We may not be big, but we’re small – What is a small business and why does it matter?

Fans of the late Stuart MacLean will recognize the title as an inside joke about the Vinyl Café. But the title also speaks to another insider group. The policy wonks amongst you will also immediately recognize this topic of conversation. Some of you may be able to anticipate much of the discussion that follows. Those of you fortunate to live outside the federal government industrial policy bubble will wonder what the rest of us are on about. Read on to find out.

Let’s start with the second question. Why does the definition of “small business” matter? Well, the question of “what is a small business?” is actually quite important to government policy makers – and therefore potentially to anyone who might, or might not, be in line to benefit from the policies that they make.

Government is, for good reason, quite interested in supporting small business in Canada. These good reasons range from the fact that the vast majority (more than 90%) of companies in Canada are small – no matter how you define it – to the fact that small businesses have a lot of characteristics that make them attractive to government. For instance, while small businesses may not be the dominant employers in every sector, they are almost always the engines of innovation. They are also almost invariably not only Canadian owned, but usually locally owned and locally managed as well. Meaning that the people who own these companies live and work in the community where the company is based. This means that small businesses are more connected to their local communities and that support provided to them by government flows more directly into local communities than support provided to larger companies that are owned and controlled from afar.

Thus, it is widely assumed, with some justification, that when money is spent supporting small business, that money will end up supporting Canadians in general and the local community in which the business is based, in particular. Now it is true that realizing these two “public good” outcomes is certainly possible when the support is provided to large companies, but the amount of regulation and oversight that is required to ensure them is far more extensive – as anyone who has ever dealt with the Industrial and Technological Benefits program will readily attest.

So, being a small business puts you in a preferred category in terms of qualifying for government support programs. And those programs are, in fact, legion. Too numerous to go into here, particularly since this isn’t a column about where to find government support.

So, how does the government decide who should qualify for these programs? The short answer is that the criteria is usually based on the size of the business in terms of employees. But here is the thing. The government does not actually classify businesses as “small.” Instead it uses a classification that is abbreviated as SME. Many of you have probably heard this term. A significant fraction of you probably use it. In almost all cases when it is said or written it is a shorthand for “small business.”

BUT THAT IS NOT WHAT IT MEANS.

SME refers to “Small and Medium Sized Enterprises.” In the government classification system this can either mean a company of up to 400 employees or a company of up to 250 employees – depending on whose definition you use. Yes, that is an issue, but not the topic we are currently discussing – stay with the tour. Now, anyone who has worked in, run, or owned a small business will agree that a company with 400 employees is not very likely to think, act, or operate like a “small” business. To put it bluntly, a 400-employee company is definitely a “medium sized enterprise” and it has different characteristics than what most of us would consider a small business.

Before we discuss why the distinction is important, let’s talk a bit about what REALLY defines a small business. Over many years of discussing this topic I have arrived at two principal criteria for calling a business small.

The first of these is that, in financial terms, small businesses are focussed on their cash flow while larger businesses are focussed their balance sheet. This sounds like the kind of technical distinction that an accountant would come up with, but it is actually very important and it has to do with how decisions are made and how resources are allocated. Saying it this way acknowledges that being a small business means that any demand for cash must always be dealt with urgently, and that important long term investment decisions must always be a lower priority than ensuring there is sufficient cash flow to STAY IN BUSINESS. This does not mean that small business cannot think or plan for the long term, but they will be very constrained in how they make plans and they will always be susceptible to having those plans disrupted by short-term needs for cash. There is an old joke about the small business CEO who was asked if he had a long term strategy. “Yes”, he responded, “to stay in business long enough to have one.”

