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Gaps in SME Financing: An Analytical Framework
Gaps, According to Suppliers of Capital
The usual sense of capital market gaps, as traditionally described in the media and much of the research literature, pertains to a shortage of the supply of capital for SMEs. However, Hillier and Ibrahimo (1993) note that suppliers of capital can equally be viewed as purchasers of "risky promises to pay". From this perspective, there is increasing evidence that suppliers of capital perceive a shortage of investment-ready opportunities. This section of the study reports on recent studies that witness a gap on the "demand side" of the capital markets.
Managerial competency is the key element in investment readiness. This is because managerial competencies are positively associated with firm performance across a variety of organizational and industry settings (Baldwin, 1993; Baum, 1995; Dyke et al., 1992; Lefebvre & Lefebvre, 2000; Tucker & McCarthy, 2001; Watson Wyatt, 2000, among others). For example:
- recent reports by Newton (2001) and Newton and Lee (2001) document that "among various sources of firms' innovation, management is the most prominent" and that "small firms rely on management as the well-spring of their innovation to a greater extent than do large firms, which tend to exploit alternative sources.
- Lefebvre & Lefebvre (2000) report that the innovative capabilities of the management team (e.g., ability to undertake R&D and unique know-how) are strongly associated with export performance and growth.
- Orser's (1997) Managerial Capacity Index presents a composite measure of managerial experience and activity. Significant differences were found among groups of business owners. Owner's breadth (versus depth) of experience was positively associated with both strategic planning practices (e.g., planning sophistication, ability to communicate business planning intentions) and high performance.
These findings demonstrate the issue of attribution of business success, an issue that goes to the core of demand-side gaps. On the one hand, while general management competencies are consistently associated with firm survival and performance, business owners often fail to attribute success (or failure) to their skills and (lack of) abilities. For example, Industry Canada's (2001) recent survey of micro-businesses owners asked respondents to indicate those factors perceived as "vitally important in determining whether or not your business succeeds". Only 6 in 10 (61%) indicated management skills. Management skill were ranked well below "favourable market conditions", "the regulatory environment", "relationship with business partners", "planning" and "clear vision".
On the other hand of the attribution issue, lack of management skill is consistently cited as the principal reason that capital is not advanced. Wynant and Hatch (1991) documented the central role of management competencies with respect to banks' lending decisions. In their comments about the planning and financial management skills in small businesses, the authors note:
"Our interviews with small businesses and accountants indicate that the vast majority of small business owners are overly optimistic about the prospects for their firms…Most small businesses engage in little, if any, planning...The financial management skills in most small businesses are weak... Many small business managers do not appear to be familiar with the actual terms of their loan facility."
More recent studies cite the association between access to capital and managerial competencies. For example, in a review of the Small Business Lending Act (SBLA) loan portfolio, Equinox (2001a) documents that the primary reason given by lenders for default of loans was poor management skills of borrowers. Management competencies also impact the ability of business owners to secure capital. For example, in a UK-based study of early stage equity finance, Mason and Harrison (2001) found no shortage of available capital. Among the 74 British business angels surveyed, 81% indicated that their ability to invest was limited by the quality of the opportunities they see. The two primary deficiencies were: (a) unrealistic assumptions or information that is not credible, and (b) the entrepreneur/management team lacked credibility. The researchers conclude:
"The implication is that there is a need for further interventions by policy makers to remove these barriers so that more small firms can take advantage of the substantial pool of angel finance that is available."
(Mason and Harrison, 2001)
Unfortunately, while the association between (a) managerial competencies and (b) the ability to secure capital and (c) firm performance is intuitively sound and supported empirically, research has yet to determine the particular competencies associated with firm survival.
Studies of small firm failures often reveal failures in managerial competence in specific areas such as financial management and marketing (Storey et al., 1987). However, such umbrella terms often disguise the specifics of failure. For example, what is meant by financial management – does it mean cashflow? Does it mean pricing? Does it mean controlling stock? Does it mean obtaining adequate fiance to begin with? Does it mean not paying too much for funding? Does it mean attracting the right type of funds for the business? Does it mean appointment an accountant?
