Where SMEs Turn When Bank Loans Fall Out Of The Picture

Nearly half of Canada’s SMEs have applied for some form of financing in recent years. But despite its market size, SMEs are struggling to get the working capital they need.

A new report by the Canadian Federation of Independent Business (CFIB) released this month explores the financing efforts of SMEs between 2012 and 2015. Banks, naturally, are often these businesses’ first destinations when seeking credit. But the CFIB’s report reveals how companies struggle to fill in the gaps after being denied for a bank loan that meets their needs.

The Gap Is Wide

Even with the SMEs that did not seek financing in the time period, the CFIB found that many of these companies expressed a need for capital anyway. Nearly half (49 percent) of companies surveyed said that, besides bank loans, they sought financing via their own personal equity or assets. And 8 percent of the SMEs that didn’t seek a bank loan said they figured their bank would decline their application.

“It is possible that, because businesses have been rejected for financing in the past, they may have stopped trying altogether,” concluded Queenie Wong, senior research analyst at CFIB and author of the report.

According to data released in the report, while the percentage of SMEs rejected for a bank loan (15.4 percent) has declined since a high of 19.3 percent in 2009, it still is significantly higher than levels seen in 2000 (10.5 percent).

But the smallest businesses, often in the most need of bank financing, are more likely to be rejected, the CFIB found. Companies with five employees or fewer face a 22.3 percent rejection rate; meanwhile, for companies with between 50 and 499 employees, rejection rates are just 3.7 percent.

In one response offered by an SME client of TD Canada Trust, a business owner expressed frustration at the current SME finance climate.

“I’m very discouraged with the banks and small business,” the business owner said. “They are very restrictive, require excessive collateral, and as a result, we’re planning an expansion and looking into alternative sources of money. We’ll likely continue to use bank money for lines of credit but will, in all likelihood, use a leasing company to finance the expansion.”

“The financing terms are comparable with fewer restrictions and entanglements with commercial banking,” the business owner added.

Filling The Gap

Alternative finance has grown with a reputation of being a solution to the lack of bank financing offered to SMEs. But according to the CFIB, only 0.1 percent of SMEs surveyed said they had used financing tools like crowdfunding to finance their business (though it is unclear whether the research includes marketplace lending sites and alternative finance players under the term “crowdfunding”).

Instead, nearly a third (30 percent) said they use credit cards to fill in their financing gaps, a trend that author Wong described as “concerning.”

“Although some of the credit card financing used could be related to day-to-day purchases by the business, the use of credit cards may suggest that financing needs are not being met by traditional sources of financing through banks, especially among the smallest businesses,” the author wrote.

The CFIB noted that SMEs are turning to “less risky” forms of financing other than bank loans to meet their needs. With so many using personal finances to fill in the gaps, small businesses appear to be looking for the safest route when seeking capital. But, as expressed in the small business owner’s response, leasing is also a popular way to finance a company, with 14 percent reporting having used this tool. Nearly the same amount (13 percent) said they turned to friends and family, while personal bank loans and lines of credit are also common.

In all, CFIB President Dan Kelly said, the report highlights the struggle SMEs face to access a bank loan — and the aftermath of rejection. And, the CFIB noted, alternative finance doesn’t seem to be lessening the burden.

“Small businesses face considerable barriers based on their size when they apply for bank financing,” Kelly said in a statement. “While there has been much buzz about FinTech and online lending in general, what small business owners want most from their bank is a personal relationship based on mutual understanding.”