The funding picture for SMEs is mixed: while access to traditional bank loans has been limited since the global financial crisis, we’ve seen a dramatic increase in equity investment – up from £1.6bn in 2011 to £12bn in 2019.
Although the financing options and tax incentives open to UK SMEs are improving year-on-year, almost one in ten small businesses are still not seeking the external capital that would allow them to grow, a new report reveals.
Unlocking Growth: How to Expand Access to Capital, a joint report from The Entrepreneurs Network and The Enterprise Trust, evaluates the funding options open to SMEs – from Start-Up Loans and grants to equity crowdfunding and peer-to-peer lending. The report identifies policy changes that will ensure businesses can access the finance they need to grow.
While traditional lending is down, according to the British Business Bank, the bank is still the first port-of-call for SMEs seeking finance. It’s only once entrepreneurs have been turned down by the bank that they investigate other types of lending, including equity investment. These alternative forms of finance are effectively filling the gap.
According to Beauhurst, the demand for equity investment via venture capitalists has exploded. In 2011 the figure stood at £1.6bn; last year it reached £12bn.
Despite this, figures suggest 9.1 per cent of all SMEs fall into the category of so-called ‘discouraged borrowers’, businesses with a real need for finance, who fail to apply due to fear of rejection, a belief that raising capital would be too expensive, or concerns the process would be too difficult or time-consuming.
This leads to an estimated £1.5bn SME investment shortfall, or £11,773 for each discouraged firm.
It also leads to fewer jobs and weaker economic growth through a lack of investment in workforce skills, investment in new technology, and investment in international expansion.
Joy Foster, founder of TechPixies, a digital training firm for returning women, raised £150,000 through EIS and SEIS, but admits she almost didn’t and considered walking away because she was daunted by the amount she needed to raise with ‘no guarantee’ she could pay it back..
Similarly Francis Toye, founder of justice software firm Unilink describes not knowing how to grasp opportunity until he joined the Goldman Sachs 10,000 Small Businesses programme and raised £1m through Funding Circle and then another £7m through defined payment terms.
This report makes the case for key policy changes that would unlock new funding opportunities for entrepreneurs including increasing VC capital flow by reforming the way defined contribution pension funds invest or fast-tracking EIS and SEIS applications.
Increasing mentoring to Start Up Loan recipients, who tend to be among those described as ‘discouraged borrowers,’ could also help deliver growth.
Richard Harpin, founder of the UK’s leading home repairs and improvements business HomeServe and new ‘think and do tank’ The Enterprise Trust, said: “All evidence points to the fact that businesses that take on investment at key moments in their growth trajectory do dramatically better than those that don’t.
“These founders go on to create jobs, generate taxes and contribute to UK economic growth.
“Yet, navigating the funding sphere has often become so difficult that it has left nearly 10% of founders discouraged from raising the finance they need to survive and thrive.
“It’s clear that finance is out there, with a dramatic uptake in Start Up Loans, equity finance and crowdfunding. However, it is also clear that this capital is not always getting to where it needs to be. We need to change that.”
Sam Dumitriu, Research Director of The Entrepreneurs Network and author of Unlocking Growth: How to Expand Access to Capital said: “By helping small businesses manage cashflow, invest in better equipment, and expand into new markets, access to the right type of finance can be transformational.
“The meteoric rise of alternative finance and VC should be celebrated, but still too many businesses fail to access the finance they need to grow.
“Reforms to reduce wait-times for early-stage investment tax reliefs and allow pension funds to invest more in venture capital will allow more businesses across the UK realise their growth ambitions.”
· Experiment with lottery-style funding to channel more grant-funding to start-ups. New Zealand’s Health Research Council uses this approach to allocate funding to proposals that are “transformative, innovative, exploratory or unconventional, and have potential for major impact” and it works well.
· Simplify and modernise Research & Development Tax Credits by providing better feedback for applications and expanding the score of activities that qualify as R&D. It could be improved on three fronts: feedback, speed, and scope. Solving these problems would enable more start-ups to benefit from the relief and reduce the risk of theirs turning to specialist tax credit advisers who can take up to 25% of the relief claimed.
· Make data sharing obligatory for incubators and accelerators receiving public funding. This will allow us to identify the most successful programmes, and better understand why they work. It will also allow us to identify the schemes best at expanding access to entrepreneurship among disadvantaged or under-represented groups.
· Improve the mentoring offer for Start Up Loans by providing additional advice when businesses finish paying their loans. The programme’s evaluation found high numbers of discouraged borrowers among participants.
· Streamline the advanced assurance process for EIS and SEIS to unlock more investment in high-growth start-ups so businesses using the pre-approved documentation could be fast-tracked and delivery more efficient.
· Unlock additional investment into venture capital from defined-contribution pensions by reforming the fee cap and clarifying rules on the valuation of illiquid assets. In the US, VCs invested more than 10 times as much as UK VCs in 2017. This is partly explained by the impact of pension fund investment in venture capital. In the US, VCs are overwhelmingly funded by institutions such as pension funds, insurance companies, and endowments. Pension funds play a much larger role in the US. They contribute 65% of the capital in the US VC market and 18% in Europe, but just 12% in the UK.
· Provide more long-term patient capital through the British Business Bank. The government should encourage the British Business Bank to investigate if funds can be better directed towards solving market-failures. For instance, there may be a case for prioritising investments in regions under-served by venture capital or tying funding from the BPC to support for start-up community building, such as training for emerging fund managers.