July 20, 2023 – The growth of Canada’s small- and medium-sized enterprises (SMEs) – the engine of our country’s economy – lag behind those in other advanced economies and face hurdles to financing that are dampening their prospects, according to a new report from the C.D. Howe Institute.
In “Scaling Up Is Hard To Do: Financing Canadian Small Firms,” authors Miwako Nitani and Aurin Shaila Nusrat examine the nature of SME growth, barriers and access to finance in Canadian financial markets – with a specific focus on the availability of financing and recommendations to ensure capital flows to firms with growth potential. This area of research is especially critical given that Canadian SMEs appear to face difficulties when scaling up.
Overall, despite Canada’s healthy supply of debt financing, access to financing is a concern for firms that are young, growth-oriented, and exporters.
Canadian SMEs also face relatively high borrowing costs compared to SMEs in other OECD countries. “Both in general, and for young, growth-oriented, and export 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,” says Nitani.
As for equity capital, such as angel financing and venture capital (VC), there appears to be a financing gap at firm’s early development stage.
Notably, the scale of angel financing business in the US dwarfs Canada. Comparing angel investment activity, there is an angel investor available for every 17 SMEs in the US, while there is an investor available for every 24-to-60 SMEs in Canada.
Although VC investments in Canadian entrepreneurial companies have increased from the past, Canadian activity still lags the US when it comes to: total dollar value of investments and the number of deals; total VC investments as percent of GDP; exit values; and internal rate of returns.
In order to sustain the industry’s growth, the authors say it is essential to add further to the supply of equity capital, taking into account how shortages in financing for companies are most severe at the low-tier capital level, or 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 other investment tiers,” says Nitani.
Notably, the authors say policy action is required in both debt financing and equity financing in order to help remedy this situation.
For instance, for young and growing 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 repaid by a balloon payment at maturity. Meanwhile, for high growth firms, the CSBF program could be amended to allow it to cover the portion of requested loan amounts that exceed what financial institutions are willing to provide. Finally, for exporters, Export Development Canada could help reduce exchange rate volatility through their foreign exchange facility guarantee program.
As for the gap in Canada’s supply of angel and seed/early stage VC financing, the authors recommend a national co-investment fund that would invest alongside angels to leverage their investment and expertise. Some approaches might be through expansion of existing programs such as the National Research Council of Canada’s Industrial Research Assistance, as well as the federal government Venture Capital Action Plan and the Venture Capital Catalyst Initiative programs.
“Growth requires financing,” says Nitani. “It is, therefore, important for Canadian policymakers to ensure that firms with high growth potential can obtain the financing they need to nourish their development and contribute to Canada’s economic growth.”
For more information contact: Miwako Nitani, Associate Professor of Finance, University of Ottawa, and Fellow-In-Residence, C.D. Howe Institute; Aurin Shaila Nusrat, PhD candidate of Finance, University of Ottawa, and former IMCO Research Intern, C.D. Howe Institute; Lauren Malyk, Communications Officer, C.D. Howe Institute, 416-865-1904 Ext. 0247, lmalyk@cdhowe.org
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.