Strategy

Small business: Chasing credit

Finding cash for small businesses just got a whole lot harder.

Glenn Mullan is developing a $500-million nickel mine in northern Quebec, or perhaps it’s more correct to say he was developing the mine. The founder of Canadian Royalties (TSX: CZZ) can no longer secure funding to keep the project going as scheduled, something Mullan blames squarely on the global credit crunch. “It’s been devastating in our case,” he says.

Canadian Royalties, based in Val-d’Or, Que., has raised about $250 million since 2007, but was counting on the banks for the other $250 million. A nine-digit figure is a steep sum for any company to raise, let alone one that had slightly more than $100 million in cash last June but was spending $1 million a day on construction. In early August, Mullan realized the funding simply wasn’t coming through and imposed an “asset conservation plan. That’s a gentle way of saying we’ve stopped construction and won’t be going forward on the whole project development until conditions return to some sort of normalcy,” Mullan says. “We appear to be a long way from that.”

Normalcy is something governments around the world are certainly trying to restore. The United States and a handful of European countries are spending hundreds of billions of dollars to stimulate lending between banks. Similar initiatives have recently been announced in Canada. The federal government is preparing to spend $25 billion to assume bank-held mortgages, and the Bank of Canada is providing $10 billion in short-term loans for financial institutions. None of the measures specifically target small and mid-sized enterprises (SMEs), a group that is finding it increasingly difficult to find financing. In tight credit markets, smaller companies with outsized ambitions such as Canadian Royalties begin to look even riskier than usual, as do startups.

Canadian Royalties is having a tough time partly because the banks now have more rigorous loan requirements, such as expecting smaller companies to find a guarantor or partner with other lending institutions — changes Mullan believes are tied into tightening credit conditions. While Mullan explores his options, the company’s share price has plummeted more than 90% since its 52-week high of $3.95 last October. Canadian Royalties had about 300 workers earlier this year, and it could have fewer than 30 by the end of the month. “Our survivalist plan comes in various stages,” he says, “and it’ll get more and more aggressive the longer these conditions last.”

Of course, the banks maintain that not much has changed from their perspective. “For us, it’s business as usual,” says David Wilton, director of small-business banking at Scotiabank. “The number of loans looks to continue to increase.” But Craig Alexander, vice-president and deputy chief economist with TD Bank Financial Group, says the cost of that credit is going up. “The ability of a lot of small businesses to negotiate more favourable terms has been constrained,” he says. Ultimately, the cost of doing business is increasing, and a company in a weak financial position will find it more difficult to stay afloat.

No surprise, then, that many SME owners see trouble ahead. More than one-quarter of them reported in October that they were having difficulties accessing bank money, according to a Canadian Federation of Independent Business survey of more than 800 SME owners. That’s up 10% since September. And in a Bank of Canada survey of senior loan officers released this month, the balance of opinion on credit markets was more pessimistic than at any point since the survey began in 1999.

“Things are definitely tightening up,” says Catherine Swift, CEO and president of the CFIB. But, she adds, the situation could be much worse. Swift says banks overreacted during the last major recession in the 1990s, severely reducing lines of credit or pulling them altogether for small businesses that were in relatively good shape. “The challenge for lenders right now is to take a long-term view, and not to make knee-jerk reactions,” Swift says. Difficult credit is far less damaging to the economy than not being able to access it at all, as is more commonly the case in the U.S., she points out. Swift also believes most small-business owners are competent enough to tough out a period of credit restriction, although a recent report from the CFIB contends the markets are still too volatile to allow business owners to plan effectively.

Of course, trouble accessing cash may impede whatever plans business owners do have. Take Ian Loughran. The Calgary entrepreneur is trying to raise $800,000 to renovate his Italian motorcycle dealership, Revoluzione Cycle Imports. “With all that’s happening, the banks are likely going to tighten down even further,” he says. “It’s going to make it even tougher for smaller businesses to get cash.” The banks probably aren’tan option for Loughran anyway, because they require a significant amount of collateral, which he isn’t able to provide as a small-business operator. Loughran is now exploring funding through the Business Development Bank of Canada, but isn’t exactly pleased with “ridiculous” interest rates that are as high as 15%. That’s why he’s also turning to private investors, which he expects more small-business owners to do as well.

But seeking out private investors isn’t exactly easy these days as Jason Tham is discovering. Tham is CEO at Toronto-based Nulogy, a supply-chain management software maker that has been trying for the past six months to raise $1 million, largely to hire more sales staff. Unfortunately, angel investors’ fortunes have sunk along with the market. “The Vegas play money for high-net-worth individuals is definitely gone,” Tham says. Instead, he’s relying on networking events for entrepreneurs and investors to drum up the money, though he’s heard investor attendance is down at such events. Regardless of whether Tham can raise the entire $1 million, he’s planning to close what he’s raised so far over the next four months and focus on building Nulogy. “There’s no point in waiting,” Tham says. “Maybe we’ll have to be more frugal, and have a little less penetration in the market. But there’s always next year.”

Others have been more successful. Chris Johnson managed to raise $2.8 million earlier this year for his Ottawa-based company, dna13, which develops software for managing communications and stakeholder relations. Johnson had the benefit of returning to the venture capital firms that provided $5 million in his company’s first round of financing in 2007. He says VCs are going to be even more selective about where they invest, and will be particularly wary of startups. VCs always invest in companies with the eye of taking them public or selling them — both very unlikely prospects in today’s volatile markets. “VCs know how hard it’s going to be over the next couple of years to exit these companies and get a return,” Johnson says.

Indeed, the SME sector is expected to weaken along with the rest of the Canadian economy in the next six months, says Benjamin Tal, senior economist at CIBC World Markets. Many SME owners wouldn’t disagree. Nearly 30% expect their companies’ performance to be somewhat weaker over the next year, compared to 18% in the previous month, according to the CFIB. But the news isn’t all bad. SMEs actually outperformed the rest of the Canadian economy between 2005 and 2007, and Tal maintains that will continue to be the case. “From a long-term perspective, I’m still very bullish on the sector,” he says. Tal believes Canada’s aging population is creating new consumer demands that small businesses are better positioned to serve since they are more nimble than large corporations. They are also increasingly tapping global markets.

But for now, SMEs will likely have to endure difficult times. “We’ve battened down the hatches and reduced our scale, all of which is designed to ensure we stay masters of our destiny,” says Mullan of Canadian Royalties. “Whether conditions change next week, next October, or three years from now, I don’t know. The market will determine that.”