Banking, Trade Banques Et And Commerce Du Commerce
38801First SessionThirty-seventh Parliament, 2001-02Première session de latrente-septième législature, 2001-2002SENATE OF CANADASÉNAT DU CANADAProceedings of the StandingSenate Committee onDélibérations du Comitésénatorial permanent desBanking, Tradeand CommerceBanques etdu commerceChair:Président:The Honourable E. LEO KOLBERL’honorable E. LEO KOLBERFriday, September 6, 2002Le vendredi 6 septembre 2002Issue No. 49Fascicule no 49THE NINETEENTH REPORTOF THE COMMITTEE(An Environment for Prosperity: Facilitatingthe Growth of Small and Medium-SizedBusinesses in Canada)LE DIX-NEUVIÈME RAPPORTDU COMITÉ(Pour un environnement propice à la prospérité:Faciliter la croissance des petites et desmoyennes entreprises canadiennes)
THE STANDING SENATE COMMITTEE ONBANKING, TRADE AND COMMERCELE COMITÉ SÉNATORIAL PERMANENT DESBANQUES ET DU COMMERCEThe Honourable Senator E. Leo Kolber, ChairPrésident: L’honorable E. Leo KolberThe Honourable Senator David Tkachuk, Deputy ChairVice-président: L’honorable David TkachukandetThe Honourable Senators:Les honorables sénateurs:Angus* Carstairs, P.C.(or Robichaud, P.C.)FitzpatrickFureyHervieux-Payette, P.C.Kelleher, P.C.*Ex Officio MembersKroft* Lynch-Staunton(or Kinsella)MeighenPoulinSetlakweStratton(Quorum 4)Angus* Carstairs, c.p.(ou Robichaud, c.p.)FitzpatrickFureyHervieux-Payette, c.p.Kelleher, c.p.* Membres d’officeKroft* Lynch-Staunton(ou Kinsella)MeighenPoulinSetlakweStratton(Quorum 4)Published by the Senate of CanadaPublié par le Sénat du CanadaAvailable from: Communication CanadaCanadian Government Publishing, Ottawa, Ontario K1A 0S9En vente:Communication Canada – Édition Ottawa (Ontario) K1A 0S9Also available on the Internet: http://www.parl.gc.caAussi disponible sur internet: http://www.parl.gc.ca
THE SENATEInterim Report of the Standing Senate Committee onBanking, Trade and CommerceAN ENVIRONMENT FORPROSPERITY:FACILITATING THE GROWTHOF SMALL AND MEDIUM-SIZEDBUSINESSES IN CANADAChairThe Honourable E. Leo KolberDeputy ChairThe Honourable David TkachukSeptember 2002
TABLE OF CONTENTSAN ENVIRONMENT FOR PROSPERITY:FACILITATING THE GROWTH OF SMALLAND MEDIUM-SIZED BUSINESSES IN CANADAMembership . ivOrder of Reference. viRecommendations . viiiI.Introduction . 1II.Poor Growth Performance of Small Businesses . 3III.Capital Market Issues. 7A. Financing Early Stages of Firms’ Development . 7B. The Special Case of Labour-Sponsored Funds. 13C. Institutional and Foreign Investment . 17D. Scale and Liquidity of Stock Exchanges and Exit Opportunities . 21IV.Regulatory Distortions . 23A. Banking Regulatory Problems. 23B. Escrow Requirements. 25C. Associated Company Rules . 29D. Directors’ Liability. 31V.Tax Incentives. 33A. Taxation of Capital Gains. 33B. Profit-Insensitive Taxation . 35C. Up-Front and Broad-Based Tax Incentives. 37ii
VI.Entrepreneurial Inadequacies. 39A. Reluctance of Management to Give Up Equity. 39B. Lack of Management, Sales and Marketing Skills . 41C. Business Culture and Education. 43VII.Conclusion. 45Addendum - Chicago Roundtables on Equity Financing of Small BusinessRoundtable # 1 . 48Roundtables # 2 and 3. 51Roundtable # 4 . 55Roundtable # 5 . 58Witnesses. 61iii
MEMBERSHIPThe Honourable E. Leo Kolber, ChairThe Honourable David Tkachuk, Deputy ChairandThe Honourable Senators:AngusKroft*Carstairs, P.C. (or Robichaud, P.C.)*Lynch-Staunton (or ette, P.C.PoulinKelleher, P.C.Setlakwe*Ex Officio MembersNote: The Honourable Senators Austin, P.C., Banks, Callbeck, Gustafson, Kenny,Kirby (as Chairman) and Mahovlich were members of the Committee atvarious stages during the course of this study.Staff from the Parliamentary Research Branch, Library of Parliament:Ms. June Dewetering, Acting Principal and Mr. Alexandre Laurin, ResearcherEconomics Division.Note: Mr. Gerald Goldstein, Director, Economics Division, Mr. Marion Wrobel,Senior Analyst, Economics Division and Ms. Margaret Smith, Researcher, Lawand Government Division were researchers of the Committee at various stagesduring the course of this study.Staff from the Committees and Private Legislation Directorate:Denis Robert, Clerk of the CommitteeNote: Mr. Gary Levy was Clerk of the Committee up to June 30, 2000.iv
