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Funding gap for smaller rounds crimping growth of Canada’s mid-sized firms, federal report says

A mural by WERC at the back of Collective Arts Brewing in Hamilton, Ont., pictured in October 2019.
A mural by WERC at the back of Collective Arts Brewing in Hamilton, Ont., pictured in October 2019. The Canadian Press/Sean Kilpatrick
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Mid-sized Canadian companies face difficulties securing smaller sums of funding to expand, according to a report commissioned by the federal government. While firms looking to raise tens of millions are well served by U.S. and Canadian funds and banks, the pre-pandemic analysis found that businesses seeking between $2 million and $5 million—less likely to be the hyper-growth technology startups venture investors favour—have fewer options and face higher deal costs.    

“The Canadian market in general is more conservative and it’s a smaller pool of investors or lenders,” said Matt Johnston, CEO of Hamilton, Ont.-headquartered Collective Arts Brewing, which has taken on external capital to grow. “It has been more challenging than we’d like.” Capital providers and company executives say the pandemic has created new demand for financing, but also new government financing programs to meet it.

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Talking Point

Mid-sized firms looking to raise between $2 million and $5 million to finance expansions and acquisitions face fewer options and higher costs of capital than companies seeking larger sums, a report commissioned by the federal government shows. While funding conditions have improved in recent years, the analysis found that challenges remain for businesses outside big cities and the tech sector.

The report—commissioned by the federal innovation department’s small-business branch— focused on firms with solid revenue and 100 to 500 employees, and that are seeking growth capital to expand or make acquisitions. The analysis was based on interviews with 40 financers and company executives in fall 2019, and found that there was enough money available to meet the needs of businesses looking to raise more than $20 million or around $10 million. 

But firms seeking smaller rounds of between $2 million and $5 million faced challenges. “Owing to the relative risk, cost of capital appears to be quite high in this tier,” wrote consultant Richard Remillard, citing interest rates as high as 25 per cent for unsecured debt. When companies make private equity placements with investors via exempt market dealers (EMD), due-diligence fees can add up to $40,000 each. “These high rates, together with the broad range of pricing overall, may be indicators of a somewhat inefficient and relatively undersupplied market,” Remillard stated. 

The report, which The Logic obtained via access-to-information request, was delivered to Innovation, Science and Economic Development Canada deputy minister Simon Kennedy in February 2020. It is a precursor to Ottawa’s review of the Business Development Bank of Canada (BDC), which focuses on companies seeking between $2 million and $5 million in funding.

“BDC is exceptional as one of the few large lenders that are active in this segment in Canada,” said Youmy Han, spokesperson for Small Business Minister Mary Ng, who oversees the agency. Han also cited the agency’s loans and investments in return for minority equity positions. 

Yet firms seeking capital from private investors face a high regulatory burden such as producing audited financial statements, said Brian Koscak, general counsel at Pinnacle Wealth Brokers, a Calgary-based EMD. “The time, money and effort involved in doing the full-on review [required] under securities law doesn’t match the capital raise,” he said. So “these companies aren’t getting the money.” 

He called for provincial regulators to widen exemptions that allow firms to raise funds from wealthy individuals and qualified professionals. 

“Some companies are not necessarily bankable,” said Alkarim Jivraj, CEO of Toronto-based Espresso Capital, which provides loans to tech companies with at least $5 million in revenue and 50 to 250 employees. Financing providers may simply consider them too risky because of their business model or management team. But for many eligible companies, “this is a time of historic liquidity in the market,” Jivraj said. Private credit funds grew from just over US$300 billion in 2010 to almost US$800 billion globally in 2018, according to the Bank for International Settlements, an umbrella group for monetary authorities. 

Meanwhile, COVID-19 has also affected the market for financing. Espresso’s loan activity dropped between April and August, as agencies like the U.S. Small Business Administration and BDC rolled out multibillion-dollar support measures. “Competitive private-market participants couldn’t get people to take our money, because they had already fuelled up with cheap government money,” said Jivraj, although he noted the continuing need for public support in the hardest-hit sectors like restaurants, travel and tourism. 

Pre-pandemic, Prana—a Saint-Laurent, Que.-based nut and snack importer and processor—was growing well. But revenue was “flat to a slight decline” last year, said CEO Alon Farber. The company, which has more than 100 employees, raised under $5 million in two 2019 rounds from Renewal Partners and Fondaction. It’s held discussions about another round. “There were additional costs that we needed to absorb in order to remain open and functioning” because of COVID-19, Farber said. Still, he said Prana isn’t seeking any new investors.  

Collective Arts’ Johnston said there’s limited government funding available to small firms that want to become mid-sized or large, forcing companies like his into the challenging private market to find financing. The 200-person brewery raised $5 million in mid-2020 from FIS Holdings, which invests in consumer-product businesses. 

The funding will help pay for capital investments in equipment to expand capacity, cash flow for inventory and hiring to support its international expansion. Collective Arts’ beer is now available in 20 countries across North America, Western Europe and Asia. “There’s very few Canadian consumer brands that have been successful globally,” Johnston said. “We’re trying to be one of those.” 

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Remillard’s report cites a consensus among financers and companies that “the supply of growth capital in Canada today has improved considerably in recent years.” But the gains have not been spread equally. “Far-flung regions may be disadvantaged” because companies can’t find specialized financial staff and their local funding ecosystems can’t support fast-growing firms. That’s in contrast to the easy access in Toronto, Montreal and Vancouver.

There are also sector-based differences. “Technology, broadly understood, is a capital magnet as has been cannabis,” Remillard wrote. “Oil and gas, forestry and hard rock mining have been the reverse.”