Scaling Up Is Hard To Do: Financing Canadian Small Firms
by Miwako Nitani and Aurin Shaila Nusrat
- Canada’s small and medium-sized enterprises (SMEs) play an out-sized role in generating jobs and promoting economic prosperity. But Canadian growth-oriented SMEs lag those of other advanced countries and face financing hurdles, whether in raising debt or attracting equity investments.
- Despite Canada’s healthy supply of debt financing, access to financing appears to be of particular concern among certain types of firms including those that are young, growth-oriented, and exporters. Plus, Canadian SMEs in general face relatively high borrowing costs compared to those in other OECD countries. As for equity capital – such as angel financing and venture capital (VC) – there appear to be shortages in financing for companies that seek investments of less than $5 million. Of particular importance, the scale of angel financing in the US dwarfs that which is evident in Canada.
- The authors recommend a number of policy actions. For young and high growth firms, the federal government should consider re-structuring the fee payment schedule on Canada Small Business Financing (CSBF) loans such that fees can accumulate over the loan’s life and are repaid by a balloon payment at maturity. This would reduce the annual borrowing costs for the most vulnerable borrowers. For high growth firms, the CSBF program could also be amended to allow it to cover the portion of requested loan amounts that exceed that which financial institutions are willing to provide. For exporters, Export Development Canada (EDC) could help reduce exchange rate volatility through its foreign exchange facility guarantee program.
- To address the gap in the supply of angel and seed/early stage VC financing in Canada, the authors recommend a national co-investment fund that would invest alongside angels to leverage their investment and expertise. One approach might be through expansion of existing programs such as the National Research Council of Canada’s Industrial Research Assistance, the Venture Capital Action Plan and the Venture Capital Catalyst Initiative programs.
- The authors also point out the need for policy research on the impacts of foreign funds on the Canadian VC industry.
The authors thank Jeremy Kronick, Alexandre Laurin, Mawakina Bafale, Daniel Schwanen and Stuart Bergman for comments on an earlier draft. The authors retain responsibility for any errors and the views expressed.
Introduction
This Commentary provides an overview of the state of financing for small and medium-sized enterprises (SMEs) in Canada.
The birth and growth of young firms are key drivers of job creation and economic welfare. The OECD has reported that approximately 72 percent of job creation across 18 OECD countries – including Canada – was attributable to firms with fewer than 250 employees, among which young firms (fewer than five years old) accounted for 40 percent of job creation while more established firms (more than five years old) accounted for the remaining 32 percent (OECD 2018).
However, in Canada, our SMEs do not grow as rapidly as their counterparts in the US or Europe. The proportion of high-growth firms with 10 or more employees in the service-producing sector in Canada is below the OECD average, both when a high-growth firm is defined as one with more than 20-percent growth in employees and when it is defined in terms of revenue growth. The percentage of high-growth firms in goods-producing sectors also lags behind the OECD average when growth is measured in terms of revenues (OECD 2017).
A key factor worthy of investigation is financing. Growth requires financing, and there is evidence Canadian SMEs are falling behind here as well. For example, Plant (2017) finds that when comparing similar tech companies that received venture capital (VC) funding in the US versus Canada, Canadian firms wait longer before they start raising funds, raise funds less frequently and raise less money over time. Moreover, Canadian SMEs face some of the highest borrowing rates among the OECD countries in terms of spreads relative to large firms. The gaps between US and Canada angel financing and a dearth of VC investments at the $2 million-to-$5 million
This report examines the environment for Canadian business creation and growth, with a particular focus on the availability of financing and provides a series of policy recommendations with the goal of ensuring smooth capital flows to young firms with growth potential.
SME Financing: Overview
It is important to acknowledge at the outset that not all SME owners want their firms to grow. The SME population includes numerous “lifestyle businesses”; that is, SMEs whose owners seek only to achieve or maintain a particular lifestyle.
To reflect the demography of the Canadian population of small businesses, Table A-1 (in the Appendix) presents a breakdown of the distribution of growth outcomes among Canadian SMEs between 2018 and 2020 (Column A): 16.4 percent of Canadian SMEs grew their revenues more than 10 percent, while almost 40 percent reported either no or negative growth.
- Larger and younger firms;
- Firms involved in international activities, exporters, and those that intend to expand sales into new markets; and
- Innovative firms,
Firms are defined as innovative if they have introduced either: (1) new or significantly improved goods/services or process/method; (2) a new organizational method in business practices, workplace structure or external relations; or (3) a new way of selling goods or services. firms with intellectual property, those that have adopted at least one form of advanced technology and those that use an e-commerce platform or payment system.
Table A-1 in the Appendix also displays the scope of SME owners’ expectations – as of early 2021 – of future growth (Column B). Only 17.3 percent of SME owners in the SFGSME sample expected annualized growth rates to exceed 10 percent. These firms, again, tend to be larger, younger, and be involved in international or innovative activities. One in four SME owners anticipated no or negative growth during 2021-2023.
As noted in in the introduction, fast-growth SMEs account for a large share of job creation; however, only a minority of SMEs are fast growing. This phenomenon, known as the “scale-up challenge,” occurs internationally. That is, only a small share of SMEs grow quickly, but it is these firms that make the most substantive contributions to employment creation (OECD 2021a). Scaling-up appears to be particularly challenging for Canadian SMEs, with only 2 percent of mid-sized firms growing into larger ones (Remillard and Scholz 2020) and a noted lag in high-growth services-producing SMEs (OECD 2017).
