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

6. Young Entrepreneurs

This section examines SMEs' financial structure by the age of the business owner by adopting a similar comparison as was used in the previous section on women entrepreneurs. This section considers the unique characteristics of the financial structure of youth-owned SMEs compared with that of more mature business owners.⁵³

Key Findings for Young Entrepreneurs in 2000: Young entrepreneurs had higher capital needs than other age groups (37-percent debt request rate versus 23 percent for all ages) Their financial structure reflects the high use of both formal instruments (53 percent of youth used commercial debt, 23 percent used leasing), and informal instruments (44 percent used personal savings of the owner(s), 42 percent used personal credit cards of the owner(s)) 94 percent of the equity in youth-owned SMEs was held by the business owner/operator

The Challenge of Access to Financing for Young Entrepreneurs

While young entrepreneurs face similar challenges to any business owner, these hurdles are exacerbated by inexperience, lack of credit history and insufficient assets to pledge as security for financing.

Several factors complicate these firms' access to financing: (1) young entrepreneurs are more concentrated in higher-risk, knowledge-based industries; (2) their firms are newer and less established, and; (3) their businesses are typically small.⁵⁴

Characteristics of an average youth-owned SME in 2000: Share of Business Population: 9 percent of 1.4 million SMEs Years in Business: 43 percent of youth-owned SMEs were older than five years (compared with the 75-percent national average) Fixed Assets: averaged $203 500 (compared with the $291 000 national average) Total Debt Outstanding: averaged $220 000 compared with the $294 000 national average) Profitability: averaged $26 500 net income before taxes (compared with the $54 000 national average) Total Equity: averaged $133 500 (compared with the $209 000 national average) Long-term Debt-To-Equity Ratio: 0.91 (compared with the 0.75 national average) Demand for Financing: 37 percent of youth-owned SMEs requested debt, 78 percent were approved (compared with 23-percent request and 82-percent approval for SMEs overall)

Formal versus informal types of financing

Formal Types of Financing in 2000

• 53 percent of youth-owned SMEs used commercial loans and lines of credit (compared with 47 percent among owners aged 45–64)
• 23 percent used leasing (compared with 14 percent)
• 11 percent used government loans or grants (compared with 5 percent)

Figure 29
Types of Financial Instruments in Use by SMEs in 2000, by Age of Owner*

Informal Types of Financing in 2000

• 44 percent of youth-owned SMEs used the personal savings of the owner(s) (highest of all age groups compared with 34 percent for owners aged 45–64)
• 42 percent used the personal credit cards of the owner(s) (highest of all age groups compared with 32 percent)
• 19 percent used personal loans of the owner(s) (highest of all age groups compared with 14 percent)
• 16 percent used loans from friends and relatives of the owner(s) (highest of all age groups compared with 7 percent)

Figure 29 shows the distribution of financial instruments used by SMEs by the age of the majority owner. Focussing on two age categories for comparative purposes, under age 35 and aged 45–64, reveals much higher use of all types of financing among the younger age cohort. Differences among age groups are particularly evident in the use of informal instruments: younger entrepreneurs relied more on personal savings, personal loans or credit cards, or financing from friends and relatives. This was also apparent in the large percentage of debt owed to private individuals (i.e. friends, relatives and private investors), which accounted for 22 percent of all debt owed by youth in 2000, the highest proportion of all age groups.

Younger entrepreneurs' high use informal types of financing is related to:

• Fewer fixed assets to pledge as debt security: Younger entrepreneurs have yet to acquire the asset base of mature entrepreneurs. Youth-owned SMEs averaged $203 500 in fixed assets in 2000, the lowest of all age categories, which may be related to the concentration of youth-owned businesses in service sectors. Younger entrepreneurs are most concentrated in the knowledge-based industries, which represents 13 percent of SMEs in this sector. Firms in this sector had the lowest request and approval rates for debt regardless of the business owner's age
• Appropriateness Financing Tools: The majority of youth-owned SMEs (57 percent) were established within the last five years. Fifteen percent of youth-owned SMEs were considered start-ups in 2000.⁵⁵ For many newer firms, formal types of financing may not be appropriate to grow and develop the business. As discussed in Part IV, types of personal financing (e.g. savings or love money) or other forms of early-stage equity financing are often more suitable to start-up firms
• Firm performance: Lower profitability combined with more leveraged equity may impair younger entrepreneurs' access to formal types of debt
  • Average net income for youth was $26 500 in 2000 — an income gap of approximately 50 percent between youth and the second-lowest income group, the 45–64-year-old cohort.
  • In 2000, 26 percent of the $24.5 billion of debt owed by youth consisted of bank loans or credit. Measuring financial leverage reveals a 0.91 debt-to-equity ratio among younger entrepreneurs, the highest of all age groups. Since younger entrepreneurs are the most highly leveraged age category, it follows that they have lower than average approval rates for formal debt

From one observation it is impossible to determine which of these factors (or others) influence the financial structure of firms owned by young entrepreneurs, or if these findings indicate a gap in the formal financing market for youth. More data will be required to gauge the impact of economic and industry conditions and to conclude what factors determine financial structure.

SME Ownership Capital in 2000

• $78,000 in average owner's equity in youth-owned SMEs (compared with $123 000 among owners aged 45–64)
• 94 percent was owned by the business owner/operator (highest of all age groupings, compared with 86 percent)
• 3 percent was owned by friends or relatives of the owner(s) (compared with 3 percent)

Youth-owned SMEs retained the highest equity ownership by the business owner/operator of any age cohort. This suggests that selling equity shares in the business to obtain capital was not a popular financing strategy among younger entrepreneurs. This tendency emerged despite the fact that KBI firms (in which many youth are concentrated), as well as firms with low assets and profitability, are prime candidates for this means of financing. Nonetheless, youth are more willing than other age groups to give up ownership of their firms to finance expansion or growth (71 percent of younger entrepreneurs indicated that they were prepared to share control of their business).⁵⁶ This suggests a possible gap in the early-stage equity financing market for younger entrepreneurs; however, more data and analysis are required to determine the presence and significance of market gaps.

---

53. In this section, young entrepreneurs refers to SME owners under 35 with over 51 percent ownership in the firm (majority owners). For comparative purposes, the financial structure of young entrepreneurs is contrasted against SMEs that are majority owned by individuals between the ages of 45 and 64. For a complete listing of data by these, and other age categories, see tables 11, 12 and 14.

54. A complete profile of youth-owned SMEs is available in Industry Canada (2002) SME Financing in Canada, 2002. A report presented to the House of Commons Standing Committee on Industry, Science and Technology as part of the SME Financing Data Initiative.

55. The Research Institute for SMEs, Université du Québec à Trois-Rivières (2002) Financing SMEs: Satisfaction, Access, Knowledge and Needs, 2001. A report prepared for Industry Canada.

56. The Research Institute for SMEs, Université du Québec à Trois-Rivières (2002) Financing SMEs: Satisfaction, Access, Knowledge and Needs, 2001. A report prepared for Industry Canada.