A Survey to Assess the Views of SMEs regarding Business Formation Options

A Survey to Assess the Views of SMEs regarding Business Formation Options Abstract G.S. Kindra University of Ottawa, Canada The 1995 marketing plan of the Corporations Directorate identifies, without much specificity, that its primary target markets are small and medium-sized businesses in the growing provincial economies of British Columbia, Alberta and Ontario. It should be noted, however, that small and medium-sized businesses account for over 99 percent of all business firms in Canada. Also, even within these three provinces, economic growth varies greatly from sector and community. Thus, before implementing its marketing plan, the Corporations Directorate must formulate a clearer and more precise understanding of its target markets of end-users, or incorporators, and then develop a marketing strategy that will focus on more narrowly defined marketing opportunities for its services and products. The term "small business" is generally understood to include businesses with fewer than 100 employees in manufacturing and fewer than 50 employees in other sectors, while "medium sized" businesses are those with 100 to 500 employees. Large businesses have over 500 employees. To date, all but approximately 2000 of the more than 2.1 million businesses in Canada were either self-employed individuals or small and medium-sized enterprises (SMEs). From 1981 to 1991, the fastest growing segment of Canadian business was the self-employed group: the number of self-employed businesses increased by 69 percent, from 678,000 to 1,146,000 firms. Over the same period, the number of employer businesses, having less than 100 employees, increased by 32 percent, from 688,359 to 910,898 firms. The slowest growing segment was large business, having more than 499 employees, which actually decreased by 0.5 percent, from 2030 to 2020 firms. (Please see Table 1 for details) Table 1: NUMBER OF BUSINESSES BY PROVINCE 1983 1993 Province No. National Share (%) No. National Share (%) Net change in % NFLD PEI N.S. N.B. QC ONT MAN SASK ALB BC YK. NWT 14,250 5,618 24,127 21,399 189,767 253,865 32,020 40,780 88,815 105,810 1,031 1,455 1.8 0.7 3.1 2.8 24.4 32.6 4.1 5.2 11.4 13.6 0.1 0.2 22,540 7,257 31,962 26,926 224,575 305,629 35,129 40,799 107,711 144,123 1,537 2,283 2.4 0.7 3.4 2.8 23.6 32.2 3.7 4.3 11.4 15.2 0.1 0.2 +0.6 --- +0.3 --- -0.8-0.4-0.4-0.9 --- +1.6 --- --- 778,937 100.0 950,471 100.0 CANADA 753,518 922,182 Source: ESBO (1995b). 1112

Extracted from: Industry Canada, "Small Business in Canada: A Statistical Overview", December 1995, p. 11. From 1990 to 1993, there have been at least 140,000 business start-ups each year, of which, on the average, slightly over 6 percent have been new federal business incorporations. Business services, which accounted for 79.3 percent of the total net change in business start-ups and exits, represented only 8.3 percent of all business exits. In comparison, the sectors accounting for the least number of start-ups included fishing (0.6%), mining (0.6%), communications (0.6%), transportation (3.7%), manufacturing (4.1%) and agriculture (5.3%). There is a clear emergence of a more knowledge-based economy that is less dependent on older and traditional sectors, such as manufacturing, for new job creation. The latest available business formation statistics provide additional evidence that Canada's dependence on a commodity- and resource-based economy is diminishing, as production of knowledge-intensive goods and services increases. Based on the cumulative net business formation by industry, from Q1 1993 to Q1 1995, three sectors accounted for 49 percent of all business start-ups across Canada: retail trade (19.9%), construction (14.9%) and business services (14.2%) The greatest increase was recorded by British Columbia whose share increased from 13.6 percent in 1983 to 15.2 percent in 1993. The greatest loss was recorded by Saskatchewan whose share fell from 5.2 percent in 1983 to 4.3 percent in 1993, closely followed by Quebec whose share fell from 24.4 percent in 1983 to 23.6 percent in 1993. Also, self-employment has grown fastest in the services, finance, insurance and real estate and construction sectors. Alberta, British Columbia, Quebec and Manitoba have experienced the largest increases in the number of self-employed persons. At the end of 1995, approximately 32 percent of the self-employed were women. Only 20 percent of self-employed women have incorporated their business. There is, however, a growing trend for women to establish incorporated businesses. Survey This report addresses the hypothesis that small and medium-sized business in Canada does not give due consideration to federal incorporation as a viable and practical alternative to other legal forms of organization or operation. The Corporations Directorate of Industry Canada recently commissioned a market research firm, to conduct a critical analysis and assessment of its marketing function (Kindra, G.S., 1996). Based on its review of various Corporations Directorate marketing initiatives, including client mail-out surveys, focus groups and telephone interviews and surveys, which were primarily targeted at such marketing intermediaries as lawyers and name search firms, the Report observed that "very little effort had been directed at understanding and knowing the end-users or incorporators". Moreover, the Report added that "knowledge of the motives, perceptions and attitudes of incorporators was almost completely lacking". It was recommended that the Corporations Directorate undertake more narrowly defined market research in order to better understand their target customer, small and medium-sized businesses. (Kindra, G.S., 1996). As a follow-up, the Corporations Directorate commissioned a survey small and medium-sized businesses across Canada on their views and perceptions of different legal forms of organization such as sole proprietorship, partnership and provincial and federal incorporation. The Questionnaire The eight-page questionnaire, which was intended to solicit the views and perceptions of small and medium-sized firms on different forms of legal organization, consisted of four sections. 1113

