Good small businesses face funding challenges

Even when an entrepreneur has a winning idea to fill a market niche, the cash to actually make it happen — or to keep a venture going — can be hard to come by.

After they’ve exhausted their own capital, along with anything they can secure from friends and family, banks are typically the first stop for a small business looking for cash. In the wake of the 2008 financial crisis, it’s not difficult to find an entrepreneur with tales involving a frosty reception from the banks, but relations are starting to warm up.

Although it's yet to return to pre-recession levels, for example, the amount of money Canada's biggest bank is loaning to small businesses is on the rise.

"We’ve seen our client counts go up quite a bit," says Mike Michell the national director for small business at Royal Bank.

"The earliest days of the recession in late 2008 were probably the low point for everything, but we've seen our volumes go up on a three-year trend."

'No one silver bullet that's going to solve the problem of access to capital' —CVCA head Greg Smith

With an albeit wobbly economic recovery now under way, Michell says the bank is seeing a larger number of businesses than normal starting up. That's not unusual coming out of a recession, but Michell is hopeful of even more potential business to come.

"We're always on the lookout," he says.

Canadian banks are extraordinarily well capitalized compared to their peers in other countries, and better-equipped to loan money to a worthy small enterprise than they have been in years.

The financial outlook for small businesses in general also seems to be improving. Business insolvencies were down 17 per cent in the year ended June 2011 compared to the same period a year earlier, official data shows.

Even more encouragingly, bankruptcies were down by even more during the same period, while "proposals to creditors" — basically alternative loan resolutions where lenders and borrowers negotiate a repayment plan different from the original terms — were actually higher.

That suggests that even when they fall on tough times, businesses are managing to keep their heads above water and are not having to pull the plug on a venture that could be on the cusp of turning things around.

That's not to say anybody's just handing out blank cheques to small businesses, though.

Entrepreneur Eric Gilboord spent the first half of his 20-year career at multinational advertising agencies helping clients expand their businesses. Then he took his marketing expertise and helped turn a small agency with four employees and annual revenue measured in the six figures into one with dozens of staff and millions in annual sales.

In his latest business venture, Gilboord founded Bizness Central, an integrated sales and marketing company with office space just outside Toronto’s downtown core. The idea builds on his passion, so the business concept was the easy part.

Finding the right funding source has proven much more difficult. His main problem is a Goldilocks scenario — he's too small to tap sources of professional, managed money, but he hasn't found the right small investor who's willing to take an active role in the company.

"I’ve got all the other pieces of the puzzle to fit, but finding that right financial partner has been a challenge," he says.

He's certainly not alone.

"What we hear from our small business clients is that they very much want to get on the bandwagon of recovery, but they’re having trouble finding the cash to do so," says Jean-Rene Halde, CEO of the Business Development Bank of Canada — the federal government’s agency tasked with supporting the financing needs of Canadian entrepreneurs.

BDC doled out $3.2 billion in financing to Canadian entrepreneurs in fiscal 2011. That was less than the $4.3 billion the year before, but in some ways it’s actually an encouraging sign.

That’s because the BDC’s mandate is to be something of a lender of last resort. In an ideal world the BDC would not be needed, Halde says, since that would mean the private sector was getting capital efficiently to promising businesses that needed it.

"If we have to ramp up our involvement, we will, but in an ideal world somebody else does," Halde says

Venture capitalists

Unfortunately, the reality in Canada today is a long way from that ideal scenario.

One of the most common ways of bankrolling a new business is to work with what’s known as venture capitalists. They are pools of professionally managed money, always looking for the next small idea that needs funding to reach its full potential.

"Canada’s venture capital industry really only got started in the 1970s and 1980s, so we’re still comparatively immature," says Greg Smith, president of the Canadian Venture Capital Association and an executive at Brookfield Financial Corp.

The CVCA says the industry invested $315 million in the first quarter of 2011, a slight increase from 2010’s level. But that’s well off the $6.1 billion that U.S. venture firms spent during the same period.

And of that $315 million invested in small Canadian firms, more than $100 million actually came from U.S. investors — another indicator that Canada's venture capital industry isn't yet standing on its own two feet, and that things have a long way to go before the private sector makes the BDC obsolete.

The old rule of thumb of taking a Canadian statistic and multiplying it by 10 to get a rough comparison with the U.S. indicates how far Canada is lagging its southern neighbor when it comes to making sure new ventures get bankrolled.

"Demand well exceeds supply," as Halde puts it.

The hottest sector for VC funding in Canada right now is the internet technology space. Tech firms got almost half of all VC funding last quarter, and communications firms did especially well, securing $69 million worth of new investment.

Life sciences and clean energy are two sectors that have attracted a lot of funding in recent years, but both saw their share of the pie decrease by between one quarter and one third this year, CVCA data shows.

"The companies that are doing well are the ones that are competitive on a global scale," Smith says.

And a closer look at the latest numbers paints an even bleaker picture. Investment has held relatively steady, but CVCA data shows fundraising activity is down by more than 50 per cent this year. That’s a troubling leading indicator for worthy entrepreneurs looking for funding in the near future.

Angels

Another option is angel investors. They typically operate on a smaller scale than the million-dollar stakes that VC funds tend to buy in a company.

Here, too, are a few rays of hope for small businesses. Angels tend to invest their own money, and with the baby-boom generation retiring they’re often self-made investors who have recently retired but are looking for investments that will keep them active in the sectors they find interesting. A deal with this type of angel can bring more than just capital to a company.

"The last thing they want to be is passive," says Gilboord, who is still looking for the right partner. "I’ve had some great conversations with angel investors who have the experience and the capital, and they want to make sure that both are well-utilized."

Some say improving government support for angel investors is the key to boosting investment in small businesses.

"We’ve got to focus on the whole ecosystem," Smith says. "There's no one silver bullet that's going to solve the problem of access to capital."

'The earliest days of the recession in late 2008 were probably the low point' —Mike Michell, Royal Bank

He’s encouraged by a few steps governments are taking across the country. The elections in B.C. and Ontario have spurred campaign promises about tax credits for angel investors, for example. And he likes government attempts to boost private investment by encouraging labour-sponsored investment funds.

But Smith is adamant it’s not just about throwing public money at the problem. Removing regulatory hurdles for eager foreign investors can be just as important.

Larger companies also need to step up, and Canada is seeing some evidence of that. Research in Motion — itself the product of some well-timed VC capital in the 1990s — backs a BlackBerry Partners Fund to discover and support the next innovators in mobile computing. Telecom giant Rogers does something similar, and Canada’s pharmaceutical industry has started funding a slew of life sciences-focused ventures.

"Success breeds success," Smith says. He notes that in the U.S., about 10 per cent of all jobs are at companies that got VC funding at some point — proof positive that focused investments at the right time can be a boon for the economy as a whole down the line.

As Smith puts it, "funding ideas doesn’t have to be a drain on finances."

That’s quite a bold little idea. And just like any small business, it’s one that needs some support.