Growth requires financing.
Table 1 summarizes the relative frequencies with which SMEs apply for key financing categories.
What one observes (excluding government sources during the pandemic) is SMEs’ heavy reliance on debt financing.
In general, equity financing is limited to the few SMEs among growth-oriented firms that were relatively large and that exhibited exceptional growth prospects. Accordingly, Table 1 shows that fewer than 1 percent of SMEs requested equity financing in either 2018 or 2021. Those that sought equity financing were concentrated among exporters and SMEs that experienced at least 20-percent revenue growth during the preceding three years, innovators and owners of intellectual property: that is, among firms that are relatively likely to have exceptional growth prospects.
Table 2 is consistent with Table 1 with respect to SMEs’ reliance on bank loans. The average amount of financing per request was much higher for bank loans than for any other source of financing. Accordingly, this paper focuses on commercial loans, the primary financing source for growth-oriented SMEs, and on equity capital, including angel financing and VC. Table 3 indicates the major providers of commercial loans, angel financing, and three types of VC financing based on deal size (according to Remillard and Scholz (2020)).
Debt Financing of Canadian SMEs
Availability of Debt Financing for SMEs
Table 4 summarizes approval rates (proportion of applications that were approved) and authorization rates (proportion of funds sought that were approved) for loan applications from Canadian SMEs in 2018 and 2021, indicating a healthy supply of debt financing. Authorization and application approval rates were both generally high.
Table A-2 in the Appendix, which reports the frequency with which business owners identify various perceived barriers to business growth, is consistent with this finding. The table is based on business owners’ responses to the 2018 and 2021 Statistics Canada Survey on Financing and Growth of Small and Medium Enterprises (SFGSME) and shows the frequencies of SME owners’ responses to the question: “Which of the following are obstacles to the growth of your business” The data show that obtaining financing is the least frequently mentioned of the obstacles listed.
However, the survey data also suggest the presence of subgroups of SMEs that might face relatively higher barriers to accessing debt capital. Citing “obtaining finance” as an obstacle to growth relatively frequently (see Table A-2), these groups include high-growth firms, negative-growth firms, immigrant-owned firms and firms that are majority-owned by women.
- High-growth firms (those that experienced at least 20-percent revenue growth during the preceding three years). While loan approval rates for this group are not significantly lower than the overall average, the authorization rates are lower for mortgage and term loans – 80 and 75 percent in 2018 and 90 and 87 percent in 2021, respectively.
- Negative-growth firms. Firms experiencing negative revenue growth during the preceding three-year period are relatively less likely than other SMEs to obtain requested lines of credit.
- Immigrant-owned firms. Firms owned by individuals who were born outside of Canada received, on average, only 75 percent of the amounts requested for lines of credit in 2018 (87 percent in 2022). The loan-approval rates were also low for immigrant-owned firms for line-of-credit applications (68 percent in 2018 and 79 percent in 2022).
Immigrant-owned firms tend to be small (Cukier 2017). Therefore, barriers to debt financing faced by these firms might be attributable to their smaller size. However, the SFGSME data do not suggest that small firms are disadvantaged in accessing debt capital. More definitive answers to these issues require access to the survey data and the use of multivariate methods. - Women-owned firms. Top-line results suggest that firms that are majority owned by women (those with 51 to 100 percent women ownership) tend to receive smaller amounts of bank loans, lease financing, trade credit, equity and government financing. However, simple comparisons may mask other features of women-owned firms that account for such differences. Women-owned firms, for example, differ systemically from those owned by men in terms of firm size, sector, firm age, etc. Huang and Rivard (2021), who used multivariate analyses of Statistics Canada data to account for such systemic differences, report, “…[a]nalysis of alternative metrics for access to financing – the likelihood of seeking external financing or of reporting that obtaining financing is an obstacle to growth – yields no evidence of gender differences.”
The previous section revealed that the supply of debt financing doesn’t appear to be a macro issue in terms of loan approval and authorization rates – although there may be important groups that face constraints. However, if the cost of debt is high, it may yet be a barrier despite its ready availability.
Kronick and Omran (2021), as well as Kronick and Bafale (2022), report that Canadian SMEs face relatively higher interest rates than large firms compared to SMEs in such key trading partners as the US, the UK, France and other OECD countries (Table 5). In Table 6, we review average interest rate spreads broken down by salient attributes of SME borrowers.
Table 5 reveals that spreads are high among:
- Younger firms. Firms less than two years old face relatively higher spreads for all three types of bank loans (mortgages, term loans and lines of credit).
- Growth-oriented firms. Firms whose owners anticipate higher revenue growth are subject to higher spreads for lines of credit and term loans.
- Exporters. Exporters face relatively higher spreads for mortgages and term loans.
- Negative growth firms. Firms whose owners anticipate negative growth in future are subject to higher spreads for term loans.
For the sake of brevity and clarity, we refer to these types of firms as “YGEN” firms. Note that, as we saw earlier, high-growth and negative-growth firms also face, on average, lower levels of loan approval and authorization rates.