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ORDER OF REFERENCEExtract from the Journals of the Senate, Tuesday, March 20, 2001:The Honourable Senator Tkachuk for the Honourable Senator Kolber moved, seconded by theHonourable Senator Cohen:“That the Standing Senate Committee on Banking, Trade and Commerce be authorized to examineand report upon the present state of the domestic and international financial system;That the papers and evidence received and taken on the subject during the First and Second Sessionsof the Thirty-sixth Parliament and any other relevant Parliamentary papers and evidence on the saidsubject be referred to the Committee;That the Committee be empowered to permit coverage by electronic media of its public proceedingswith the least possible disruption of its hearings;That, notwithstanding usual practices, the Committee be permitted to deposit an interim report on thesaid subject with the Clerk of the Senate, if the Senate is not sitting, and that the said report shallthereupon be deemed to have been tabled in the Chamber; andThat the Committee submit its final report no later than March 31, 2002.After debate,The question being put on the motion, it was adopted.”Extract from the Journals of the Senate, Wednesday, March 6, 2002:The Honourable Senator Kolber moved, seconded by the Honourable Senator Maheu:That the date for the presentation by the Standing Senate Committee on Banking, Trade andCommerce of the final report on its study on the present state of the domestic and internationalfinancial system, which was authorized by the Senate on March 20, 2001, be extended to Thursday,March 27, 2003.The question being put on the motion, it was adopted.Paul BélisleClerk of the Senatevi
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RECOMMENDATIONSThe inclusion rate on capital gains be further reduced from thecurrent 50% established in the October 2000 EconomicStatement and Budget Update of the Minister of Finance.The federal government undertake activities designed tocoordinate better existing matchmaking services, such as theCanada Community Investment Plan sponsored by IndustryCanada, as a means of ensuring that willing investors arematched with entrepreneurs who need financing.The federal government convene a meeting with provincialsecurities regulators with a view to ensuring that minimumpurchase requirements and tax impediments do notunnecessarily deter investment.The federal government, in contemplating future legislative andregulatory initiatives, consider any negative impact on LabourSponsored Funds.The federal government study the issue of venture investmentsby pension funds, including an examination of tax, regulatory,structural and other impediments to such investments, includingto Labour-Sponsored Funds.The federal government, through its legislative and regulatoryfunction, foster an environment that enables the developmentand prosperity of stock exchanges in Canada.The Federal government undertake a study of any barriers orimpediments affecting the ability of the venture capital operations ofbanks to compete in the marketplace on the same basis as theircompetitors. Barriers or impediments identified during the studyshould then be removed.The federal government initiate a dialogue among stakeholderswith respect to a national escrow regime. Moreover, the extent towhich escrow requirements may inhibit public offerings shouldbe examined, with a view to eliminating any unnecessaryrequirements.viii
The Department of Finance review the associated company rulesunder the Income Tax Act with a view to exempting from theirapplication shares owned by venture capital organizations.The federal government take actions to implement fully therecommendations made by the Standing Senate Committee onBanking, Trade and Commerce on the issue of directors’ liability.The federal government amend the Income Tax Act to reducefurther the rate of capital gains taxation.The federal government study the impact of business taxes, with a viewto reducing or eliminating the federal share of such taxes.The federal government undertake a study of existing tax andother incentives and determine if they are achieving their goals ina manner that does not distort investment decisions.The federal government study possible incentives for skillsdevelopment and lifelong learning among Canadianentrepreneurs and management. These incentives mustrecognize the particular skill needs and challenges faced by theseCanadians as distinct from the government’s more general focuson skills development and lifelong learning.ix
