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Canada's Industry Minister Tony Clement speaks during Question Period in the House of Commons on Parliament Hill in Ottawa February 15, 2011.CHRIS WATTIE

One of Industry Canada's key small business lending programs helped pump $957-million into startups and other small and medium-sized enterprises last year.

But the Canada Small Business Financing program (CSBF), which has been criticized for its high costs and messy red tape, also took a hit of $113-million last year from companies that defaulted on their loans.

The program essentially encourages traditional lenders such as banks and credit unions to make loans to small businesses, by providing a government guarantee to cover 85 per cent of their losses if there is a default.

More than 7,400 businesses took advantage of the program last year – the lowest number ever – and the average loan was $128,561. More than half went to startups and new businesses, and the biggest chunk – almost 30 per cent – went to companies in the hospitality and food sectors.

The program was designed to be self-funding – generating enough fee income to balance off its costs. With loss claims on the rise, that's clearly not happening, although the government says the benefit of boosting small businesses more than outweighs the expense. In his introduction to the program's annual report, tabled last week, Industry Minister Tony Clement describes the CSBF as "helping to fill a gap" in lending, allowing companies to start new businesses and expand existing ones, "thereby creating jobs and retaining employees."

Corinne Pohlmann, vice-president of national affairs at the Canadian Federation of Independent Business, said the CSBF is valuable, despite its problems, because it encourages more lending for startup companies.

"In Canada it has always been a lot more difficult for smaller companies and brand new startups to find financing, and this allows banks to take that extra step."

It makes sense to have the banks administer the loans, she said, because they are in a position to assess the risks of each applicant. That's far better than having government bureaucrats make those judgments.

One problem with CSBF is that many small business managers don't know that the program exists, she said. And the paperwork is onerous for the banks, making them hesitant to take advantage of it.

Ms. Pohlmann said it is very difficult to know if the overall benefits offset the costs – especially given the rising defaults. But she noted that roughly one-in-five new small businesses ends up collapsing, so the rate of claims is not surprisingly high.

In a five-year review, published in 2009, Industry Canada acknowledged that the program is not recovering anywhere near its overall costs through administration and registration fees. However, the department said that if Ottawa counts the additional income taxes and GST generated by small businesses that used the program, it more than breaks even.

Ms. Pohlmann said CSFB "needs a few tweaks here and there," but is valuable to the small-business community and should remain in place. "We believe it does fill a gap in the marketplace, especially for those newer, smaller, startup type of firms," she said.

It is no surprise that the overall number of loans under the CSFB is falling, she said, because many small businesses now go beyond traditional lenders for funding "They are looking at other options [such as]creating more equity for themselves, getting angel investors, or [asking their]families to invest."

Peter Hambly, senior director of the Grey-Bruce commercial lending centre for Ontario's Meridian Credit Union, said the CSBF can be a good fit when a small company doesn't quite qualify for a loan under normal circumstances.

"It's a bit similar to an insured mortgage," he said, in that it can support lending when otherwise "the deal is a bit thin."

If a small-business owner is a new borrower, has a limited net worth, or doesn't have much of a track record, the government guarantee "allows you to make a loan that you might otherwise not make," he said.

It makes sense that the program is heavily weighted toward the hospitality industry, Mr. Hambly said, because that sector has "a big 'don't go there' sign" over it, from a lender's point of view. Companies in the food sector often have little inventory or equipment to use as collateral, but the government guarantee can allow a financial institution to approve a loan, he said.

Still, Mr. Hambly said, the fees and red tape associated with the CSBF often make lenders and borrowers balk, so the program is rarely used by his clients.