Meanwhile, Table A-2 in the Appendix shows that “obtaining financing” is the least frequently cited obstacle to business growth among Canadian SME owners, yet these same SMEs appear to face higher borrowing costs than counterparts in other OECD countries. While what might explain this contradiction is unclear, what is clear is that high debt costs squeeze free cash flows. As well, debt’s contractually fixed costs increase the volatility of firms’ residual cash flows. The higher costs and greater volatility may increase firms’ exposure to financial distress, especially during periods of low demand. This argument is consistent with the relatively high frequency with which SME owners cite cash flow/debt management as an obstacle to growth (Table A-2).
Government interventions in markets have historically been guided by an understanding that they should only address identified market imperfections, such as capital market gaps. Interventions may be costly to taxpayers: accordingly, those that seek to facilitate access to financing should be efficient and without unreasonable exposure to risk.
Young firms. Young firms are often considered risky due to severe information asymmetry. Nevertheless, young firms are more likely to grow (see introduction and Table A-1), warranting consideration of policies designed to support such growth. In this regard, loans to these firms are often extended under the Canada Small Business Financing (CSBF) program, where the federal government guarantees the repayment in the event of default. The CSBF program requires borrower firms to pay fees in addition to lenders’ fees and interest charges – the higher payments associated with young firms might be an outcome of these additional fees. Since the program has a mandate to “increase the availability of financing to establish, expand and modernize Canadian small businesses,” it might be useful for CBSF to consider reducing the periodic fee payments.
Growth-oriented. High-growth firms might be regarded as risky because: (1) they are growing, requiring investments. In addition, they are small and thus less likely to enjoy economies of scale and more likely to be left short of cash for debt obligations; (2) they are subject to more intense information asymmetry due to the rapidly changing environment in which they operate (Binks and Ennew 1996); (3) the assets they hold are more likely intangible and, therefore, difficult to collateralize (see Section 1 and Table A-1); and (4) they are likely to engage in international trade, entering new markets (see below).
Nevertheless, as discussed in the Introduction, since the birth and growth of firms is a key driver of job creation and economic welfare, it is important to ensure their smooth access to financing to sustain their growth. In particular, it is important to address their relatively higher debt costs compared to firms they must compete with in other jurisdictions. To facilitate easier access to financing for growth-oriented firms (similar to the case of young firms), the early debt burden could be reduced by allowing fees to accumulate until maturity, thereby creating a balloon payment due at maturity to be paid by the then-grown firm. The CSBF program could also be amended to allow it to cover the portion of requested loan amounts that exceed that which financial institutions are willing to provide.
Exporters. Relatively higher interest rates charged to these firms might be due to international factors that create additional cash-flow volatility (such as fluctuations in exchange rates and more severe information asymmetry resulting from long distances to suppliers, distributors, and customers). Export Development Canada (EDC) might be well-positioned to help exporter firms reduce this volatility, which, in turn, might lower the interest rate. For example, EDC has a platform to assist SMEs with identifying appropriate hedging strategies, offers a foreign exchange facility guarantee program, and maintains publicly available databases on foreign countries and markets.
Environmental and social issues also challenge exporters, who must comply with ever-changing regulations related to sustainable development goals (SDGs) in countries to which they sell their products. This implies additional costs and risk that exporter SMEs must manage and absorb. To the authors’ knowledge, there is no policy support in this respect.
Negative-growth firms. Firms experiencing negative revenue growth are likely to be facing cash-flow issues. For these firms, it is important to identify, first, the reasons for declining revenues and whether providing (additional) lines of credit would help them recover. Only those deemed likely to return to more sustainable growth should be considered for policy intervention. Negative growth firms arguably require remedial non-financial support that might include educational programs to enhance entrepreneurs’ financial knowledge (and to prevent them from relying on such high-cost sources of borrowing as payday loans). For example, the Financial Consumer Agency of Canada offers a variety of educational programs to boost financial literacy among Canadians. It might be efficient to expand such programs for entrepreneurs. Further expanding the Business Development Bank of Canada’s (BDC) advisory capacity might also be a well-suited means of assisting these firms. Again, the CSBF program and its loans – with suggested amendments – could be applied here.
In general, and for YGEN firms in particular, the higher interest rates our SMEs face relative to their international peers increase business exit rates, leading to broader negative impacts on the Canadian economy.
We need to encourage greater competition that could further improve access to affordable capital for SMEs. One example is to encourage further business lending activity to SMEs among cooperative lenders already present within the Canadian SME sector (Nitani and Legendre 2021) through policies aimed at helping co-op lenders scale. Another might be to implement open banking, which would increase competition in the financial sector and which has lagged in Canada compared with other countries (Koeppl and Kronick 2020).
Equity-related Investments in Growing Firms
The previous section suggests that growth-oriented SMEs may, with respect to debt financing, face lower authorization rates or higher interest rates (or both) than non-growth-oriented counterparts. This might be because the amount of financing required for growth often exceeds that which banking institutions are able to provide, and the risks associated with growing enterprises may exceed that which banks can bear. Equity capital – such as angel financing and venture capital (VC), is more risk tolerant, and its investors are usually willing to provide larger amounts of financing (especially VC). Thus, equity capital constitutes a particularly important financing source for growth-oriented SMEs. This section considers these sources of financing.
Business angels are individuals who make risk capital investments directly in new and growing businesses.
- Compared to venture capitalists, they tend to concentrate on the startup and early stages of business enterprises (i.e., when access to capital is most difficult).