AN ENVIRONMENT FOR PROSPERITY:FACILITATING THE GROWTH OF SMALL ANDMEDIUM-SIZED BUSINESSES IN CANADA“In the United States, when they do an incentive, they do it in a way that would encouragethe growth of firms, such as encouraging initial public offerings (IPO). When Canada offersincentives, we do it to keep firms small.” (J. Mintz, Evidence, 36th Parliament, 1st Session,Issue 52)I.IntroductionDuring the 1990s, access to financing for small and medium-sized businesses hadbecome an important public policy issue in Canada. With Statistics Canada’s data showing adecline in bank financing for the small business sector, and numerous complaints from smallbusinesses, it appeared that access to capital had declined substantially after the recession inthe early part of the decade.What became evident to this Committee, and to others, is that debt is only one partof the financing equation for small businesses. Indeed, the over-emphasis on debt financingmasked the fact that the source of many financing woes of small business stemmed from alack of equity. Part of the reason that small businesses could not access bank financing wasthat they were not “bankable.” In other words, their balance sheets did not containsufficient equity to make them eligible for additional bank loans.This point was stressed by the Canadian Federation of Independent Business. “Bankdebt is one part of the equation, but equity capital is the other part. We tend to focus verymuch on bank debt, but if we do not concentrate on equity capital, we will always beconcentrating on bank capital. I think that if we want to grow firms in this country at therate that we had hoped, we have to realize that we must examine the equity capital provisionfor the SME [small and medium-sized enterprises] market and bring tools to that sector thatcurrently do not exist.” (B. Gray, Evidence, 36th Parliament, 1st Session, Issue 50)This is precisely what the Committee wishes to do with this report. We wish to movethe focus of attention away from debt financing and towards equity financing. Indeed, it isapparent that debt financing for SMEs is made available in a well-developed and highlyutilized market. On the other hand, “early stage equity financing” is accessed in a marketthat is less well-developed. Why is that so, and what can be done about it? The Committeehopes that this report will help to provide some of the answers.1
The barriers to equity financing for SMEs originate from a variety of sources. Someare due to the nature of the market. There is asymmetric information between entrepreneursand financiers. On the one hand, from the investors’ perspective, equity financing is highlyrisky. On the other hand, the poor understanding by entrepreneurs of financing leads themto have unrealistic expectations about the value of their enterprises, leading them to thinkthat equity financing is too expensive. Coupled with the natural desire of entrepreneurs tomaintain ownership and control, it is not surprising that it is often difficult to conclude anagreement between those with capital and those who need it.But the existing barriers to equity financing are not due just to characteristics of themarket and its participants. Governments, both federal and provincial, are themselvesresponsible for some of the barriers. Some of the impediments are tax-related, while othersare regulation-related.In the discussion that follows, Section II explores the growth of small businesses,while Section III examines capital market issues regarding start-up and early stage equityinvestment. Section IV concentrates on regulatory barriers which are hindering smallbusiness equity financing activities. Section V explores the taxation of investment incomeand its effect on investment behaviour. Finally, Section VI deals with issues related toentrepreneurs, such as culture, education and skills.2
II. Poor Growth Performance of Small BusinessesSmall and medium-sized enterprises (SMEs) make up a significant portion of theCanadian economy. They account for 50% of all private sector employment and nearly 43%of gross domestic product. 1 Seventy-eight per cent of all firms in Canada have five or feweremployees; about 94% have 20 or fewer employees, while 97% have 50 or fewer employees.(Evidence, 36th Parliament, 1st Session, Issue 50) Since the 1980s, the small business sector hascreated 87% of all new jobs in Canada. 2There are plenty of entrepreneurs in Canada. According to a 1999 Statistics Canada’sstudy, self-employment accounted for about 80% of the net employment gain in Canadabetween 1989 and 1997, in contrast to only 1% in the United States. About 40% of thesenew jobs were in the higher-paying service industries. 