Financing SMEs in Canada: Barriers Faced by Women, Youth, Aboriginal and Minority Entrepreneurs in Accessing Capital — Phase 2: Gap Analysis and Recommendations for Further Research

Overview of SME Financing

Trends Worth Noting

As noted in Phase 1 of this report, all business ventures require capital in order to initiate, maintain and/or expand operations. Capital may be acquired via debt or equity financing and may take the form of any number of financial instruments.

Debt instruments used by SMEs may include bank term or demand loans, private loans, operating lines of credit, credit cards, leases, supplier credit contracts, and government-backed loan programs. Equity investments in SMEs are typically reflected through ownership of one or more classes of shares in the venture. These investments may include personal investment by the entrepreneur, private investment by friends and family (love money), angel investments, venture capital investment and in cases of publicly traded companies, public market equity. In the case of established companies, retained earnings may also be re-invested in the venture.

A survey by Thompson, Lightstone and Company (1998) noted that half of all SMEs in Canada use debt financing from financial institutions to finance their business, which means that half are using other financing alternatives, likely some form of equity financing. Typically, debt financing places more emphasis on business experience, financial credit rating and the track record (if applicable) of existing businesses. In comparison, equity financing may place more emphasis on the personal characteristics of the business owner.

Different types of equity financing come with varying rates of accessibility. For example, access to personal investment and love money is largely dependent on the personal characteristics of the entrepreneur and the economic strata the entrepreneur occupies. Angel investors tend to invest in businesses working 'close to home' and in the sector these individuals made their money in; as such there may be broad disparities in the availability of 'angel investments' depending on geographic location and sectoral focus. Venture capitalists typically invest in initiatives perceived to have 'high growth' potential (e.g., information technology, biotechnology); therefore entrepreneurs not starting businesses in these knowledge-intensive areas are not likely to be able to access venture capital equity financing.

In general, it is harder to access funding for earlier stages of SME development (e.g., seed money, start-up capital) than for later stages (e.g., working capital or expansion funds). As the CFIB (2001) notes, SMEs in existence less than 10 years have a much higher likelihood of being underfunded than those in existence 10+ years.

Entrepreneurial ventures in low-growth sectors (e.g., service and retail) typically have fewer financing options available than those in high growth sectors (high technology, life sciences). As low-growth industries tend to have lower profit margins, there are also fewer dollars available for reinvestment in these businesses. Thompson, Lightstone and Company (1998) note that retained earnings are a common form of equity financing for SMEs with 51% employing this strategy. Lack of retained earnings to reinvest may have a significant impact on rates of business growth, and limit future growth opportunities.

Other factors which affect the accessibility of financing for SMEs include business size (with micro-businesses typically having less access to financing than larger SMEs) and geographic location. Urban entrepreneurs are likely to have a larger pool of financing options to draw on than rural entrepreneurs, particularly those dwelling in communities without easy access to financial institutions. Similarly, SME financing options are affected by proximity to the 'central areas' for particular industries, particularly in cases where angel investors or venture capital is sought. In these cases it is critical for an entrepreneur to be geographically located in ways that provide access to the networks of investors providing financing in various sectors. For example, the high technology networks in Canada tend to be clustered around the Ottawa area, and thus the financing options for high-tech start ups will be more prevalent there than in other regions of Canada.

Research on Financing for SMEs

In terms of research on the SME sector as the whole, the following table summarizes some of the key aspects of studies examined which looked at financing issues for the SME sector. The numbers in the left hand column identify the reference number of the complete summary of research findings presented in Appendix A of this report. It should be noted that there may be more research in this area than is represented here. Because the focus of this project was on particular Profile Groups, emphasis was placed on identifying studies that dealt with one or more of these profile groups rather than the SME sector as a whole.

Ref. No.	Reference	Methodology	Type of Financing	Sector	Stage
9	CBA, 2001	Interviews	All	All	All
11	CFIB, 2001	Membership survey	All	All	All
17	Groupe Secor, 2000	Survey	Debt	All	All
21	Industry Canada, 1998	Review of program	Debt	All	All
32	Statistics Canada, 1994	Stats Canada data	All	All	All

While this research provides an overview of issues related to SME financing over the last decade, there are also some significant gaps which make these findings difficult to use as a comparison point for examining barriers to financing faced by particular Profile Groups. These studies do not provide any detailed differentiation about access to SME financing depending on business age, sector, size and other firm characteristics that are identified in the literature as relevant for examining access to financing.

An important gap appears to be a lack of acknowledgement regarding the stratification of financial access within the SME sector, and the collection of data which can be disaggregated in order to assess the impact of factors such as business size, age, and stage. In addition, the relatively small number of studies makes it difficult to draw substantive conclusions about the present state of SME financing, and the issues new small and medium-sized businesses are currently facing.

Although the studies are all national in scope, the sample sizes and research methodologies vary to such a degree that it would be difficult to compare the results of these studies. The studies do provide a snapshot of issues facing the SMEs from a variety of perspectives. For example, the Groupe Secor (2001) study was conducted at the institutional level, and the majority of participants were members of the financial services industry, whereas the Canadian Federation of Independent Business study (2001) collected data through a membership survey. While both provided interesting and timely insights into issues related to SME financing, the scope of research of each was so different they are not directly comparable.

The following sections examine the research literature specific to the particular groups profiled in this study: women, youth, Aboriginals, visible minorities and language groups.