- Business angels are relatively accommodating to the needs of SME owners with lower rejection rates than VC funds and long-exit horizons (patient capital). Yet, their target rates of return are not dissimilar to those of institutional venture capitalists.
- They usually invest within their respective local economies.
Business angel investors typically provide financing of $100,000 ~ $200,000 (median values) to growth-oriented SMEs: exporters, innovators and firms in the information and communication technology (ICT) and healthcare sectors. Typically, angels invest at stages that are complementary to those on which VC firms focus. They are often early investors in firms that subsequently obtain VC financing. They fulfill accreditation roles and help these firms prepare for future investment stages. Madill, Haines and Riding (2005) note that a high proportion of SMEs that had received venture capital had previously benefitted from business angel investment. Like VCs, business angels mentor entrepreneurs, serve on boards of directors and provide advice, networking opportunities, hands-on assistance and business intelligence.
Business angels typically rely on three forms of financial instruments to structure their deals: preferred shares (32 percent), convertible debentures (25 percent) and Simple Agreement for Future Equity (SAFE) notes
According to the National Angel Capital Network (NACO 2022),
Despite these numbers, there appears to be a financing gap at this early stage of firm development. According to Remillard and Scholz (2020), approximately 10 percent of medium-sized SMEs hope to achieve high growth and become large firms; that is, approximately 2,257 growth-oriented medium-sized SMEs.
This gap is even more apparent when one compares Canadian angel investment activity with that in the US, where 69,060 companies collectively obtained US$29 billion of angel financing in 2021 (Table 7).
Business angels are key participants in SMEs’ early-stage growth. They provide not only growth financing but mentorship, contacts and experience as well. Business angel investment bridges the gap between early-stage, growth-oriented SMEs and firms that would be attractive to institutional VC investment. The NACO (2021) advanced several possible measures to address this gap in the supply of angel financing in Canada. We summarize them here, focusing on their advantages and disadvantages, successes and failures.
Tax incentives. The NACO has advocated for the national level front-end tax relief to stimulate business angel financing.
A national co-investment fund. Such a fund would invest alongside angels to leverage their investment and expertise. One approach might be through expansion of existing programs such as the National Research Council of Canada’s Industrial Research Assistance Program. Such programs could focus on early-stage deep tech companies that may be too risky for private fund (angels and VC)-only investments, yet might become future unicorns.
Relaxation of accredited investor requirements. On the one hand, this approach could increase the number of potential angel investors. However, this might provide risky early-stage investments to individuals who do not possess sufficient knowledge, experience and contacts to make well-informed early-stage investments or to provide the mentoring that guides enterprise growth. It is essential to consider not only increasing the pool of angel capital but also the quality of investors and investor protection. Extensive debates held in the US and Canada regarding the participation of retail investors in equity crowdfunding exemplifies this point.
Education systems for both investors and entrepreneurs. According to Thornhill and Amit (2003), poor financial decisionmaking is the primary cause of failure among young Canadian SMEs. Accordingly, education to enhance entrepreneurs’ and investors’ managerial and financial knowledge could potentially further the creation and survival of a larger pool of angel investors and promising investment-ready young firms.
Institutional Venture Capital in Canada
Historical Background and Current Figures
VC comprises professionally managed capital invested in high-potential, early-stage private companies, often in the form of equity-related financing. In addition to making financial investments, VC investors typically provide multiple tranches of follow-up financing and various forms of non-financial value-added.
Until relatively recently the supply of VC to young growing Canadian companies was heavily reliant on government and tax-incented Labour-Sponsored Venture Capital (“Retail”) funds. Canadian private independent VC funds were small compared to their international counterparts and fund managers were relatively inexperienced (Nitani and Riding 2013).
In the last decade, however, we have witnessed important changes in the Canadian VC landscape. First, most provincial jurisdictions are phasing out tax-incented retail funds. These funds were introduced in the 1990s as an initiative to facilitate the growth of the Canadian VC industry but have been criticized with respect to their effectiveness (Cumming and MacIntosh 2006).
Bradley (2019) et al. observe:
VC investment in Canada has surged. Foreign investment now represents more than 50 percent of total VC investment in Canada. VC inflows to Canada are larger than outflows. Top international funds and fund-of-funds (mostly from the US) have opened offices in Canada. A group of leading Canadian VC managers is now emerging, the size of their funds is growing, and they are becoming increasingly recognized in the US and beyond. Importantly, returns in the Canadian VC industry have improved, and leading Canadian funds are now able to raise most of their funding from private sector investors.
Both the BDC (2022) and the Canadian Venture Capital Association (CVCA 2022) report that deal volumes have reached previously “unprecedented” levels (BDC, p. 4), particularly among large (more than $50 million) deals. Likewise, the BDC notes that exits have also reached historical peaks and, for example, “12 VC-backed Canadian companies [recently went] public at home or abroad, generating exit values of $6.5 billion.”
VC investments in Canada tend to be highly concentrated in the information technology sector ($9.5 billion in 2021), with somewhat less investment allocated to the healthcare ($1.7 billion) and environment/cleantech ($0.75 billion) sectors. All other sectors combined accounted for approximately $2.7 billion during 2021. The latter category includes enterprises in primary sectors (energy, mining and forestry), which had positive earnings and above-average growth prospects but which do not seem to be as attractive to VCs.