The second of the criteria that defines a small business is the lack of specialised staff. Because of the first criteria above, small businesses are always resource limited. Other than cash, the most constrained resource is usually personnel. In a cash-conscious environment it is seldom possible to justify the expense of staff who have niche expertise in areas such as HR, contracts, legal, public relations, or government relations. In fact, many small companies will not even have permanent full-time personnel filling the finance function. Instead, these roles are usually filled by either the CEO or another one of the management team wearing “more than one hat.” This means that while those functions are usually performed competently, the roles are filled by people who do not have the training or the time to appreciate complexities or nuance.

So, why does any of that matter? Well, it matters because the two criteria that I have described are operational constraints that being small imposes on a business. They are not just descriptions or definitions of “how big is small” they are definitions that say something about how small businesses work, think, and critically, how they are able to interact with and consume government programs and policies.

The constraints that these characteristics impose are real and important when designing such programs and policies. The cash flow focus of small business means that any requirement to spend, or even to set aside, cash may render a program designed to support small business functionally unusable by many such businesses. A good example of this might be, for instance the SRED program (Scientific Research and Experimental Development). On the one hand, the small business provisions in the program mean that qualifying small businesses will actually receive their contributions as cash – as opposed to a reduction in tax owing as is the case for larger companies. On the other hand, however, companies must wait until the they have filed a return and had it approved before they see the cash. In my experience it can be up to two years from the time qualifying expenditures were made until the refund is obtained. In a cash-flow constrained environment that can make it a difficult program for a small business to take full advantage of.

The limitations of specialised staff are also a significant constraint for companies trying access government support mechanisms. Any program for which the application process is complex may be problematic, particularly for companies not well versed in the ways of government. Any program that has terms and conditions that are lengthy, detailed, or require legal review will place a significant burden on a small business. Likewise, any program that has significant, frequent, or complex compliance reporting provisions may be an issue. Many of you can probably think of any number of government programs that were designed to benefit “SMEs”, but which exhibited any or all of these features.

And that brings me to my last point. And one of my very favourite soapboxes. The term SME can really be problem. In can be a problem because it’s official and technical meaning is different from the way that it is almost always used. A program that is designed to benefit Small AND Medium sized Enterprises may well ignore the constraints and limitations I described above – and still be considered well designed and successful because it benefits the larger end of the SME scale but not those at the small end of the scale. So, when we say SME and think we are saying Small Business but actually make policy to benefit “medium sized enterprises” it leads to policy confusion and to real unintended consequence that reduce the efficiency of government programs.

Importantly, it also reduces the credibility of the policy making efforts on behalf of small business. Too many small businesses have heard claims that the government has programs designed to support them only to encounter rules, regulations and implementation policies that are more easily digested by the medium sized end of the SME spectrum. It does not take very many of these experiences to convince small businesses that government is not serious (or not competent enough) to provide them with real support. So, they stop looking for it. And the effectiveness of the government policy or program declines.

And just to be clear. I have no problem with grouping small and medium sized business into one category and having a term that describes the category. But, I do have a problem with using the term SME when what is meant is Small Business. I am also not suggesting that the government replace it’s “size based” definitions of smallness with some kind of operational definition like the one I discussed above. The definition needs to be simple and easy to apply. I am saying, however, that if a program or policy is designed to help Small Businesses, it must be designed with the constraints of those businesses in mind. Programs and policies that are designed to help, for instance, rapidly growing medium sized firms – which are another important constituent in Canada’s business ecosystem – will need to account for different constraints, features and limitations and should be separated from initiatives to help small businesses. SME is not a bad term. But it does not mean Small Business and it should not be used as if it does.

So yes, small businesses are important. Knowing what constitutes a small business is important not only to identify them but also in order to understand how their needs and constraints are different from larger businesses. I believe that the government desire to provide supports designed to help small business is a good thing. But in order for the government to make the best use of those good intentions they need to not merely apply a test related to the size of the enterprise, they need to design programs that serve the unique needs of businesses that may not be big, because they are small.

Disclaimer: The opinions expressed in this column are entirely my own. They are not reflective of, or endorsed by, any other group with whom I may be associated.