Can the Exempt Market Revive Canadian Small Business?
By: Cora Pettipas
Small businesses are considered the backbone of the Canadian economy, but they currently have a backache from the funding gap. Small to mid-size enterprises (SMEs) are the future in terms of employment and innovation drivers for the Canadian economy. Unfortunately, they are having challenges in accessing capital needed for operations and growth. With current government austerity plans and cheaper labor resources found elsewhere in the world, the external environment leaves the Canadian economy vulnerable. Could the exempt market help efficiently allocate capital to revive smothering SMEs?
To understand SMEs vital role in the economy, it is important to appreciate just how prevalent they are in Canada. SMEs, firms defined as having less than 500 employees, make up approximately 98.1% of Canadian companies, and approximately 54% of GDP. SMEs are defined by the number of employees, not by total revenue or profitability. Mid-size firms are defined as having 100-499 employees; small firms have 4-99 employees (micro firms have 1-4 employees).
The vast majority of these businesses are privately owned, and not publicly listed corporations. According to a recent study from the Business Development Bank of Canada (BDC) in 2011, SMEs contributed to 63.7% of Canadian private sector employment, the majority of private sector jobs. Contrary to popular belief, the minority of employment and job growth in Canada comes from publicly listed multinational corporations.
Unfortunately, the number of Canadian SMEs is decreasing, especially in the mid-size range. A concerning trend is that firms in the mid-size range have decreased by 17% from 2006 to 2010 in Canada. In Ontario, the trend is more severe, as they had a 25% decrease for the same period, attributed to the hollowing out of the manufacturing base caused by globalization pressures in that province. SMEs are decreasing because of limited access to capital. In the BDC’s study What Happened to Mid-sized Firms? Mid-Size businesses’ key challenge, as stated by 40% of respondents, is ‘availability of financing.’ “Overall, three quarters of key decision makers working at Canadian mid-sized firms believe it is very important or important for government institutions to provide banking and financing services for growing companies,” stated the BDC report. Currently, 55% of mid-size business use bank financing as their primary source of capital, and only 1% comes from private investors and private financing. According to the BDC Viewpoints study in 2011, ‘problems accessing additional financing’ was stated as the second greatest challenge to SMEs, at a 32% response rate.
Lack of access to capital is effecting SMEs strategic business decisions and stagnating plans for growth, innovation and investment. Entrepreneurs are cash starved, and not investing as much as they would like into their businesses. The Investments BDC Viewpoint Study published in 2012 surveyed over 500 principals of Canadian SMEs about business investment spending. Over half of respondents stated that they plan to participate in business investment, and the majority stated that they would like to invest more or earlier, but access to credit was an inhibiting factor. The stated obstacles to investment were ‘insufficient working capital’ at 50%, and ‘limited access to credit’ at 30% of respondents polled.
SMEs do have other capital raising options. SMEs can raise money to fund and grow their small businesses through the exempt market. The OM exemption gives SMEs another option to infuse their business with capital; other than the more prevalently used options: traditional bank financing, going public with a prospectus offering, or bootstrapping. To prepare an OM costs as little as $20,000, as opposed to a prospectus which costs $200,000 or more depending on the law firm involved. In addition, an OM can take as little as four weeks to create, whereas the prospectus offering can take up to six months. SME credit financing from banks, the most predominant form of SME financing, has never been harder to come by. In our current economic climate, banks are much more inclined to finance ongoing businesses with proven cash flows than they are new ventures or SMEs in growth stages.
Small Business is also looking for alternative sources of capital, and they can utilize alternative strategies. SMEs are requesting that the government help them to raise capital, although it is unlikely that in an austerity environment government will increase small business funding and grant programs. A current solution is raising funds though the Exempt Market. As stated by Darren Smits, partner at Miller Thomson and a Director of NEMA, “Our firm in Alberta is very experienced in the exempt market industry, and have seen first-hand how the exempt market allows entrepreneurs to efficiently raise capital and for investors to participate in a broader range of investment options.”
Businesses have flexibly in their options with business structures and types of securities for raising investment capital, but they also need flexibility in their capital raising options. By providing options for more readily accessible capital, the exempt market can support the revival by filling the funding gap for Canadian small business.