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Financing Profile: Small and Medium-Sized Enterprises in Tourism Industries

Financing activity

Small and medium-sized enterprises in tourism industries were less likely to seek financing and less likely to be approved

In order to determine if SMEs in tourism industries have more difficulty accessing financing than their non-tourism counterpart, the following section examines the recent financing activity of these businesses.

As presented in Table 4, SMEs in tourism industries were less likely to request external financing, both in 2004 and 2007. Debt financing was the most common type of external financing requested by SMEs in both tourism and non-tourism industries. In 2007, SMEs in tourism industries were slightly less likely to seek debt financing compared with SMEs in non-tourism industries (10 percent versus 13 percent).

As shown in Table 4, SMEs in tourism industries were not only less likely to request external financing, they were also less likely to be approved^{Footnote 1} for external financing. Specifically, in 2004, 87 percent of SMEs in tourism industries were approved for external financing compared with 91 percent of SMEs in non-tourism industries. In 2007, the approval rate for SMEs in tourism industries increased to 93 percent but was still below the 96 percent reported by SMEs in non-tourism industries. In particular, SMEs in tourism industries were less likely to be approved for debt financing and significantly less likely to be approved for government loans or grants in 2007.

Of the main tourism industries, accommodation had the highest external financing request rate

Given the diversity of the industries within the tourism sector, Table 5 demonstrates the request and approval rates by industry within tourism. In 2007, the highest external financing request rate was in the accommodation industry (21 percent), followed by the recreation and entertainment industry (18 percent), both having a higher request rate than the overall tourism average (15 percent). On the other hand, the external financing request rates for the food and beverage industry (13 percent) and the transportation industry (10 percent) were below the tourism average.

The most common type of external financing sought by all industries was debt financing, with the exception of travel services, which had equal request rates for debt financing and government loans or grants. The accommodation industry had the highest debt financing request rate (13 percent) of all industries.

As shown in Table 5, the approval rates for external financing in the recreation and entertainment industry (100 percent) and for the accommodation industry (94 percent) were higher than the tourism average (93 percent) in 2007. On the other hand, approval rates for the food and beverage (90 percent) and transportation industries (78 percent) were lower than the tourism average.

Debt Financing

Tourism small and medium-sized enterprises were less likely to be fully approved for the debt financing they requested in 2007

Given that debt financing is the most popular type of external financing sought by SMEs, further investigation of this type of financing is warranted. Table 6 presents the average approved debt amounts for SMEs in both tourism and non-tourism industries to examine the magnitude of debt requests. As shown, regardless of the type of debt requested (short-term or long-term), the average amount approved for SMEs in tourism industries was lower than that approved for SMEs in non-tourism industries.

Based on the size of loan approved, it is not possible to determine whether SMEs in tourism industries were more likely than SMEs in non-tourism industries to be fully or partially denied debt financing or whether SMEs in tourism simply requested smaller amounts of debt financing. To investigate this, the ratio of total amount of financing approved-to-requested is considered. As shown in Table 6, this ratio was slightly lower for SMEs in tourism industries than for those in non-tourism industries in 2004 (86 percent for tourism and 88 percent for non-tourism). In 2007 however, this ratio decreased dramatically for SMEs in tourism industries to 67 percent, indicating that on average, SMEs in tourism industries received only 67 percent of the amount of debt financing they requested. This was significantly lower than the 93 percent ratio observed for SMEs in non-tourism industries.

To verify that SMEs in tourism industries had a more difficult time accessing financing, Table 7 illustrates the full and partial approval rates for SMEs in tourism and non-tourism industries in 2007. As shown, SMEs in tourism industries were less likely to be authorized for the full amount they requested (82 percent compared with 89 percent for SMEs in non-tourism industries). Moreover, SMEs in tourism industries were significantly more likely than SMEs in non-tourism industries to be only partially approved (10 percent versus 5 percent) and also more likely to have their request turned down (9 percent for tourism and 6 percent for non-tourism).

The accommodation industry required the most debt financing but had the most difficulty obtaining it

In order to determine if any particular tourism industry had more difficulty accessing financing, Table 8 presents approved debt financing amounts by tourism industry in 2007. As noted in the table, the accommodation industry had the highest average debt financing amount approved (both short-term and long-term) of all industries in tourism. Despite this, the accommodation industry also had the lowest total debt approved-to-requested ratio at 42 percent. This suggests that SMEs in the accommodation industry required the most financing but had the most difficulty being approved for the full amount they requested compared with SMEs in other tourism industries.