(Hines, 1995)
Similarly, the absence of managerial skills is associated with poor firm performance. For example, Baldwin (1997) concludes that the main reason for Canadian business failure is inexperienced management. Seventy-one per cent of the firms that failed reflected deficiencies in both general and financial management. This author also refers to issues related to depth and breadth of knowledge about marketing, finance and operations. Loss of management control, inability to adapt, lack of flexibility and poor communication were also cited as problematic.
It is not clear, however, which competencies are required to successfully start or build firms. This is likely because managerial competencies are situation-specific (Hines, 1995). Footnote 18 These results do, however, suggest that gaps in the demand-side of the capital demonstrate the importance of business owners' managerial capacity when evaluating access to capital.
Hypothesis
Access to all forms of debt and equity capital is positively associated with business owners' managerial capacity.
While it is beyond the scope of this study to review the theories of SME growth, the concepts of managerial competency and threshold theory is particularly relevant given managerial competency is consistently associated with firm survival and growth and hence, the ability to acquire capital. Thornhill and Amit (1998) point out the importance of competency research, work "that seeks to ascribe credit (or blame) for performance to the decisions of the manager or entrepreneur. Again, according to Thornhill and Amit:
Which strategies are utilized, and which distinctive competencies or capabilities are cultivated and employed, can each have a significant impact on a firm's chances for survival and, ultimately, for growth. The resource-based view (RBV) depicts firms as heterogeneous bundles of idiosyncratic hard-to-imitate resources and capabilities (e.g., Conner, 1991; Rumelt, 1984; Wernerfelt, 1984). This baseline view of the firm has been extended by Amit and Schemakrer (1993), who emphasize the importance of capability development within industry context, and by Teece, Pisano and Shuen (1997) who lend a dynamic perspective to the RBV."
Two Canadian research teams have recently explored empirically the notion of managerial competency and thresholds of growth. A third recent Canadian report focuses on the deficiencies in management skills in the small business population:
Orser et al (2000) argue that firm growth is most likely to occur if the management team attains a threshold of administrative and managerial acumen. The study investigated the problems that confront owners and managers at different stages in business development. It found that the severity of managerial problems varies by firm attributes, including size. Problems of domestic demand, the firm availability of alternative sources of finance, a lack of financial expertise and lack of information about financing options were particular problems for smaller (micro) operations. Female business owners were more likely to report lack of access to capital as a problem. Growth was associated with younger and larger firms, incorporated businesses, the manufacturing sector, and a business plan. "Planning was clearly associated with expansion".
In a study about the importance of innovative capabilities as determinants of export performance, Lefebvre and Lefebvre (2000) also comment on organizational thresholds in the non-linear growth patterns of SME:
"Furthermore, it is quite possible that, above a certain threshold, size no longer plays a significant role. Evidence from Australia, Denmark, Italy, Japan, and Spain supports this observation: size is of considerable importance during the early stages of internationalization but does not seem to be a significant factor afterwards (OECD, 1997)... The relationship between age and exports may also produce conflicting results. On the one hand, mature firms may have accumulated considerable stocks of knowledge (Baldwin and Rafiquzzaman, 1998) and built strong core capabilities that allow them to better penetrate foreign markets. On the other hand, core capabilities can become core rigidities or competence traps (Leonard-Barton, 1992) and younger firms may be more proactive, flexible and aggressive.
These empirical results are consistent with the conceptual paper on "Management Skills for Small Business" by Newton (2001). This author concludes that policy-makers require a better understanding of the links between the development of small business management skills and performance. More information is also required about potential generic management skills sets that are common across industries and competencies that are specific to particular lines of business.
These studies suggest the following hypothesis:
Hypothesis
Particular management competencies are related to the stage of firm development.
The two hypothesis advanced in this section suggest that management competence is a key determinant of access to capital and that a lack of appropriate management skills may mitigate against access to financing and encourage the perception of gaps when they may not exist.
Footnote 18 Burgoyne (1989) refers to eight problems that any competency-based approach must address: divisibility of the competencies and their reintegration for performance; measurability of competencies, and appropriate methods to measure; how universal or generalisable a listing is over different categories of manager; the ethical/moral content of professional management, and their representation in competency listings; the permanence of competency listings given the changing nature of managing; accommodating different styles and strategies of managing; how managerial competencies relate to the whole person; and finally, how individual competence contribute to and integrate into collective or organizational competence.
