SME Financing in Canada, 2003 — Part II: Financial Structure of Canadian SMEs

4. Business Size

Key Findings for Business Size: The size of a business, independent of age, has a strong impact on financial and ownership structures. Self-employed businesses had the highest use of informal types of financing: 37 percent used personal credit cards 36 percent used personal savings of the owner(s) 34 percent used commercial loans and lines of credit Micro businesses had a balanced use of both formal and informal financing: 50 percent used commercial loans and lines of credit 36 percent used personal credit cards of the owner(s) 34 percent used retained earnings Medium-sized firms have the highest use of formal types of financing and trade credit (a similar pattern to that seen in the manufacturing sector): 86 percent used commercial loans and lines of credit 56 percent used leasing 75 percent used trade credit from suppliers

Business size, measured by number of employees, is the strongest determinant of a business' financial structure, regardless of the age of the firm.⁴⁴ Removing the influence of age by only examining established SMEs over two years of age shows that smaller businesses relied on informal financing, such as the business owner's savings or personal credit facilities, as commonly as do start-up SMEs. Medium-sized firms, on the other hand, tend to turn to formal commercial instruments and the resources of the business. To highlight these differences, Figure 26 examines the financial structures of three business size categories: the self-employed, micro-businesses and mid-sized firms.⁴⁵

Figure 26
Financial Instruments in Use by Established SMEs in 2000, by Size of Business*

4.1 Self-Employed Firms (Firms without Employees)

Characteristics of an average self-employed firm in 2000: Share of Business Population: 46 percent of the 1.4-million SMEs Years in Business: 78 percent of self-employed firms were older than five years Fixed Assets: averaged $268 500 Debt Outstanding: averaged $200 500 Profitability: averaged $31 000 net income before taxes Total Equity: averaged $173 500 Long-Term Debt-To-Equity Ratio: 0.80 Demand for Financing: 19 percent of SMEs requested debt, 82 percent were approved

Formal versus informal types of financing

Formal Types of Financing in 2000

• 34 percent of established self-employed firms used commercial loans and lines of credit (lowest of all business sizes, compared with the 49-percent national average)
• 20 percent used commercial credit cards (lowest of all size categories, compared with 26 percent nationally)
• 9 percent used leasing (also lowest of all size categories, compared with 16 percent nationally)

Informal Types of Financing in 2000

• 37 percent of established self-employed firms used the personal credit cards of the owner(s) (highest of all business sizes, compared with the 33-percent national average)
• 36 percent used the personal savings of the owner(s) (highest of all sizes categories, compared with 35 percent nationally)
• 25 percent used the business' retained earnings (lowest of all size categories, compared with 31 percent nationally)

Self-employed businesses relied more on informal financing than larger firms; they tended to use the owner's personal savings or other easily acquired and flexible instruments (e.g. personal credit cards or lines of credit) rather than formal sources of debt or leasing.

The limited use of formal debt may indicate a market gap in self-employed firms' access to financing, since they tend to have among the fewest assets to pledge as collateral for debt, the lowest profit levels and a higher than average long-term debt to equity ratio, which indicates that these firms are more highly leveraged than other size categories. As discussed in Section 3, these characteristics mean that the risks associated with financing self-employed firms are often beyond financial institutions' comfort zone.

SME Ownership Capital in 2000

In 2000 there was:

• $117,000 in average owner's equity in self-employed businesses
• 94 percent wass owned by the business owner/operator (highest of all size categories; compared with the 86-percent national average)
• 2 percent was owned by friends or relatives of the owner(s)

As discussed in SME Marketplace, 20 percent of self-employed businesses operate in agricultural sectors. This influences self-employed firms' ownership patterns — most of the ownership capital in self-employed businesses is owned by the business owner/operator. However, from available data it is premature to determine whether this is the result of the influence of the agricultural sector or whether it reflects self-employed firms' preference to retain ownership and managerial control.

4.2 Micro Businesses (Firms with One to Four Employees)

Characteristics of an average micro-business in 2000: Share of Business Population: 35 percent of the 1.4 million SMEs Years in Business: 70 percent of micro-businesses were older than five years Fixed Assets: averaged $190 000 Debt Outstanding: averaged $157 000 Profitability: averaged $52 500 net income before taxes Total Equity: averaged $144 000 Long-Term Debt-To-Equity Ratio: 0.65 Demand for Financing: 23 percent of SMEs requested debt, 79 percent were approved

Formal versus informal types of financing

Formal Types of Financing in 2000

• 50 percent of established micro businesses used commercial loans and lines of credit (compared with the 49-percent national average)
• 16 percent used leasing (similar to the national average)
• 4 percent used government loans or grants (slightly below the 7-percent national average)

Informal Types of Financing in 2000

• 36 percent of established micro businesses used the personal credit cards of the owner(s) (higher than the 33-percent national average)
• 34 percent used the business' retained earnings (higher than the 31-percent national average).
• 32 percent used the personal savings of the owner(s) (lower than the 35-percent national average)

Micro business financing trends mirror the overall trends in SME financing: both categories tend to use informal and formal types of financing to similar degrees. As discussed in SME Marketplace, this may reflect the fact that micro-businesses include an array of firms from all industry sectors; no particular sector affects the overall financial structure of these firms.