There are a number of reasons why securing financing can be challenging for a business in the accommodation industry. The seasonal nature of the tourism sector in Canada means many accommodation businesses have short operating seasons in which they must generate the majority of their revenues to cover their costs. The industry is faced with low profit margins, fluctuating sales and high bankruptcy rates (Canadian Tourism Commission, 2009b). These businesses are also extremely vulnerable to external events such as, economic, political and health issues. Dealing with these circumstances requires accurate forecasting and leaves little room for management error.

Additionally, businesses in the accommodation industry require significant capital for their real estate component, including buildings, operating systems, furniture and equipment. In many cases these assets are specialized or built in to the building, making them hard to realize in the event of liquidation. Moreover, due to high attrition rate and changing preferences in the industry, the liquidation values of these assets are low—often less than 25 cents in the dollar (Council of Tourism Associations of British Columbia, 2009).

All of these factors cause lenders to be conservative when lending to these businesses. A recent study conducted by PKF Consulting (2011) on behalf of Industry Canada found that 13 percent of the lending companies surveyed (chartered banks, private sources and finance and trust companies) indicated that they did not lend to the accommodation industry in 2010. Of those 13 percent, half noted that the influencing factor for not lending was the perceived risks associated with the sector.

The study also showed that of the active lenders to the accommodation industry, many imposed certain lending restrictions in order to mitigate their exposure to risk. For example, 67 percent of the companies said they restricted hotel financing to certain hotel asset types and the same number said that they only finance hotels in certain regions or markets. Furthermore, 42 percent indicated that they limited the amount lent per hotel asset and 33 percent said they had a ceiling to the overall amount lent to the industry. This therefore indicates that due to the nature of the industry, businesses in accommodation have difficulties generating confidence in lenders. This may help explain why they have more difficulty securing the full amount of financing they require compared with businesses in other tourism industries.

Financing Terms and Conditions

Small and medium-sized enterprises in tourism industries faced less favourable non-pricing loan conditions but similar pricing loan conditions compared with small and medium-sized enterprises in non-tourism industries

When a business is perceived as being relatively risky, it is not unusual for a lender to provide less favourable loan conditions. In 2007, compared with non-tourism businesses, those in tourism industries faced more stringent non-pricing loan conditions (documents and security required to obtain the loan) but similar pricing loan conditions (interest rates). Specifically, SMEs in tourism industries were significantly more likely than SMEs in non-tourism industries to be required to provide business financial statements, appraisals of assets, cash flow projections and a business plan to secure debt (see Figure 6). Moreover, a higher percentage of SMEs in tourism industries were required to pledge collateral or to provide a co-signature in order to obtain requested credit compared with SMEs in non-tourism industries.

Figure 6
Documents and Security Required During Loan Application Process, 2007*

[Description of Figure 6]
* Bold values denote statistically significant difference at 5 percent.
Note: Multiple responses were possible.
Source: Statistics Canada, Survey on Financing of Small and Medium Enterprises, 2007.

Conversely, Table 9 illustrates that SMEs in tourism industries paid similar interest rates to SMEs in non-tourism industries in both 2004 and 2007. This is contrary to what would be expected for a relatively risky industry. Moreover, SMEs in tourism industries had a longer interest term on their loan compared with non-tourism.

Reasons for Not Applying for Financing

Small and medium-sized enterprises in tourism industries were more likely not to request financing because the process is too difficult and time consuming

As found earlier, SMEs in tourism industries were less likely to request financing than those in non-tourism industries, but what is the reason for this? As shown in Table 10, in 2004 the primary reason for not applying for financing was because financing was not needed; however, fewer SMEs in tourism industries cited this reason.

Six percent of SMEs in tourism industries and five percent of SMEs in non-tourism industries did not apply for financing because they thought they would be turned down. These businesses are known as discouraged borrowers because although they required financing they were discouraged from requesting it for fear of being rejected.

SMEs in tourism industries were more likely not to have requested debt because the application process was too difficult or time consuming. This is likely a reflection of having to provide more documents and security to obtain their loan compared with SMEs in non-tourism industries.

Additionally, SMEs in tourism industry were more likely not to have sought financing because they felt that the cost of debt was too high. Interestingly, this finding is not consistent with the findings on interest rates, which showed no statistically significant difference in rates paid between SMEs in tourism industries and those in non-tourism industries.

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