Overall, VC investments in Canadian entrepreneurial companies increased sharply in 2021 over 2020. The median exit values and the 10-year horizon annual internal rate of returns also increased during the 2020-to-2021 period (from $31.5 million to $89.4 million and from 6 to 14 percent respectively (BDC 2022). However, given a 10X approximate population multiple, Canadian VC activity still lags behind that in the US in terms of: (1) total dollar value ($14.7 billion versus US$332.8 billion) and the number of deals (752 versus 15,855);
In this subsection, we draw from Remillard and Scholz’s (2020) recent canvas of participants active in the Canadian VC marketplace as well as from recent reviews by the BDC (2022) and the CVCA (2022).
Remillard and Scholz provide a useful characterization of the supply side of the Canadian VC deals as comprising three “tiers”:
- The low tier: deals that fall in the $2 million-to-$5 million range;
- The medium tier: deals between $6 million and $10 million; and
- The high tier: deals worth $20 million or more.
US-based VC funds dominate the high tier.
In the medium tier, the supply side primarily comprises domestic VCs, bank-owned investment firms, government funds and family offices. Remillard and Scholz conclude that the supply of capital at this level is sufficient to “meet the needs of companies that are worth backing and that the only ones complaining are companies that should not be financed in the first place.”
Conversely, a financing gap appears to exist in the low tier. To make investments in this segment, VCs face a combination of low capital requirements, relatively high risks and the consequent high fixed costs (relative to deal size) of legal and due diligence fees. Deal sizes are typically beyond the range of interest to business angel investors, even if they accept the high risk (see Table 6), too risky for banks and too small and too risky for VC funds. While Crown corporations (BDC, EDC) are active in this tier, private funds tend to shy away. Active investors also include exempt market participants (see footnote 12), family offices, specialty debt funds, junior stock exchanges
The availability of US funds provides Canadian investors with international networks and sector-specific expertise, factors that might facilitate further the development of the Canadian VC sector. Nonetheless, Remillard and Scholz (2020 p.12) report industry participants’ concern that in today’s technology-driven world, “Canada risks losing its future high-potential, job-creating and export-oriented champions.” Bradley et al. (2019 p.10) also make a similar argument: “There is a growing concern that very few Canadian VC-backed companies scale up in Canada and that the large role played by foreign investors may increase the probability of promising companies moving South of the border or being acquired (too early) by foreign companies.”
In addition, the small size of Canadian VC funds (relative to US counterparts) may limit Canadian funds’ and entrepreneurs’ negotiation powers. This is because a small fund size may imply the VC has limited ability to provide the quanta of financing sufficient for their investee firms to reach successful exits (an IPO or an acquisition) without relying on US funds.
In all tiers, domestic VC funds make significant value-added to investee firms, while monitoring them closely (often as a lead investor in the syndicate). They do so by taking advantage of their expertise on, and networks within, the local market, as well as their proximity to investee companies, which allows them to give hands-on advice.
To sustain the healthy growth of the Canadian VC industry observed in 2021, it is essential to add further to the supply of equity capital, taking into consideration that the supply issues are most severe at the low-tier capital level (investment deals in the $2 million-to-$5 million range). Ensuring sufficient capital supply for entrepreneurial firms at this stage is also critical to cultivating attractive deals for the subsequent tiers.
Government initiatives, such as the VCAP and VCCI programs, should focus their attention on ensuring sufficient supply of low-tier capital.
One potential barrier to VCs making these kinds of low-tier investments is the administrative, professional, regulatory and personnel costs associated with a VC investment, which is in large part fixed, regardless of the investment size. These fixed costs make it very hard for most VCs to commit themselves to investment deals in the $2 million-to-$5 million range and generate sufficiently high returns. One possible policy recommendation to deal with this concern is for the government and para-public to cover some portion of the due diligence costs incurred by private VC funds in association with low-tier deals.
Foreign VC domination in high- tier deals:
With respect to the domination of US funds among top-tier deals and their impact, there is a lack of consensus and scarcity of empirical evidence. Complex questions that remain include:
- To what extent does the presence of US funds provide Canadian investors with international networks and sector-specific expertise?
- Does the presence of US funds risk Canada losing future high-potential, job-creating and export-oriented businesses?
- For what reasons do Canadian VC funds include US funds within later-stage financing syndicates? Are Canadian VCs capable of providing the quanta of financing sufficient for their investee firms to reach successful exits (an IPO or an acquisition) without reliance on US funds? If not, and if this is why US funds are involved in late-stage Canadian deals, does this weaken Canadian investors’ negotiation power?
At present, these critical questions are difficult to answer conclusively without analyses of detailed deal-level data, which we do not have. Nevertheless, consistent with Bradley et al. (2019), we argue that it remains critical to support the growth of domestic funds for all tier deals, which expand Canadian companies’ sufficient scale-up opportunities before foreign investors are involved.
Conclusions
This Commentary has reviewed the scope of access to financing among Canadian SMEs. This is an especially critical area of research given the fact that Canadian SMEs appear to face difficulties with respect to scaling up.
