Select Committee on Treasury Written Evidence


Letter to the Chairman from Nigel Griffiths MP, Parliamentary Under-Secretary for Construction, Small Business and Enterprise, DTI

REGIONAL PRODUCTIVITY ENQUIRY

  I am writing further to your request for written evidence from the Small Business Service on the availability of venture capital and loans to small firms in the regions in advance of the Committee's evidence session to be held on 9 November 2004.

  The enclosed paper considers the markets for debt and equity finance, and their operation across the regions of the UK. It describes the areas in which the Government has identified specific market failures, considers whether there is any regional dimension to these failures, and discusses the main policy interventions managed by the Small Business Service.

  To ensure continued growth of the UK economy it is important that we seek to reduce the disparities that exist in growth rates between the regions and make certain that sustainable improvement is made in the economic performance of all English regions over the long term. I welcome the Committee's inquiries into this important area and look forward to seeing its findings.

NOTE ON REGIONAL ASPECTS OF "ACCESS TO FINANCE"

1.  OVERVIEW

  1.1  Financial markets are key to the proper allocation of resources within the economy, ensuring that businesses can access the external finance they need to achieve their full potential. The discipline of the market is also important in ensuring that scarce resources are channelled to viable businesses: it is in nobody's interests that propositions with little prospect of success should receive finance.

  1.2  The UK is widely acknowledged as possessing one of the most efficient financial markets in the world, and survey evidence shows that the financing needs of a clear majority of businesses are met. Nevertheless, a small but important minority of firms—typically innovative, growth-oriented businesses—continue to face difficulties in attracting external funding, providing a case for targeted government intervention to assist markets where these difficulties create a barrier to enterprise and innovation.

  1.3  This note considers the markets for debt and equity finance, and their operation across the regions of the UK. It describes the areas in which the Government has identified specific market failures, considers whether there is any regional dimension to these failures, and discusses the main policy interventions managed by the SBS.

2.  SUPPLY OF DEBT FINANCE

  2.1  Banks are the principal source of debt finance, either in the form of overdrafts or term loans, but smaller businesses are increasingly making use of alternative sources of debt: leasing, invoice discounting and factoring and other forms of asset-backed finance are becoming increasingly well used.

  2.2  Evidence suggests that the availability of debt finance has improved significantly over the past decade, reflecting increasing economic stability and the increasing sophistication of the business banking market. Research by the Bank of England has emphasised the role of credit scoring systems in helping to improve the supply of debt finance, and the Bank concluded in 2003 that there was "no real evidence of firms having difficulties accessing bank finance".

  2.3  However, while most viable businesses appear able to access debt finance, lenders often rely on collateral to support lending to SMEs, especially where the borrower lacks an established track record in business. Not all business owners are able to offer suitable security, and the availability of collateral will be lower in regions where house prices and rates of home ownership are low. Where no collateral is available to support a commercial loan, and regardless of location, the SFLG offers a government guarantee of 75% of the value of the loan, in exchange for a 2% premium paid by the business to the DTI.

  2.4  The SFLG has just been the subject of an extensive independent review, led by Teresa Graham OBE of Baker Tilly. The review confirmed that there is a strong ongoing rationale for the SFLG—but, among other things, identified significant geographical variations in the take-up of the scheme (see Chart below). It made various recommendations to encourage a more consistent availability of SFLG so that more firms can access the programme, regardless of their location. Further information is contained within the interim and final reports of the Graham review. The Government has welcomed the review's recommendations, as has confirmed that it will implement its proposals in full.


  2.5  Where enterprises are unable to access finance from mainstream lenders, often due to falling outside lender credit risk parameters—even with SFLG—the Phoenix Challenge Fund (PCF) has been able to help by providing finance for enterprises through Community Development Finance Institutions (CDFIs). This has been targeted at enterprises and entrepreneurs in disadvantaged communities, both geographic and, thematic. Over 60 CDFIs are in receipt of over £40 million from PCF, mainly capital finance for loan fund on lending but also including revenue and some loan guarantee support.

  2.6  To enable CDFIs to raise additional finance from the private sector for on lending (and/or investing if in social enterprises), Community Investment Tax Relief (CITR) was introduced in 2003. The first 22 accredited CDFIs hope to raise over £80 million over the next few years. A number of Banks have also provided some capital and revenue support (and made referrals) to some CDFIs, which helps share risk and enhances joint working.

