1.1. Background and rationale
34. Bank lending is the most common source of external finance for many SMEs and entrepreneurs,
which are often heavily reliant on straight debt to fulfill their start-up, cash flow and investment needs.
While it is commonly used by small businesses, however, traditional bank finance poses challenges to
SMEs and may be ill-suited at specific stages in the firm life cycle. The WPSMEE has long recognised the
limitations of traditional debt financing for responding to the different financing needs that SMEs
encounter along their life cycle, and for sustaining the most dynamic enterprises.
35. In particular, debt financing appears to be ill-suited for newer, innovative and fast growing
companies, with a higher risk-return profile. The “financing gap” that affects these businesses is often a
“growth capital gap”. Substantial amounts of funds might be needed to finance projects with high growth
prospects, while the associated profit patterns are often difficult to forecast. The financing constraints can
be especially severe in the case of start-ups or small businesses that rely on intangibles in their business
model, as these are highly firm-specific and difficult to use as collateral in traditional debt relations
(OECD, 2010a). Yet, for most enterprises, there are few alternatives to traditional debt (OECD, 2006).
This represents an important challenge for policy makers pursuing sustainable recovery and long-term
growth, since these companies are often at the forefront in job creation, the application of new technologies
and the development of new business models.
36. While alternatives to traditional debt finance are particularly important for start-ups, high-growth
and innovative SMEs, the development of alternative financing techniques may be relevant to the broader
population of SMEs and micro-enterprises. Capital gaps exist also for companies seeking to effect
important transitions in their activities, such as ownership and control changes, as well as for SMEs
seeking to de-leverage and improve their capital structures. The thin capitalisation and excessive
“leverage” (excessive reliance on debt financing compared to equity) impose costs, as loans to companies
that already have considerable amounts of debt tend to have higher interest rates, and increase the risk of
financial distress and bankruptcy.
37. In the aftermath of the 2008-09 global financial crisis, the bank credit constraints experienced by
SMEs in many countries have further highlighted the vulnerability of the SME sector to changing
conditions in bank lending. The long-standing need to strengthen capital structures and to decrease
dependence on borrowing has now become more urgent, as many firms were obliged to increase leverage
in order to survive the crisis, and, at the same time, banks in many OECD countries have been contracting
their balance sheets in order to meet more rigorous prudential rules. As banks continue their deleveraging
process, there is a risk that a large-scale reduction in bank assets could lead to a credit crunch (IMF, 2012a,
2012b). There is a broad concern that credit constraints will simply become “the new normal” for SMEs
and entrepreneurs and that they could be disproportionately affected by the on-going financial reforms, and
especially by the rapid pace of their implementation, as they are more dependent on bank finance than
large firms and less able to adapt readily (OECD, 2012a).
38. It is therefore necessary to broaden the range of financing instruments available to SMEs and
entrepreneurs, in order to enable them to continue to play their role in growth, innovation and employment.
Financial stability, financial inclusion and financial deepening should be considered as mutually
reinforcing objectives in the quest for sustainable recovery and long-term growth. While bank financing
will continue to be crucial for the SME sector, more diversified options for SME financing could support
long-term investments and reduce the vulnerability of the sector to changes in the credit market. Indeed,
the problem of SME over-leveraging may have been exacerbated by the policy responses to the financial
crisis, as the emergency stabilisation programmes tended to focus on mechanisms that enabled firms to increase their debt (e.g. direct lending, loan guarantees), as funding from other sources (e.g. business
angels, venture capital) became more scarce (OECD, 2010b, 2012a).
39. An effective financial system is one that can supply financial resources to a broad range of
companies in varying circumstances and channel financial wealth from different sources to business
investments. As the banking sector remains weak and banks adjust to the new regulatory environment,
institutional investors and other non-bank players, including wealthy private investors, have a potential role
to play for filling the financing gap that may widen in the post-crisis environment (OECD, 2013d).
40. Recognising that “financing gaps” exist for certain categories of SMEs and that excessive
leverage may increase financial distress, in its 2011-12 Programme of Work, the WPSMEE agreed to
investigate alternative financing techniques for SMEs, in which investors, entrepreneurs and governments
develop innovative ways to distribute risks and rewards in fast growing and/or newer companies, and to
address entrepreneurs’ diversified financing needs in a rapidly changing economic and regulatory
environment. A first analytical study was conducted, which provides a preliminary overview of non-debt
financing techniques, with a focus on mezzanine finance (OECD, 2013b). This represents the first outcome
of a longer-term agenda, intended to improve understanding about how to broaden the finance options
available and accessible to SMEs and micro-enterprises, taking into account the heterogeneity of the
sector, the challenges for small firms to actually access and use the instruments available, the implications
of on-going financial reforms, and the specific financing needs of certain types of firms, such as innovative
and high-growth enterprises, SMEs seeking international expansion or those undertaking a major
transition.
41. In the course of this earlier study, it was revealed that a lack of awareness and understanding on
the part of SMEs, financial institutions and governments of these alternative instruments, their modalities
and operations constitute a major barrier to their use. The 2013-14 project on new approaches to SME and
entrepreneurship financing aims to address this important knowledge gap by developing a full mapping of
the available financing options and investigating their potential for responding to the diverse needs of
SMEs and entrepreneurs.
42. Through the present project, the WPSMEE intends to make a tangible contribution to government
efforts to ease finance constraints and promote business growth, by helping them develop and implement
new policy approaches and support well-functioning markets in offering a broader range of finance
instruments for SMEs and entrepreneurs.