Overall, there appears to be a healthy supply of debt capital for Canadian SMEs. However, the data suggest that growth-oriented firms may not be able to obtain the size of bank loans they require. Moreover, compared to the borrowing costs SMEs enjoy in other OECD countries, the interest rates faced by Canadian SMEs are relatively high, especially for growth-oriented enterprises. To address this issue, it would be useful to consider a redesign of the CSBF program through which many young growth-oriented firms obtain loans. Encouraging greater competition among commercial lenders through scaling up of cooperative lenders and implementing open banking could further improve access to affordable capital.
As for equity financing, there appear to be shortages in financing for companies that seek investments of less than $5 million. Of particular importance – and while estimates are not as reliable as might be hoped – the scale of business angel financing in the US dwarfs that which is evident in Canada. Given the importance of business angels in providing entrepreneurs with various forms of non-financial value added (mentoring, advice, contacts, etc.),
The OECD (2021b, and Williams 2021) indicates that Canada will have the lowest economic growth among OECD countries for the next 40 years, largely due to its low productivity. One of the key drivers for productivity growth is faster innovation adoption (Williams 2021) and growth-oriented firms are most likely to be the providers. Yet, as this paper has shown, growth-oriented firms are disadvantaged in accessing debt financing, and early stage equity financing is limited. Time for that to change.
Appendix
References
Adelino, M., S. Ma, S., and D. Robinson. 2017. “Firm Age, Investment Opportunities, and Job Creation.” The Journal of Finance, 72(3): 999-1038.
Binks, M., and R., C.T. Ennew. 1996.” Growing Firms and the Credit Constraint.” Small Business Economics, 8(1): 17–25
BLG. 2022. “Canada’s Exempt Market – Growing, Growing, Growing.” Accessed at: https://www.blg.com/en/insights/2022/12/canadas-exempt-market-growing-growing-growing, accessed January 7 2023.
Bradley, W. A., G. Duruflé, T.F. Hellmann, and K.E. Wilson. 2019. “Cross-Border Venture Capital Investments: What is the Role of Public Policy?” Journal of Risk and Financial Management, 12(3): 1-22.
Business Development Bank of Canada. 2022. “Canada’s Venture Capital Landscape.” Accessed at: https://www.bdc.ca/globalassets/digizuite/36181-report-canada-venture-capital-landscape-2022.pdf
Bygrave, W., M. Hay, E. Ng, and P. Reynolds, P. 2003). Executive forum: a study of informal investing in 29 nations composing the Global Entrepreneurship Monitor. Venture Capital: An International Journal of Entrepreneurial Finance, 5(2): 101-116
Camerer, C., and D. Lovallo. 1999. “Overconfidence and excess entry: An experimental approach.” American Economic Review, 89(1): 306-318.
Canadian Venture Capital and Private Equity Association (CVCA). 2022. “Canadian venture capital market overview YTD Q3 2022.” https://www.cvca.ca/research-insight/market-reports/q3-2022-vc-pe-canadian-market-overview. Accessed on November 27, 2022.
______________. 2023. “Canadian venture capital market overview 2022 year in review.” Accessed at: https://www.cvca.ca/research-insight/market-reports/year-end-2022-vc-pe-canadian-market-overview. Accessed on April 26, 2023.
Carpentier, C., and J.M. Suret, J. M. 2016. “The effectiveness of tax incentives for business angels.” In Handbook of research on business angels (pp. 327-353). Edward Elgar Publishing.
Cukier, W. 2017. “Immigrant Entrepreneurship: Barriers and Facilitators to Growth” (p. 44). Ted Rogers School of Management’s Diversity Institute.
Cumming, D. J., and J.G. MacIntosh. 2006. “Crowding Out Private Equity: Canadian Evidence.” Journal of Business Venturing, 21: 569-609.
Dachis, B., and J. Lester. 2015. Small Business Preferences as a Barrier to Growth: Not so Tall after All. Commentary 45. Toronto: C.D. Howe Institute.
Dixon, J. 2014. “The Distribution of Employment Growth Rates in Canada: The Role of High-growth and Rapidly Shrinking Firms.” Statistics Canada. https://www150.statcan.gc.ca/n1/en/pub/11f0027m/11f0027m2014091-eng.pdf?st=gTOQpT4f, accessed on November 28, 2022.
European Commission. 2015. “Effectiveness of tax incentives for venture capital and business angels to foster the investment of SMEs and start-ups.” Accessed at: https://taxation-customs.ec.europa.eu/system/2017-06/final_report_2017_taxud_venture-capital_business-angels.pdf.
Fairlie, and F. Fossen. 2018. “Opportunity Versus Necessity Entrepreneurship: Two Components of Business Creation.” In Policy File. CESifo Group Munich.
Gompers, P., and J. Lerner. 2003. “Short-Term America Revisited? Boom and Bust in the Venture Capital Industry and the Impact on Innovation.” Innovation Policy and the Economy, 3: 1–27. https://doi.org/10.1086/ipe.3.25056151
Govindarajan, V., B. Lev, A. Srivastava,,and L. Enache, L. 2019. “The Gap Between Large and Small Companies Is Growing. Why?” Harvard Business Review, https://hbr.org/2019/08/the-gap-between-large-and-small-companies-is-growing-why, accessed on December 27, 2022.
Hacamo, I., and K. Kleiner, K. 2020. « Forced Entrepreneurs. » Working Paper. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2801637
Haines Jr, G. H., J.J. Madill, and A.L. Riding. 2003. “Informal investment in Canada: financing small business growth”. Journal of Small Business & Entrepreneurship, 16(3-4): 13-40.