3.  SUPPLY OF EQUITY FINANCE

The equity gap

  3.1  The UK has the largest and most developed private equity market in Europe, through growth of the market has been accompanied by an increasing concentration on larger investments in well-established businesses. However, structural features of the market have resulted in an ongoing, and indeed worsening, shortage of equity finance to support smaller-scale investments—the so-called "equity gap". Features of both the supply and the demand sides of the market contribute to the gap.

  3.2  There are significant costs involved in making equity investments. These include search costs (the costs of identifying investment opportunities), the costs of due diligence (appraising the quality of the investment opportunities received), legal and other transaction costs, and the ongoing costs of post-investment monitoring. These costs contribute to an equity gap for smaller businesses because they contain a large fixed-cost element: they do not vary proportionately with the value of investment being made.

  3.3  When the Regional Venture Capital Fund programme was being designed, some five years ago, the consensus was that the equity gap was a significant constraint for businesses seeking up to around £½ million of equity finance. Although there were tentative signs that the gap was widening, it was unclear at the time whether this was for cyclical or structural reasons. Subsequent evidence shows that the gap has widened significantly, reflecting a structural consolidation in the VC industry towards ever-larger funds, the economics of which clearly favour making larger investments.

  3.4  Evidence of an equity gap, which is now generally a significant constraint for businesses seeking up to £2 million of equity finance, was, presented in Bridging the finance gap—next steps. [9]However, as that paper also discussed, the severity of the equity gap does not just depend on investment sizes: it will vary according to various factors—including the amount of investment being sought (smaller investments face. proportionately larger transaction costs) and the characteristics of the company seeking investment (information costs may be higher for businesses at an early stage of development, and especially those seeking to develop unproven technologies, products and markets).

How does the equity gap vary between regions?

  3.5  The structural causes of the equity gap are generic, and are not specific to particular regions or geographic areas: the gap is therefore a feature of all regions of the UK. However, the severity of the equity gap will vary according to various factors: as noted above, these include the amount of investment being sought and the characteristics of the company seeking investment.

  3.6  But the location of a company seeking investment will also be important: the costs of making equity investments will increase with distance between the investor and the business. The presence of well-developed venture capital and business angel communities will therefore be an important determinant of a firm's ability to access equity finance.

  3.7  Data from the British Venture Capital Association show that there are substantial geographical differences in the concentration of VC activity: table 1 below shows this at a regional level, but the availability of equity finance can also vary within regions. For example, internal research by HM Treasury (based on a small sample of venture capital deals) suggested that disadvantaged areas may attract only half as much venture capital per head of population as the rest of the UK.



  3.8  Likewise, the supply of equity finance from business angels appears to vary substantially between regions. Although robust estimates of the regional distribution of angel investment are not available, given the informal and often invisible nature of such investment, it is well known that most business angels invest within a relatively short radius of their home. More prosperous regions are therefore likely to have a greater supply of business angel finance. Data on usage of the Enterprise Investment Scheme (EIS) tax incentives, which are widely used by business angel investors, are consistent with this view (see table).
RegionNumber of companies receiving EIS investment (FY2002-03) Number of VAT-registered businesses (thousands, end-2002) Companies receiving EIS investment, per thousand VAT-registered businesses
North East  45  43.8 1.0
North West187169.7 1.1
Yorkshire and Humber116 124.40.9
East Midlands  98 120.50.8
West Midlands128146.3 0.9
South West187163.5 1.1
East of England194177.9 1.1
London634280.8 2.3
South East443277.5 1.6
Wales  57  76.3 0.7
Scotland179124.2 1.4
Northern Ireland  35   56.10.6
Total2,303 1,761 1.3

Sources: Inland Revenue, Small Business Service. EIS figures may not be fully complete, due to delays in receiving EIS claims.

The Government's approach to addressing the equity gap

  3.9  The Government's approach is to develop targeted interventions that work with the market to stimulate increased investment activity where there is demonstrably a shortage of capital. Harnessing market forces, with investment decisions taken by private-sector participants facing clear financial incentives to maximise financial returns, is the most effective way to ensure that government support is channelled to commercially viable businesses with good prospects of success.

  3.10  The SBS has developed a number of national solutions to market imperfections that cut across regional boundaries,[10] and so its interventions have not been targeted at specific regions:

    —    The Regional Venture Capital Funds are a national programme, comprising nine regionally-based funds that together provide England-wide coverage. The RVCFs are able to make investments of up to £500,000 in two separate funding rounds, and each Fund is underpinned by a subordinated Government investment of up to 30% of the total fund size. The Devolved Administrations operate their own schemes to address this part of the equity gap.

