ARCHIVED—Comprehensive Review Report (2004–09)

3. Small Business Financing Challenges

3.1 Small Business and the Financial Marketplace

SMEs account for the majority of businesses in Canada and drive job creation, productivity and growth in the economy. In 2008, there were nearly 1.1 million employer establishments⁶ in Canada, 98 percent of which have fewer than 100 employees, 75 percent have fewer than 10, and 55 percent have only one to four employees.

In 2008, small businesses had more than 5.2 million paid employees, or roughly 48 percent of the private sector labour force. These enterprises accounted for the creation of over 100 000 jobs, or 40 percent of all jobs created in Canada. In addition, in the previous decade small businesses accounted for 37 percent of all jobs created in the private sector.

On average, between 2002 and 2007, more than 130 000 businesses entered the Canadian marketplace each year. These businesses must have access to capital to become established and grow. Their capital starts with personal savings and investment by family and friends and can come to include loans, lines of credit, retained earnings and other sources of financing. Figure 1 reveals the types of financial instruments used by SMEs in 2007 on total borrowings of $50 billion.⁷

Long description for Figure 1: Types of Financial Instruments in Use by SMEs in 2007

The vast majority of small businesses meet their financing needs through market transactions without any government involvement. Most turn to debt financing at an early stage of development. Banks are approached the most often, with 68 percent of small businesses approaching banks for their latest financing request in 2007. Trust companies, credit unions, Caisses populaires and other institutions play a smaller but important role.⁸

Financial institutions have strived to improve their service to small businesses. Many have developed product offerings specifically tailored to meet small business financing needs (e.g., commercial credit cards). They have also taken action to speed up credit decisions through the application of information technology. So-called credit scoring permits institutional lenders to reduce the transaction costs of high-volume, low-value loans, expanding the number of small business clients that can be profitably extended credit.

3.2 Current Environment and Financing Challenges

A global economic slowdown began in the third quarter of 2007, and the Canadian economy entered a recession in the fourth quarter of 2008. As economic conditions deteriorated, financial institutions became increasingly reluctant to lend to those businesses that were deemed to be higher risk. Certain types of businesses, including most CSBF Program borrowers, represent greater risk to lenders and investors than others. They include start-ups with little or no credit history and firms with few tangible assets to secure a loan. Moreover, enterprises engaged in developing new products and services can encounter lenders or investors with comparatively little knowledge of the business and corresponding perceptions of high risk. These factors and others help to explain why 51 percent of small businesses use commercial or personal loans to start up, compared to 64 percent of businesses that used this type of financing once they are established.⁹

Size of firm is also a major determinant of a business' financing profile — both start-ups and established smaller firms make more use of "informal" financing, including loans from friends and family, than do other businesses. Larger, more established firms are more likely to successfully obtain commercial loans, mortgages, lines of credit and other "formal" types of financing.

Obtaining relatively small sums of money for small business financing can be difficult. Notwithstanding credit scoring, some small loans often still do not justify overhead costs. Moreover, a report from a 2007 survey by the Canadian Federation of Independent Business emphasized that relationships between loan managers and their clients had a strong influence on loan application success rates — the higher the turnover rate of account managers at a financial institution, the higher the loan rejection rate.¹⁰

3.3 Role of Government

Like governments in many other countries, including all of Canada's major trading partners, the government has long recognized the importance of small businesses to economic growth and well-being and that access to financing can be a critical issue for small businesses, particularly during their early years. Therefore, the government has sought to help small businesses and entrepreneurs through a variety of financing programs.

This effort includes loan programs offered by some of the regional development agencies, federally supported community futures and other local economic development organizations, and the Business Development Bank of Canada (BDC). The Business Development Bank of Canada Act states that as a complementary lender, BDC's "loans, investments and guarantees are to fill out or complete services available from commercial financial institutions." The BDC works in partnership with other financial institutions to create borrowing diversification: its flexible, longer-term financing supplements short-term financing available from other sources. BDC's financing is provided directly to Canadian SMEs on a commercial basis, at rates commensurate with the higher degree of risk assumed by the BDC.

The CSBFA was developed on the premise that there are many small businesses in Canada whose financing needs are not being met by traditional private sector lending and that there remains a public policy rationale for government to help fill marketplace gaps. The CSBF Program is unique in that it is available to small businesses throughout the country through more than 14 000 points of service operated by private sector financial institutions. At the time of enactment, the CSBFA was considered to be highly relevant to the needs of small businesses and, overall, an efficient, effective and simple mechanism to facilitate debt financing for emerging and established small businesses.¹¹ It has been subsequently confirmed that there are no attractive alternatives to a federally managed program along the lines of the CSBF Program and that there is minimal overlap between it and other federal initiatives to support access to financing by small businesses.¹²

---

⁶ Employer establishments are those businesses that maintain a payroll of at least one person.
⁷ Statistics Canada. Survey on Financing of Small and Medium Enterprises, 2007.
⁸ Statistics Canada. Survey of Suppliers of Business Financing, 2007.
⁹ Statistics Canada. Survey on Financing of Small and Medium Enterprises, 2007.
¹⁰ Canadian Federation of Independent Business. Banking Matters, 2007.
¹¹ Industry Canada publication prepared in conjunction with the 1998 Parliamentary Review of the Small Business Loans Act, Access to Financing for Small Business: Meeting the Changing Needs, 1998.
¹² KPMG. Evaluation of the Canada Small Business Financing Program, 2009.