Harrison, R. T., and C.M. Mason. 1992. “The roles of investors in entrepreneurial companies: a comparison of informal investors and venture capitalists, in N.C. Churchill, S. Birley, W.D. Bygrave, D.F. Muzyka, C. Wahlbin and W.E. Wetzel Jr. (Eds) Frontiers of Entrepreneurship Researc. Babson Park, MA: Babson College.
Harrison, R T, A.J. Bock, and G. Gregson. 2020. “Stairway to heaven? Rethinking angel investment policy and practice.” Journal of Business Venturing Insights, 14(1).
Hodgson, L. 2022. “Singapore tops list in VC funding per capita.” https://pitchbook.com/news/articles/vc-funding-per-capita-singapore-israel-united-states
Huang, L., and P. Rivard. 2021.” Financing of women-owned small and medium-sized enterprises in Canada.” Innovation, Science and Economic Development Canada. Retrieved from https://www.ic.gc.ca/eic/siTe/061.nsf/eng/h_03138.html
Hurst, E., and B.W. Pugsley. 2011. What Do Small Businesses Do? Brookings Papers on Economic Activity, Fall: 73-118.
Industry Canada. 2014. Evaluation of the Canada Small Business Financing Program. https://www.ic.gc.ca/eic/site/ae-ve.nsf/eng/h_03711.html
Innovation, Science and Economic Development Canada (ISED, 2021, 2022, 2023). Key Small Business Statistics (KSBS). Ottawa: Innovation, Science and Economic Development Canada. Retrieved from https://ised-isde.canada.ca/site/sme-research-statistics/en/key-small-business-statistics
Koellinger, P., M. Minniti, andC. Schade. 2013. “Gender Differences in Entrepreneurial Propensity.” Oxford Bulletin of Economics and Statistics, 75(2): 213–234. https://doi.org/10.1111/j.1468-0084.2011.00689.x
______________. 2011. “Excess Entry and Entrepreneurial Decisions: The Role of Overconfidence.” In The Dynamics of Entrepreneurship. Oxford University Press. https://doi.org/10.1093/acprof:oso/9780199580866.003.0002
Koeppl, T.V., and J. Kronick. 2020. Open Banking in Canada – The Path to Implementation. Commentary No. 579. Toronto: C.D. Howe Institute. September.
Kong, S., M. Nitani, and A. L. Riding. (2016). “Cross-border VC investment in Canadian firms: implications for exit patterns.” Venture Capital, 18 (1): 63–93.
Kronick, J., and F. Omran, F. 2021. “Upping our Game: How Canada’s Financial Sector Can Spur Economic Performance.” E-Brief. Toronto: C.D. Howe Institute. Retrieved from https://www.cdhowe.org/sites/default/files/attachments/research_papers/mixed/e-brief_314_0.pdf
Kronick, J., and M. Bafale. 2022. “Deepening Canadian Capital Markets.” Intelligence Memos. Toronto: C.D. Howe Institute. Retrieved from https://www.cdhowe.org/intelligence-memos/kronick-bafale-deepening-canadian-capital-markets
Lerner, J., Bernstein, S., Dev, A., and Bai, J. (2021). The government as an (effective) venture capitalist. The Centre for Economic Policy Research (CEPR). Retrieved from https://cepr.org/voxeu/columns/government-effective-venture-capitalist.
Madill, J. J., G.H. Haines, Jr., and A.L.Riding. 2005. “The role of angels in technology SMEs: A link to venture capital.” Venture Capital, 7(2): 107-12.
Mazzucato, M. 2018. “Mission-oriented innovation policies: challenges and opportunities.” Industrial and Corporate Change, 27 (5): 803–815.
National Angel Capital Organisation (NACO). 2022. “Annual report on angel investing in Canada.” https://digital.builtbyangels.com/link/913906/60/.
National Venture Capital Association (NVCA). 2022. NVCA 2022 Yearbook. Retrieved from https://nvca.org/wp-content/uploads/2022/03/NVCA-2022-Yearbook-Final.pdf.
Newman, A., M. Obschonka, S. Schwarz, M. Cohen, and I. Nielsen. 2019. “Entrepreneurial self-efficacy: A systematic review of the literature on its theoretical foundations, measurement, antecedents, and outcomes, and an agenda for future research.” Journal of Vocational Behavior, 110: 403-419.
Neville, F., B. Orser, A. Riding, and O. Jung. 2014. “Do young firms owned by recent immigrants outperform other young firms?” Journal of Business Venturing, 29(1): 55–71.
Neymotin, F. 2021. “’Necessity and Opportunity Entrepreneurship in Canada.” Review of Economic Analysis, 13(2): 235-251.
Nitani, M., and N. Legendre. 2021. “Cooperative lenders and small business loan performance.” Journal of Banking and Finance, 128(7):106-125
Nitani, M., and A. Riding. 2013. “Fund size and the syndication of venture capital investments.” Venture Capital (London), 15(1): 53–75. https://doi.org/10.1080/13691066.2012.730654
Nitani, M., A. Riding, and B. Orser. 2020. “Self-employment, gender, financial knowledge, and high-cost borrowing.” Journal of Small Business Management, 58(4), 669-706.
