaying loans rather than borrowing for expansion.

The pattern of demand for debt is determined by a number of factors. As will be seen in Part II, the borrowing practices and the types of financing sought by Canadian SMEs will be reviewed from the perspectives of industrial sector, region, size of business (by number of employees), stage of business and demographic characteristics of the business owner.

2.2 Other Findings Concerning Application and Approval Rates for Debt in 2001

The following sections review SMEs' application and approval rates by region and industrial sector and present request and approval results for rural and urban SMEs, and for women and youth entrepreneurs.

Regional overview

As noted in SME Marketplace, the economic structure of Canada's regions varies considerably — some regions depend on agriculture and primary industries and others concentrate on manufacturing, services or knowledge-based industries. As Part II will show, different sectors require different financial structures, which in turn influence SMEs' use of formal types of financing. For example, agricultural SMEs have a higher demand for debt than firms in most sectors. Since they also tend to have a high asset base against which to secure their debt, agricultural SMEs have higher approval rates and secure higher amounts of financing. The regional analysis of application and approval rates must take local industrial structure and sector of operation into account.

Figures 13 and 14 show request and approval rates for firms across Canada. As was the case in 2000,¹¹ firms in Western Canada had the highest request rates for commercial debt in 2001. These results reflect the prevalent industrial sectors in these regions — agriculture and primary industries. As Part II will demonstrate, SMEs in these sectors use commercial loans and credit to finance their operations more than any other financial instrument. In fact, 71 percent of agricultural SMEs used commercial loans to finance their operations (higher than the national average of 49 percent) in 2000. This tendency was also reflected regionally — Manitoba, Saskatchewan and Nunavut had the highest percentage of SMEs using commercial loans and credit to finance their operations in 2000. Therefore, it is not surprising that SMEs in these provinces have higher request rates for debt than SMEs in other regions.

Approval rates for SMEs in Canada remained relatively stable between 2000 and 2001. As noted in previous reports, SMEs in Manitoba, Saskatchewan and Nunavut had the highest approval rates — a reflection of regional economic structures. As will be seen in Part II, agricultural firms, which account for a high proportion of these regions' economic activity, tend to have high asset bases and low long-term debt to equity ratios. When reviewing debt applications, financial suppliers evaluate opportunities and risks based on these criteria.

Figure 13
SMEs' Request Rate for Debt by Province in 2001

Figure 14
SMEs' Approval Rate for Debt by Province in 2001

Industry Sector Overview

Figures 15 and 16 show request and approval rates of firms in different industries. As was the case in 2000,¹² agricultural and primary industry firms were more likely to request debt than firms in knowledge-based industries and professional services. As noted above, this likely reflects regional and sectoral variations in financial structure and requirements for formal types of financing.

The economic slowdown did affect the debt request rates in some industries. In particular, there was a decline in debt requests for SMEs in primary (11 percent) and agricultural (10 percent) industries between 2000 and 2001. This could reflect the more cautious approach by firms in these industries during the economic slowdown. For example, requests to buy machinery or equipment declined (10 percent) in 2001 for primary industry and agricultural SMEs. Since these assets are typically sought by SMEs in these industries, the economic slowdown may have influenced their financing patterns and business strategies.

Figure 15
SMEs' Request Rate for Debt by Sector in 2001

The 2001 findings were consistent with those from 2000 — agricultural and primary industry SMEs had high approval rates for debt, while KBI and other industry SMEs had the lowest approval rates. This is related to agricultural businesses' tendency to hold land or equipment as collateral, while firms in the services sector may lack assets to pledge as security. As will be seen in Part II, agricultural SMEs tend to have high assets and low long-term debt to equity ratios, which financial suppliers evaluate when providing formal types of financing.

Approval rates for wholesale and retail SMEs increased by 15 percent between 2000 and 2001, possibly a result of the increase in consumer spending noted above. Canadian consumers' willingness to maintain spending levels during the economic slowdown may have contributed to wholesale and retail firms' strong performance. However, data limitations prevent a more thorough analysis. Additional data collection and analysis will be required to determine whether these are short-term or long-term trends and to evaluate implications for wholesale and retail SMEs' access to financing.

Figure 16
SMEs' Approval Rate for Debt by Sector in 2001

Other highlights regarding request and approval rates in 2001:

• Rural and Urban communities: 17 percent of urban SMEs¹³ requested debt, compared with 22 percent of rural SMEs. The higher requests for debt in rural communities reflects the fact that agricultural, manufacturing and primary sectors use more debt financing than firms in other sectors (see Figure 15). Moreover, rural SMEs' demand for debt fell 9 percent between 2000 and 2001. This is consistent with the findings noted above — agricultural and primary businesses also had fewer requests during the same year.
• Youth entrepreneurs: 27 percent of youth-owned SMEs (under 30) requested debt in 2001. As will be discussed in Part II, youth-operated firms tend to be early-stage and expansion businesses. These firms may not have internal sources of financing such as retained earnings to finance their operations, and so rely on external formal types of financing. In 2000, 53 percent of youth-owned businesses used commercial loans and credit to finance their operations, slightly higher than the national average (49 percent).
• Women entrepreneurs: Despite the economic slowdown in 2001, requests for debt by women entrepreneurs remained relatively stable between 2000 and 2001. In 2001, 15 percent of women-owned businesses requested debt, compared with 17 percent for men-owned businesses. This finding is not surprising, given the tendancy of women entrepreneurs to gravitate to the professional services and wholesale/retail industries — industries that tend to make fewer requests for debt (see Figure 15).

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10. Conference Board of Canada, A Changing Demand for SME Debt Financing?, January 2001.

11. Industry Canada, Small and Medium-sized Enterprise (SME) Financing in Canada, 2002.

12. Industry Canada, Small and Medium-sized Enterprise (SME) Financing in Canada, 2002.

13. See the Glossary of Terms at the end of this report for a definition of rural and urban locations