Lending to knowledge-based businesses in Newfoundland and Labrador

Abstract

Knowledge-based businesses (KBBs) have the potential to make a significant contribution to peripheral regions with marginal economies, such as Newfoundland and Labrador. However, traditional lending approaches generally emphasize tangible collateral and historical performance. As a result, new knowledge-based firms, whose assets are primarily intangible, experience difficulty with access to financing. Financial institutions have responded by implementing specialized approaches to address the needs of KBBs. This exploratory study is designed to increase our understanding of institutional lending to KBBs, particularly at the start-up stage. Following a review of the literature a research framework was developed to explore the demand-side perspectives of entrepreneurs and the supply-side perspectives of lending institutions. A mail survey to entrepreneurs was employed to determine the roles played by chartered banks and government agencies in financing KBBs and to ascertain entrepreneurs' perceptions of financial institutions. Results indicate KBBs experience greater difficulty obtaining financing from chartered banks. Further, KBBs perceive banks to follow traditional risk assessment processes, emphasizing collateral. Findings suggest efforts by banks to cater to KBBs have been less than successful. Supply-side data were obtained from interviews with senior managers in banks and government agencies and from business plan reviews and follow-up interviews with account managers. Simultaneous verbal protocols were used to examine risk assessment processes in six banks and four government agencies. Hypothetical business proposals were presented to account mangers for initial review and subsequent due diligence. Data obtained at two stages of assessment were analyzed using consensus analysis, multidimensional scaling, hierarchical clustering, and standard multivariate techniques. Findings confirm chartered banks have establishcd specialized approaches to deal with KBBs. However, there is no evidence to indicate any differential effects on KBBs as a result of identified organizational variables. There is evidence among specialized account managers of differences in risk assessment of KBBs and of a common lending culture that reflects the needs of KBBs. Evidence of a common lending culture is also evident among traditional bankers and among government agencies that share an economic development mandate. Findings also confirm chartered banks are more concerned with financial aspects of the proposed ventures and perceived higher levels of risk than government account managers. Overall, findings provide important insights into institutional lending and have significant implications for theory, management practice and public policy. This study is one of very few to explore lending and borrowing from the perspective of KBBs and from the perspective of government agencies. Study validity is enhanced considerably by reviewing lending decisions in context and with reference to specific proposals. The use of cultural consensus theory to examine loan evaluation and risk assessment represents a significant contribution to understanding theory on lending to KBBs. Lending practices of chartered banks, while evolving to meet the needs of KBBs, have not met expectations and may need to be reexamined. Entrepreneurs in KBBs are advised to seek out KBB specialists to enhance the likelihood of obtaining financing. Government should take steps to ensure expertise is available to deal with KBBs and to encourage financial institutions, especially banks, to extend efforts to provide specialized assistance to the KBB sector. Finally, additional research is needed to confirm findings from this study and to increase their generalizability.