    —    The High-Technology Fund was established to stimulate institutional investment in venture funds targeting early-stage, high-technology businesses across the UK. Again, there are systematic nation-wide market imperfections here: the due diligence and other costs involved in investing in these kind of companies are particularly high because of the unproven nature of the technologies, products and product markets involved.

    —  Early Growth Funding was developed to test innovative methods of providing of risk capital in amounts averaging between £50,000 and £100,000 to business start-ups and other businesses in the early stages of growth. Funds were established following an England wide competitive bidding process that sought innovative models that showed a promise of making commercial returns. These returns should help attract future investors. Six of the seven funds operate as business angel co-investment funds. One of these is a nationwide technology fund the others will tend to operate regionally as they focus on particular business angel networks. The remaining fund offers loans with a royalty charge.

    —  The Bridges Community Development Venture Fund has-a specific remit to invest in businesses located in the most disadvantaged 25% of wards in England. Again, this reflects the fact that the market imperfections leading to the equity gap are likely to be more severe in these areas, as borne out by the research on the supply of venture finance in disadvantaged communities, mentioned above. The focus on these areas is part of the Government's wider strategy to help overcome the barriers to enterprise in the Enterprise Areas, where the social benefits of stimulating business formation and growth are likely to be particularly high.

  3.11  Further details of the SBS supply-side interventions are annexed to this paper: these details were prepared for another purpose during July 2004.

  3.12  Where there are market imperfections that are peculiar to a particular region or sub-region, and that are not addressed by existing national programmes, the Devolved Administrations (DAs) and the Regional Development Agencies (RDAs) now have the flexibility to implement their own solutions in accordance with regional priorities. Currently the North West, Yorkshire and the Humber, South West and North East have all used ERDF Objective 1 and/or Objective 2 fund monies to develop additional specific solutions for their regions. It is understood that the Treasury Select Committee will be hearing from some of those involved in these funds when it holds its evidence session on 9 November 2004. SBS maintains a role working with the RDAs to ensure that regionally-based measures complement existing nationally-managed interventions, and in disseminating best practice across the regions. SBS meets regularly with the RDAs.

4.  DEMAND FOR FINANCE

  4.1  There is a growing realisation that boosting the quality of demand for finance is at least as important as increasing the supply of funds in improving the flow of growth capital to SMEs. Many businesses lack awareness of sources of finance and may also be not properly prepared for that finance; prospective investors report that many business proposals they receive are of low quality. Improving the quality of these proposals would help to reduce the information costs involved in making loans or equity investments, so helping to increase the efficiency of the market.

  4.2  The Government is therefore taking action to help ensure that measures to boost the supply of risk capital are backed by effective demand. The SBS supported a number of investment readiness, "demonstration projects", the outcomes of which have been evaluated and the findings disseminated to RDAs and others to inform them as they develop regionally-based interventions with their local partners. The projects demonstrated the importance of having networks of key players at regional level to support the delivery team. The SBS will continue to play an important role in helping RDAs drive forward this agenda through sharing best practice across the country and ensuring that RDAs are well placed to learn from each other's experiences.

  4.3  In September 2004, a joint Government-Accountants working group, chaired by Michael Snyder, Senior Partner of Kingston Smith, made a series of recommendations to help SMEs access the advice and support they need to maximise their prospects of raising finance. The group did not identify a specific regional dimension to the demand side of the market. The recommendations included a self-accreditation scheme for funding advisors, financial health-checks for small businesses and "no-nonsense guides" on small business finance. The Government will shortly be publishing two "no-nonsense guides", tailored respectively to the needs of start-up and high-growth businesses, under the SBS's Business Link brand.

5.  FUTURE DEVELOPMENTS/POLICY DIRECTION

  5.1  On the debt side, the Government's key priority is now to implement the recommendations of the Graham review of the Small Firms Loan Guarantee.

  5.2  On the equity side, following an extensive consultation with the business and SME finance communities and other interested parties, the Government has announced that it will be launching a "pathfinder" round of Enterprise Capital Funds (ECFs). These will be launched as soon as possible after European state aid clearance is received. ECFs are broadly based on a variant of the US Small Business Investment Company programme, which has channelled over $25 billion of finance to "smaller, growing companies in the past ten years.