OECD. 2018. “Enabling SMEs to scale up.” Paris: OECD publishing. Retrieved from https://www.oecd.org/cfe/smes/ministerial/documents/2018-SME-Ministerial-Conference-Plenary-Session-1.pdf
______. 2017. “SME and Entrepreneurship Policy in Canada.” Paris: OECD publishing. Retrieved from https://www.oecd.org/publications/sme-and-entrepreneurship-policy-in-canada-9789264273467-en.htm
______. 2021a. “Understanding Firm Growth: Helping SMEs Scale Up.” OECD Studies on SMEs and Entrepreneurship. Paris: OECD publishing. Retrieved from https://doi.org/10.1787/fc60b04c-en
______. 2021b. “The long game: fiscal outlooks to 2060 underline need for structural reform.” OECD Economic Policy Paper no.29. Paris: OECD publishing. Retrieved from https://www.oecd.org/economy/growth/scenarios-for-the-world-economy-to-2060.htm
______. 2022. Financing SMEs and Entrepreneurs 2022: An OECD Scoreboard, OECD Publishing, Paris, https://doi.org/10.1787/e9073a0f-en.
Ontario Securities Commission. 2021. “The exempt market explained.” https://www.getsmarteraboutmoney.ca/protect-your-money/investor-protection/regulation-in-canada/the-exempt-market-explained/. Accessed January 7 2023.
Orser, B. J., A.L. Riding, and K. Manley, K. 2006. “Women entrepreneurs and financial capital. Entrepreneurship Theory and Practice, 30(5): 643-665.
Parastuty, Z, R.J. Breitenecker, E.J. Schwarz, and R. Harms. 2016. “Exploring the Reasons and Ways to Exit: The Entrepreneur Perspective.” In Contemporary Entrepreneurship (pp. 159–172). Springer International Publishing. https://doi.org/10.1007/978-3-319-28134-6_10
Pavitt, K. 1984. “Sectoral Patterns of Technical Change: Towards a Taxonomy and a Theory.” Research Policy, 13(6): 311−379.
Plant, C. 2017. “A Failure to Scale: Are We Creating Financially Unattractive Companies?” Impact Brief. University of Toronto, Impact Centre. February.
Politis, D. 2008 “Business angels and value added: what do we know and where do we go?” Venture Capital 10: 127-147.
PWC (2020). “Private equity: a significant driver of growth for Canadian SMEs.” Retrieved from https://www.cvca.ca/files/PwC-Private-Equity-A-significant-driver-of-growth-for-Canadian-SMEs-FInal.pdf
Remillard, R. 2017. Government Intervention in Venture Capital in Canada: Toward Greater Transparency and Accountability. Commentary No. 466. Toronto: C.D. Howe Institute. https://www.cdhowe.org/sites/default/files/2021-12/Commentary_466.pdf
Remillard, R., and M. Scholz. 2020. Access to Capital for Canadian Growth-Oriented, Medium-Sized Firms, Small Business Branch, Innovation, Science and Economic Development Canada, https://www.ic.gc.ca/eic/site/061.nsf/vwapj/2020_AccesstocapitalforCanadiangrowth.pdf/$file/2020_AccesstocapitalforCanadiangrowth.pdf
Shaheen, J. A. 2019. Emerging the US Firm Size Distribution Using 4.2 Billion Individual Tax Records. In Proceedings of the 12th International RAIS Conference on Social Sciences and Humanities (pp. 74-82). Scientia Moralitas Research Institute. April.
Song, M., and C. Bérubé. 2021. “Canadian Start-ups: Growth and Scale-up Transitions.” Ottawa: Innovation, Science and Economic Development Canada. Retrieved from https://www.ic.gc.ca/eic/site/061.nsf/eng/h_03132.html
Statistics Canada. 2020. Various tables: The Survey of Financing and Growth of SMEs. https://www150.statcan.gc.ca/n1/daily-quotidien/220302/dq220302b-cansim-eng.htm
_____________. 2021. Table 33-10-0493-01: Canadian Business Counts, with employees, December 2021 [Data table]. doi: https://doi.org/10.25318/3310049301-eng
_____________. 2021. Table 14-10-0026-01: Employment by class of worker, monthly, unadjusted for seasonality (x 1,000) [Data table]
_____________. 2022. Table 14-10-0068-01: Employment by establishment size, annual (x 1,000) [Data table]. doi: https://doi.org/10.25318/1410006801-eng
Sylla, D. 2018. Enterprise size class transitions in Canada. Statistics Canada. Retrieved from https://www150.statcan.gc.ca/n1/pub/18-001-x/18-001-x2018001-eng.
Thornhill, S., R. Amit. 2003. “Learning about failure: Bankruptcy, firm age, and the resource-based view.” Organization Science, 14(5): 497–509.
Tu, J., Clarke, W., Dolan, S. 2022. “Untangling the seed and early-stage funding environment in Canada.” ISED, Retrieved from https://ised-isde.canada.ca/site/sme-research-statistics/sites/default/files/attachments/2022/2022_Untangling.pdf
Williams, D. 2021. “OECD predicts Canada will be the worst performing advanced economy over the next decade…and the three decades after that.” Business Council of British Columbia, Insights. Retrieved from https://bcbc.com/insights-and-opinions/oecd-predicts-canada-will-be-the-worst-performing-advanced-economy-over-the-next-decade-and-the-three-decades-after-that