The debt structure of micro-businesses is also similar to the overall average for all business sizes. Twenty-nine percent of the debt owed by micro-businesses was held by chartered banks (similar to the national average). Twenty-three percent of their debt was owed to other individuals (including friends, relatives, angels, etc.) — higher than the 18-percent national average. Micro businesses also tended to fall within the mandate of credit unions and caisses populaires. Consistent with the client profile of these suppliers as providers of smaller amounts of capital to personal and smaller business clients, micro-businesses owed 8 percent of their debt to credit unions or caisses populaires, which accounted for the highest proportion of debt owed to these suppliers of any size category.⁴⁶

SME Ownership Capital in 2000

In 2000 there was:

• $95 000 in average owner's equity in micro businesses
• 88 percent was owned by the business owner/operator (above the 86-percent national average)
• 6 percent was owned by friends or relatives of the owner(s) (highest of all size categories; compared with the 4-percent national average)
• 2 percent was owned by the parent company

4.3 Medium-Sized Firms (Firms with 100 to 499 Employees)

Characteristics of an average medium-sized firm in 2000: Share of Business Population: 0.3 percent of the 1.4 million SMEs Years in Business: 88 percent of medium-sized firms were older than five years Fixed Assets: averaged $5 753 000 Debt Outstanding: averaged $6 870 000 Profitability: averaged $1 151 500 net income before taxes Total Equity: averaged $4 511 500 Long-Term Debt-To-Equity Ratio: 0.69 Demand for Financing: 35 percent of SMEs requested debt, 94 percent were approved

Formal versus informal types of financing

Formal Types of Financing in 2000

• 86 percent of established medium-sized firms used commercial loans and lines of credit (by far the highest of all business sizes, compared with the 49-percent national average)
• 56 percent used leasing (highest of all size categories, compared with the 16-percent national average)
• 46 percent used commercial credit cards (highest of all size categories, compared with the 26-percent national average).

Informal Types of Financing in 2000

• 75 percent of established medium-sized firms used trade credit from suppliers (highest of all business sizes, compared with the 39-percent national average).
• 51 percent used the business' retained earnings (compared with the 31-percent national average).
• 11 percent used the personal savings of the owner(s) (lowest of all size categories, compared with the 35-percent national average).

Medium-sized firms tend to use more formal debt than firms in other business size categories. The fact that these firms hold significant fixed assets (to provide collateral security), have high profit levels (to provide debt coverage) and moderate debt to equity ratios (indicating that they are not highly leveraged) means that these firms are likely to have easier access to formal forms of financing and are in a better position to finance their operations through the internal resources of the business (i.e. retained earnings). In fact, chartered banks were the leading suppliers of financing for medium-sized firms, accounting for 39 percent of the debt owed by these businesses. Loans and credit from credit unions or caisses populaires only accounted for 1 percent of the debt owed by medium-sized firms.

Another determinant of medium-sized firms' financial structure is the fact that 32 percent of these businesses operate in the manufacturing sector. As discussed in Section 3.1.2 of this part of the report, manufacturing firms have a comparatively balanced financial structure in terms of debt (e.g. commercial debt, trade credit, leasing) and equity (e.g. retained earnings, informal investment), and medium-sized firms and manufacturing firms share similar ownership structures. Further data and analysis will be required to determine whether the financial, debt and ownership structures of mid-sized firms are related to sector of operation in this size class or if other factors determine their in access to financing.

SME Ownership Capital in 2000

In 2000, there was:

• $2 million in average owners' equity in medium-sized firms
• 64 percent was owned by the business owner/operator (far below the 86-percent national average)
• 5 percent was owned by private foreign and domestic investors (angels) (higher than the 1-percent national average)
• 4 percent was owned by the parent company
• 4 percent was owned by friends or relatives of the owner(s)

---

44. In this section, findings are only presented for established businesses older than two years. The rationale for excluding start-up firms from the business size analysis is to remove the influence of start-up financing, which consists mostly of formal financing. Excluding these firms allows a more accurate determination of whether business size has an impact on a firm's financial structure.

45. Data on the financial structure and sources of financing used by other business size categories is available in Tables 11, 12, and 14.

46. For a more detailed discussion of the financing provided by credit unions and caisses populaires, see Part III.