Financial strategies in small firms

A new study has found a strong relationship between knowledge intensity in small and medium-sized enterprises in Canada and their patterns of financing.

Companies that operate in high-knowledge industries - innovative sectors that stress research and development, technology use or skilled workers - are less likely to maintain debt-intensive financial structures, according to the study.

In other words, small and medium-sized firms in high-knowledge industries make less use of debt instruments than those in other sectors. In high-knowledge industries, such firms had, on average, 38% of their capital in the form of short- or long-term debt. For those in low-knowledge industries, the average debt share increased to 56%.

The findings are based on an elite group of successful small firms, the 20% of new businesses that survive their first decade of life. Data came from the 1996 Survey of Operating and Financing Practices, which collected data on the business strategies and financial characteristics of successful small firms.

The study did not show that small firms are debt-constrained or equity-constrained. Small firms in knowledge-intensive industries might use more equity because debt financing is harder to obtain. Alternatively, they might use more equity because they prefer equity over debt to finance their business activities.

The study found that the rate of growth among small and medium-sized enterprises was not a strong predictor of their financial structure. Faster-growing firms were no more likely than those that grew more slowly to exhibit debt-intensive capital structures. There was some evidence, however, that faster-growing firms drew on more sources of capital to finance their operations.

Overall, however, financial structures of small firms were not very diversified. Most of the firms in this study relied heavily on equity instruments with relatively little debt, or debt instruments with relatively little equity.

The study also showed some evidence that expectations about future growth were related to patterns of debt and equity use. Small and medium-sized firms that expected to grow rapidly tended to maintain more debt in their capital structures than those with more modest expectations of their future performance.

The economic analysis research paper Growth history, knowledge intensity and capital structure in small firms (11F0027MIE2003006, free) is now available on Statistics Canada's website (). From the Our products and services page, under Browse our Internet publications, choose Free, then National accounts.

Also available on Statistics Canada's website is information on related papers on small-firm financing.

For more information, or to enquire about the concepts, methods or data quality of this release, contact Guy Gellatly (613-951-3758), Micro-economic Analysis Division.