Section A asks a series of six questions whose answers will be used to construct a "snapshot" of the composition of the small business sector in terms of different legal forms of organizations. Section B of the questionnaire is intended to provide valuable insight into how persons starting a business decide what legal form of organization is most appropriate for their business. Section C of the questionnaire evaluates the role and performance of federal and provincial governments as providers of information and services related to the formation of new businesses. Section D of the questionnaire examines how small and medium-sized businesses perceive the relative costs and benefits of unincorporated versus incorporated businesses. Frame Design and Survey Response The sample was stratified by region, size, industry, incorporation status and age of business. According to Statistics Canada definition of SMEs, the total in-scope population was 338,867 business establishments. A sample of 4000 such business establishments was used. The 8-page questionnaire consisting of 22 questions was pre-tested with 30 individuals. Minor wording and format changes were made on the basis of the pre-test results. A stamped, self-addressed return envelope was provided. In April 1996, the questionnaire was sent out by mail to 4000 SMEs - i.e. businesses having 99 or fewer employees and which, when taken together as a group, represent a cross-section of the Canadian economy. Usable, complete questionnaires, suitable for analysis, totaled 1,002 for a response rate of 25 percent. Findings Small- and Medium-Sized Businesses Of the 1002 responses received, 517, or 51.6 percent of all respondents were from companies with 0-9 employees. "Larger" small businesses having 10-24 employees accounted for 296 firms, or 29.5 percent of all respondents. Therefore, "small" businesses having fewer than 25 employees accounted for 81.1 percent of all respondents (please refer to Table 6). Business Size and Legal Form of Organization Based on the 1002 responses received, and irrespective of business size, provincial incorporation was by far the most popular legal form of organization. Approximately 70 percent of all respondents were provincially incorporated. In comparison, only 12 percent of all respondents were federally incorporated. Therefore, provincial incorporation was almost six times more common than federal incorporation. Sole proprietorships accounted for 10.3 percent of all respondents and partnerships accounted for 7.6 percent of all respondents. Approximately 19 percent of small businesses were unincorporated, compared with 15 percent of medium-sized businesses. The relative popularity of federal incorporation is greater for medium-sized businesses. As figure 1 indicates, the federal incorporation share grew from 10.8 percent for small businesses to 17.7 percent for medium-sized businesses. Meanwhile, the relative shares for sole proprietorship and, more importantly, provincial incorporation, both fell. Industrial Activity and Regional Distribution 1114

