Bank of Canada urges banks to set up national SME growth fund

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The Bank of Canada is pushing the country's banks to launch a national fund that would invest in small-to-medium-sized businesses, modelled on a similar fund in Britain that has proven to be controversial.

The initiative is at an early stage but has been discussed in multiple meetings between civil servants and Bay Street executives in Ottawa and Toronto in recent weeks. The plan is to have banks – and potentially pension funds and insurers – put money into a $1-billion-plus private-sector fund that would make $2-million to $20-million debt and equity investments in domestic companies and ensure they have the resources needed to expand globally while remaining based in Canada.

"We are good at starting companies in this country but not good at nurturing them," said one banker whose employer is in talks with Ottawa. "There is agreement that seeing our best small companies snapped up by foreign buyers is a problem, and this fund is one way to deal with that problem."

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Sources who have attended the sessions say the concept is getting a mixed reception, as some bankers question the need for the fund and the potential returns, while a handful of institutions, including Canadian Imperial Bank of Commerce, are supportive.

A confidential nine-page briefing titled Growth Capital Fund, prepared by CIBC and obtained by The Globe and Mail, explains that "the idea for a fund of this nature emanates from the Bank of Canada's intrigue with a bank and government-sponsored initiative in the U.K. called the Business Growth Fund (BGF). Representatives from the BGF recently met with the Bank of Canada who are keen to develop a similar fund with Canadian banks."

Proponents of the fund are Bank of Canada Governor Stephen Poloz and Victor Dodig, the CEO of CIBC, sources say. The Bank of Canada and CIBC declined comment. Another backer is said to be Sam Duboc, CEO of private equity fund EdgeStone Capital Partners, who helped launch the $1.35-billion federal Venture Capital Action Plan (VCAP) with government and private-sector backing, and is now chairman of the Business Development Bank of Canada, which is responsible for VCAP. Mr. Duboc declined comment.

Mr. Dodig described the British fund in favourable terms during a speech last fall on innovation, and said: "Could a similar approach work here? We'll see. I understand the Australians are giving consideration to a similar program."

Australia is working with the country's four largest banks on a fund that would put money into small-to-medium-sized enterprises, or SMEs, after a government study concluded that these companies had trouble accessing capital.

CIBC's study of the Canadian fund highlighted the fact that small businesses in Canada account for 70 per cent of job creation, a statistic that has caught the eye of the Bank of Canada.

CIBC's internal document concludes that while the case for the initiative is "not as compelling" in Canada as it is for Britain and Australia, "given the importance of the bank's relationship with the Bank of Canada, CIBC should support and ultimately back an SME Growth Fund initiative in Canada, if funding gaps are properly investigated and capital commitments are well targeted at key segments that create future jobs/economic benefit."

On Friday, a spokesperson for CIBC declined further comment.

Canadian bankers and pension-fund executives say the British program was created to fill a need for business financing that doesn't exist in Canada, and the new fund duplicates existing capital sources.

That funding includes business loans from banks and other lenders, and equity from private funds and existing provincial and federal programs, such as Ontario's $50-million Scale Up Ventures fund, which Premier Kathleen Wynne unveiled in April, and the VCAP program that was launched in 2013 by the former Conservative government and partly funded by banks.

"I'm not sure this [Canadian] fund solves a problem," said one bank executive briefed by Ottawa, who asked to remain anonymous because his employer has not made a decision on whether to participate. The executive said: "The issues facing small-to-medium-sized business are typically expanding outside Canada and building client relationships with large corporations, not access to capital."

Canadian banks, including Toronto-Dominion Bank, CIBC and Royal Bank of Canada, scaled back or exited venture capital and private equity over the past decade because of poor returns.

If the new fund is created, several banks say Ottawa will need to loosen regulations on bank capitalization to ensure banks can make an adequate return on their investment.

Britain's fund was created after a government task force found there was "a negative view of banks by the U.K. public for being a contributing factor to the 2008 financial crisis and for not doing enough post crisis to grow lending and hence help the economic recovery." In Britain, statistics showed small-to-medium-sized businesses had trouble getting credit at banks from 2008 to 2010, with about 40 per cent of loans turned down.

In contrast, Canadian Bankers Association data show that lending to small businesses is rising. The industry group also has research showing that Canadians respect the performance of their banks since the global financial crisis.

The British fund was launched in 2011 with £2.5-billion ($4.3-billion) of capital from the country's five largest banks, and to date it has invested more than £500-million in 121 businesses, or roughly £4-million a business. BGF has invested in everything from juice bars to satellite technology and software. The fund claims to have created more than 3,000 jobs. In the past nine months, BGF sold stakes in six companies and generated its first gains, after four years of posting an operating loss.

Critics say the British fund will crowd out existing private-sector investors in small- to mid-cap businesses, and is likely to generate subpar results for its five founding banks and their shareholders. The CIBC study projects returns on a Canadian fund will lag the 7-per-cent to 15-per-cent historic performance from traditional private equity funds.

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THE BUSINESS GROWTH FUND AT A GLANCE

Under pressure from the government, Britain's banks created an independent fund to invest in small business in 2011

Size

£2.5-billion

Backers

Barclays, HSBC Bank, Lloyds Bank, Royal Bank of Scotland, Standard Chartered Bank

Average investment

£4-million

Number of investments

121 companies to date

Investments realized

Six to date

Size of companies

£5-million to £100-million in annual sales

Time frame

10-year-plus commitments

Jobs created

3,000 plus to date, according to the fund

Types of investments

Minority equity, preferred shares, loans

Sectors

Broadest possible reach, from Mexican food chains to construction, media and software

Andrew Willis

Source: Business Growth Fund