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Nine years into the economic cycle, small and medium-sized (SME) businesses are showing signs of fatigue and reporting lower confidence, and are also facing several potential headwinds, finds a new CIBC Capital Markets report.

“Small and medium-sized enterprises were the pioneers of the economic recovery, able to generate jobs at a pace faster than managed by larger corporations. But the cycle is maturing, and SMEs are showing some signs of fatigue,” says CIBC deputy chief economist Benjamin Tal. “External shocks such as higher interest rates, a stronger Canadian dollar, rising minimum wages and potential tax policy changes will further test the durability of this critical segment of the Canadian economy. Are they up to the task?”

Read: Canada’s young entrepreneurs drive exports: CIBC

With healthy cash positions and debt levels, and business investment in positive territory, large corporations are now outpacing SMEs in job creation. While there are no major red flags for corporate Canada, the report says a closer look reveals early signs of fragility.

Profit margins, at just under 7%, are consistent with numbers posted in the second half of the past two expansions. But, this time, margins have been helped by lower unit labour costs, reflecting in part wages that are remaining tame for deeper into the cycle than textbook models predict.

Already, SMEs are telling us that the euphoric 4%-plus GDP growth is not going to last, Tal says.

Read: Higher growth, inflation forecast through 2024: report

Their “confidence took a nosedive in the past few months, paving the way to a much softer economic reading in the second half of the year. And that reduced confidence is visible in the hiring momentum in the SME space,” with SME hiring slowing down and its share in employment falling, the report says.

“Over the past two years, the pace of job creation by SMEs was half of that seen among large corporations,” says Tal.

Despite the challenges, the exit rate among SMEs has been trending downward, suggesting that businesses are surviving for longer. The report also noted the number of new business entrants has also been on the decline, and the average age of SMEs is rising.

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However, the younger a business is, the faster it tends to grow, the report says.

“The rising average age of SMEs is working to reduce the dynamism and growth potential of the entire sector, regardless of where we are in the cycle,” Tal says.

Secrets to SME success

The report examines SMEs with above-average revenue growth over the past five years. Here are some key trends:

  • Small firms that receive outsourced work from other companies grow their revenues, on average, 45% faster than firms without outsourcing work.
  • Export-oriented firms see their revenues rise 50% faster than non-exporting firms.
  • Companies with an increased number of services and products saw on average stronger revenue growth, and, by sector, service-oriented SMEs outperformed, including firms in finance information and recreation.

“This finding suggests that small business owners are able to adjust to an evolving marketplace by shifting products or services,” says Tal.  “The key to success is the business model and the ability to adapt to changing market conditions.”

Read: NAFTA dedicates chapter to small biz, but issues still remain

The report also notes that success in business doesn’t hinge on the owner’s motivation for launching the business, such as being laid off and needing to find work, or being passionate about a business idea.

“Interestingly, we found no performance difference between SMEs that were created due to negative economic circumstances and companies that were established by the entrepreneur’s choice to become self-employed,” Tal says.

Originally published on Advisor.ca
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