The respondents were classified, by their activity into two categories: goods and services. Nationally, approximately 83 percent of all respondents were in the service sector, with the highest percentage being in Western Canada. Atlantic Canada had the lowest percentage of respondents in the service sector. In fact, based on the survey's findings shown in Table 5, the relative importance of the service sector grew progressively from east to west across the country. Almost 90 percent of all respondents from British Columbia reported that they were in the service sector. Changes to Legal Form of Organization Approximately 3 percent of all respondents intend to change their form of organization within the foreseeable future. Provincial incorporation is the anticipated choice of about 60 percent of these individuals, whereas, federal incorporation is the choice of about 15 percent. Information Sources Preliminary Sources of Information Respondents identified trade associations and banks, closely followed by business seminars and courses, as the most important sources for information on starting a business. Government offices were ranked next, closely followed by public libraries and self-help guides on starting a business. The least important sources were Entrepreneurship and Small Business Centers, Federal-Provincial Business Service Centers and Chambers of Commerce and Boards of Trade (see Table 2 for details). Whereas banks provide general information on starting a business and the legal requirements that must be satisfied before opening a commercial account, trade associations, especially in regulated trades and professions, provide information that is specific to operating a business in their sector of activity. Many respondents subscribe to very tradespecific publications and association newsletters for their industry information. It is interesting to note the relatively low importance that respondents gave to government and community-run small business promotion and information centers. Their low importance might be due to low public awareness, combined with non-use of such facilities. Table 2: SOURCES OF INFORMATION SOUGHT BY BUSINESSES (N = 860) Source of Information Mean Score 1 Standard Deviation Mean Count 3 Count Rank 2 Rank Not Applicable Total Count 4 Library, self-help publications 1.98 1.28 5 379 8 481 860 Entrepreneurship and Small Business Centers 1.76 1.08 8 382 7 478 860 Federal-Provincial Service Centre Business 1.80 1.16 7 406 5 454 860 Chambers of Commerce/Boards of Trade 1.84 1.12 6 396 6 464 860 Banks 2.60 1.40 2 552 1 308 860 1115

Government offices 2.18 1.31 4 485 3 375 860 Business seminars/courses 2.57 1.36 3 480 4 380 860 Trade Associations 2.64 1.45 1 488 2 372 860 1 Level of importance on a Likert scale ranging from 1 = low to 5 = high. 2 Rank determined by mean importance. 3 Number of responses ranked. 4 Total responses ranked and not applicable. Publications There was a general consensus that, nationally, the most important and widely read business journals, newspapers and magazines were The Globe and Mail, followed by The Financial Post. Respondents chose The Globe and Mail ahead of The Financial Post by a ratio of 6 to 4. Neither newspaper was of significance in Quebec where the most popular journal was Les Affaires. Expert Advice on Starting a Business Approximately 70 percent of all respondents sought expert advice when deciding their legal form of organization. The survey found that accountants, and not lawyers, were the most important advisors. Lawyers and notaries were the second most important advisor, followed by persons who are "familiar" and "trusted": the entrepreneur's friends, family, business colleagues and bank manager. Furthermore, in spite of an abundance of available low cost, self-help information on starting a business, a large majority of entrepreneurs continue to seek out professional advice, or counseling, from accountants and/or lawyers and notaries when determining their legal form of organization. As noted earlier, 70 percent of all respondents had sought expert advice. Persons Table 3: SOURCES OF INFLUENCE ON FORM OF ORGANIZATION DECISION Mean Score 1 Standard Deviation Mean Count 3 Count Rank 2 Rank Not Applicable Lawyer 4.16 1.18 2 582 2 83 665 Notary 5 3.25 1.65 3 138 10 527 665 Accountant 4.43 0.91 1 633 1 32 665 Bank Manager 2.66 1.39 6 414 3 251 665 Management Consultant 2.18 1.52 8 201 7 464 665 Financial Advisor 2.44 1.57 7 221 6 444 665 Search Firm 1.27 0.74 11 133 11 532 665 Teacher/Seminar lecturer 1.75 1.18 9 170 9 495 665 Business Colleague 2.68 1.41 5 280 5 385 665 Government Official 1.66 1.09 10 201 7 464 665 Friend or Family 2.73 1.44 4 300 4 365 665 1 Level of importance on a Likert scale ranging from 1 = low to 5 = high. Total Count 4 1116

2 Rank determined by mean importance. 3 Number of responses ranked. 4 Total responses ranked and not applicable. 5 Available in Quebec Only. Dealings with Government As was noted earlier, respondents ranked government officials second to last in terms of their importance in influencing their choice of legal form of organization. They also ranked the Federal-Provincial Business Service Centers second to last in terms of their importance in providing information on starting a business. It is interesting to note that a higher number of respondents (i.e. 28.7 percent) had dealings with Revenue Canada than all other agencies combined (21.3 percent). This would suggest that the Corporations Directorate ought to coordinate information services related to the legal requirements for starting a business with other federal government departments and agencies like Revenue Canada as well as the BDB in order to tap into a broader business clientele. Dealings with the ICCD About 21 percent of all respondents have had direct dealings with either the ICCD or their provincial counterparts. More than two-thirds, or 145 firms, contacted only the provincial authorities, while only 7.5 percent, or 16 firms, contacted only the ICCD. Based on these findings, incorporation-related inquiries to the provinces out-number similar inquiries to the ICCD by a margin of 9 to 1. Also, 9.8 percent of the 214 respondents to the questions, indicated that they had dealt directly with the ICCD prior to submitting their application for federal incorporation. Respondents measured the importance of ICCD services on the basis of their information value in helping them to decide to incorporate. Table 4: How ICCD Can Improve Its Service Delivery Mean Score 1 Standard Deviation Rank 2 Count 3 Fast Service 2.27 0.87 2 79 More professional and knowledgeable service 2.53 0.90 5 79 Lower incorporation fees 2.25 1.01 1 79 More friendly, courteous, and thoughtful service 2.51 0.93 4 79 More accessible service (e.g. via regional offices or electronic/fax filings 2.42 0.98 3 79 More convenient business hours. 2.54 0.80 6 79 1 Level of agreement on a Likert scale ranging from 1 = strongly agree to 5 = strongly disagree. 1117

