Canadian startups could use some regulation
It’s tempting but dangerous to loosen standards for small business funding.
Anyone who's ever made it through biology class is familiar with the life cycle of various organisms. But those lessons apply just as much to businesses as they do to plankton and fruit flies.
When it comes to small businesses these days, the ability to get enough nutrition to survive the early stages of development — let alone flourish — has become a cause of both economic and political focus.
The ranks of venture capitalists has been culled by the global financial crisis. Pension funds and other institutional investors are skittish because of historically poor returns on startups — even during good years. Credit unions tend to invest locally and on a very small scale. Big banks are more cautious than ever these days about parting with capital and providing loans. And stock markets are very fussy about initial public offerings (IPOs) these days.
Furthermore, because their prospects are harder to quantify in the best of economic times, the additional overlay of risk means that small business owners pay a premium for the money they borrow. And that's something that could bite hard when interest rates start to rise.
In a 2011 survey by TD Bank, cash flow management and credit conditions topped the list of impediments to growth for small business owners. The Survey of Suppliers of Business Financing confirms that outstanding debt to business decreased sharply by 10 per cent between 2008 and 2009 alone.
Despite these conditions, however, it's generally acknowledged that small and medium-sized businesses are a critical part of a healthy, well-rounded economy. And that they are mighty job-creation engines under the right circumstances.
According to Statistics Canada, small and medium-sized enterprises contribute about 55 per cent to Canada's gross domestic product every year. And as a share of employment, SME employees make up an impressive 63 per cent of the national total.
Politically, governments take singular pride in creating the conditions that allow entrepreneurs to build innovative businesses, creating jobs and tax revenues.
Certainly, the political considerations are hard to discount in the recent — and controversial — push by U.S. President Barack Obama to encourage alternative financing for small business startups with the Jumpstart Our Business Startup (JOBS) Act.
This new legislation, which was signed in early April and has led to an overhaul of existing rules by the Securities Exchange Commission (SEC), is a precedent that's well worth watching.
That's because some of the measures it facilitates — such as encouraging "crowd funding" that allows small investors to raise equity online, exempting small ventures form regular filings with the SEC and allowing so-called emerging growth companies (those with less than $1 billion in annual revenue) an exemption from outside audits of internal accounting for five years after they go public — set a potentially worrisome long-term trend.
For many experts, the repeal or amendment of some of the most important investor protection measures is a stark reminder of the toxic times of the dot-com bubble. They note that over 70 per cent of the initial public offerings from that heady period went bust.
There will always be investors who are duped by market sharks, whatever steps regulators take to protect them. But whenever that happens on a large scale — as it has so many times in the past — it results in a huge setback for an entire sector.
In other words, the real risk in aggressively loosening standards and oversight around small business financing is that small enterprises will be the ones who suffer from the potential fallout.
Furthermore, because it's so tough to raise money in the relatively small and scattered pools in Canada, many small businesses turn to the U.S. in the early days. The recent repeal of the withholding tax for non-Canadian investors in Canadian companies has only strengthened that tendency.
As a result, the new rules south of the border make Canadian small businesses vulnerable to fallout.
There's no question that red tape is a persistent and costly problem for small businesses. In 2010, the Canadian Federation of Independent Business (CFIB) estimated that compliance with various levels of rules and regulations by three levels of government costs small businesses about $30.5 billion a year. That's a figure corroborated by Industry Canada, one of the federal departments on the forefront of the effort to reduce the red tape burden.
But not all red tape is created equal and it needs to be reduced strategically and surgically. Regulation and compliance have a critical role in retaining the trust in and credibility of financing for small business. And those are two key elements in allowing them to approach the next phase in their life cycle.
Ask any fruit fly.
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