3Although the importance of SMEs to the economy is well documented, theCommittee felt that not enough attention had been directed towards the growth of smallbusinesses in Canada in particular, and the impact on Canada’s economic well-being ingeneral.According to Dr. Jack Mintz, President of the C.D. Howe Institute, a number ofstudies have shown that Canadian entrepreneurs created many new small businesses in the1980s and 1990s, but the record of those enterprises in the years following their creationshows only little growth. He told the Committee that one of his main concerns is that theCanadian system may provide attractive incentives for the creation of small businesses, butthe system is not supportive of the growth of those SMEs.For example, if one looks at companies with employment in 1985 that were lessthan five employees, eight years later [by 1993] only 1.1% of those businesses actuallygrew to have more than 20 employees. Also, if one looks at the category 5 to 19.9employees in 1985, by 1993 only 12% grew to have more than 20 employees. Thisis well substantiated in a number of studies. (J. Mintz, Evidence, 36th Parliament, 1stSession, Issue 52)Thus, Canadian SMEs appear to be growing rather slowly, especially in the high-techsector which constitutes Canada’s emerging economy. New ventures, particularly in the neweconomy, have the greatest potential to enhance Canada’s growth. Equity financing is themost appropriate tool for them. Vernon Lobo, Managing Director at Mosaic VenturePartners, told the Committee that:The Conference Board of Canada. “What's New in Debt Financing for Small and Medium-Sized Enterprises.” 1997,p. 2.12Ibid.3 Garnett Picot and Marilyn E. Manser. “Self-employment in Canada and in the United States.” Perspectives on Labour andIncome, Autumn 1999, pp. 37-44.3
In the U.S., the emerging economy has created more than 25 times the economic wealththat it has in Canada. If we exclude the largest companies in each country, the ratiogrows to 48 times. That is in nominal dollars; if we were to put it in equivalent dollars,it is something like 75 times. (V. Lobo, Evidence, 36th Parliament, 1st Session, Issue50)Enhancing access to external financing is essential if the rate of growth of SMEs inCanada is to increase. Smaller firms do not enjoy the same financial flexibility as do largerfirms. They represent greater risks for traditional creditors. This is especially true inknowledge-intensive industries, where newly-created firms are essentially the product ofinnovative ideas and human capital traditional sources of debt financing are not suited tosupport these entrepreneurial firms if they do not have sufficient equity or machinery to useas collateral. But whether new-economy or old-economy firms, many small businesses aresimply not “bankable” because of the condition of their balance sheets. In short, there isnot enough equity.The primary source of financing for all [small business] activities is equity. However,investments in knowledge assets, such as R & D and technology acquisition, are moreoften financed through equity than are physical assets. Investments in physical assets, suchas machinery, equipment, land and buildings, which are usually less risky, are more oftenfinanced with long-term debt than investments in knowledge assets. Consequently, firmsmust have a high degree of equity to invest in knowledge.The importance of equity for financing knowledge activities is also evident from differencesin financial structure across industries. Firms operating in dynamic, high-knowledgeindustries (industries where R & D spending, technology use and/or use of skilledworkers is high) use relatively more equity capital. Conversely, firms in low-knowledgeindustries rely more heavily on debt financing. 4The importance of equity capital for new-economy firms is not surprising. Whereasphysical assets can provide some security for debt financing, intangible assets are less wellsuited to this. With the evolution of the Canadian economy, access to equity becomes evermore important. Gordon Thiessen, the predecessor of David Dodge as Governor of theBank of Canada, said recently that major technological change is taking place
Banques et du commerce Pr . Banking, Trade and Commerce on the issue of directors’ liability. The federal government amend the Income Tax Act to reduce further the rate of capital gains taxation. The federal government study the impact of business taxes, with a view
Le Comité permanent des banques et du commerce se réunit aujourd’hui à 15 h 35 dans la pièce 505 de l’édifice Victoria, sous la présidence de l’honorable sénateur Kolber (président). 28:4 Banking, Trade and Commerce 6-2-2002
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2. R.K. Gupta, Banking - Law and Practice (2nd ed. 2008) 3. Mark Hapgood, Paget’s Law of Banking (13th ed., 2007) 4. M.L. Tannam, Banking Law and Practice in India (23rd ed., 2010) Topic 1: The Evolution of Banking Services and its History in India History of Banking in India, Bank Nationalization and social control over banking, Various
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