2 Rank determined by mean importance. 3 Number of respondents. Respondents were consistently in favor of lower incorporation fees, followed by faster and more accessible service. They were least concerned about convenient business hours or the knowledge level and professionalism of ICCD service agents. When asked to comment on ICCD service levels, about one-half of all respondents had neither a positive or negative opinion. It should be noted, however, that as many as 15.4 percent of respondents strongly disagreed that ICCD service levels satisfied their federal incorporation needs. On the other hand, over one-quarter of respondents were satisfied with ICCD service levels. Business Perceptions For unincorporated respondents, financial considerations were the most important factor. Incorporation implied higher costs that small business cannot seem to afford. Secondly, respondents felt that incorporation was for more established businesses and thirdly, respondents followed the advice of experts who recommended the establishment of either a sole proprietorship or a partnership. When incorporated respondents were asked their reasons for incorporating, the most important factor was limited liability, closely followed by tax advantages. Like unincorporated respondents, the third most important reason given was their expert advisor's recommendation to incorporate. The prestige associated with incorporation (i.e. stability, success and permanence) was ranked low in terms of importance, slightly ahead of last place "business license or franchise requirements". The relative importance of the three primary factors does not vary with the size of the respondent's business. Less important factors did vary in terms of their ranking when medium-sized businesses were examined separately. However, the variance is insignificant and does not affect the relative importance of the primary factors involved in selecting incorporation as a legal form of organization. For provincial incorporations, the primary reasons for selecting a provincial incorporation are: first, planning to operate in one province only; second, following one's expert's recommendation; and third, feeling that a federal incorporation offers no additional benefit. Follow-Up Telephone Survey A follow-up telephone survey of 50 respondents, chosen at random, was conducted to seek further clarification on certain issues. Majority of the sample indicated that the price of incorporation was not the sole consideration. Rather, most respondents surveyed cited the local nature of their business as a primary reason for selecting to incorporate provincially. They did not perceive nor were not aware of any benefits from being federally incorporated. The respondents felt that a federal incorporation fee within a narrow range of their provincial incorporation fee would be most acceptable. Telephone respondents confirmed the key role of expert advisors like lawyers, accountants, friends, and bank managers. Respondents also confirmed that information about federal incorporation should be made available to such intermediaries, or expert advisors, on a regular basis in the form of mail-outs and brochures. Brochures, or information packages targeted directly at potential entrepreneurs should focus on cost and procedural information as well as explain the key advantages of a federal incorporation. Implications of the Survey's Findings The survey has demonstrated that lower incorporation fees must be accompanied by two key changes: enhanced service delivery, improved communications and promotion targeted at small businesses and their key advisors: accountants and lawyers of federal incorporation. 1118

Secondly, the majority of lawyers seem to have a personal preference for provincial incorporation, which is reflected in the responses received. Incorporators, on the other hand, place their trust in the better judgment and expertise of their expert advisor. Third, the survey revealed the primary importance of accountants as an alternative distribution channel for information on ICCD products and services. Not only do accountants have greater market penetration in the small business community, different branches of the accounting profession such as the CGAs and the CMAs provide a cost competitive alternative to more expensive CA services. Fourth, the bank manager was identified as a trusted and respected source of information for entrepreneurs starting a small business. Given his position as "an objective" provider of information, the bank manager occupies a key position at the front end of the information chain. The bank manager will not prepare the incorporation papers, but he can maintain a level playing field by assuring that his clients are made aware of all alternative forms of legal organization, including federal incorporation. Therefore, the ICCD should involve Canadian banks as an integral component of its information and public education strategy. 1119

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