  5.3  ECFs will be managed by private-sector fund managers on a fully, commercial basis. Subject to state aid clearance, ECFs will be able to participate in investment rounds of up to £2 million: a higher limit than for RVCFs, but reflecting the structural widening of the equity gap Since the RVCFs were introduced. The government's investments in ECFs will be on less subordinated terms than in some previous interventions;" the ECP structure will attract private capital by enhancing reward to investors in successful funds, but public capital will not be exposed to greater risk of loss than the private investors'.

  5.4  At this stage, the government has committed only to introducing a "pathfinder" round of ECFs, in order to inform the development of a longer-term programme. Pathfinder ECF managers will be selected through a competitive bidding process. Depending on the applications received, this pathfinder round is likely to comprise between three and five ECFs, sufficient to test the viability of the model and to gauge the likely level of market appetite for a longer-term programme. ECFs are to be demand-driven (ie they will be established only where prospective ECF managers can demonstrate a viable market opportunity), and so the likely regional impact of the pathfinder round cannot be judged until the successful applicants have been selected.

  5.5  A key objective for the pathfinder is to demonstrate the commercial viability of the ECF model, which will require maximum flexibility for participants to take fully commercial investment decisions within the equity gap. There is no specific objective for the pathfinder round to achieve regional or social policy objectives, as the emphasis is on demonstrating the commercial viability of the model. No decisions have yet been taken as to the selection criteria for future rounds of ECFs beyond the initial "pathfinder" round, and such decisions will be taken in the light of early experience with the pathfinder process.

DELIVERY OF SME FINANCE MARKET INTERVENTIONS

  5.6  The SBS is currently in the process of establishing a company limited by guarantee to deliver all of DTI's SME-focused debt and equity programmes. The new company will maximise the commercial focus and professionalism of management of the Government small business finance programmes.

6.  RELATED PAPERS

  Bridging the finance gap—a consultation on improving access to growth capita/for small businesses, HM Treasury and Small Business Service, April 2003, www.sbs.gov.uk/financegap.

  Bridging the finance gap—next steps in improving access. to growth capita/ for small businesses, HM Treasury and Small Business Service, December 2003, www,sbs.gov.uk/financegap.

  Early evaluation of the Regional Venture Capital Funds—Summary of findings, August 2003, http://www.sbs.gov.uk/finance/venturecap.php.

  Graham Review of the Small Firms Loan Guarantee—Interim Report, June 2004, http://www.hrn-treasury.gov.uk/independent reviews/ graham review/ review graham index.cfm.

  Graham Review of the Small Firms Loan Guarantee—Recommendations, September 2004, http://www.hm-treasurv.gov.uk/independent reviews/ graham review/review graham index.cfm.

REGIONAL VENTURE CAPITAL FUNDS

SUMMARY OF PROGRAMME

  Regional Venture Capital Funds (RVCFs) are an England wide programme to provide risk capital finance in amounts up to £500,000 to SMEs in order to address an acknowledged "equity gap" at the lower end of the market. There are 9 RVCFs, one in each English region. The funds are managed by private sector venture capital fund managers and are operated on a purely commercial basis.

  The Government's investment in the funds is as a subordinated cornerstone investor with funds providing a hurdle rate of return to investors before a capped Government return. Government takes first loss.

PROGRAMME BUDGET

  £80 Million

EXPENDITURE

    (a)  Total Expenditure to date:

  As at 30 September 2004, the nine funds had drawndown £41,962,500 from the DTI since the first funds launched in January 2002.

NUMBER OF FUNDS IN OPERATION

  Funds are operational in all nine English regions and are of the following sizes:

Total since 1981
(to 31 Dec 2003)
2002-03
(full year)
2003-04
(full year)



Number of loans guaranteed
88,4963,9165,966
Value (£m)3,602 269.5409.258
Cost (£m net)482.8 * 40.8 **53.7


NUMBER OF FUNDS IN PIPELINE
  N/A—the aim of the programme was to establish a fund in each English region. This has been achieved.

NUMBER OF COMPANIES RECEIVING SUPPORT
  As at 30 September 2004, the nine funds had made 192 investments in 134 SMEs since the first launch in January 2002. Of these 134 are initial investments and 58 are follow on investments.

RESULT OF ANY ETHNICITY OR SEX MONITORING
  The funds are managed on a purely commercial basis. No specific ethnicity or sex monitoring has therefore been undertaken.

EVALUATION PLAN
  An Early Assessment Study (phase 1) of the RVCF programme was completed in June 2003. This initial study was designed to check if the Funds are on track to meet their short term objectives for the programme, as well as making progress towards the longer term objectives. The Summary Report for this study is available at www.sbs.gov.uk/finance/venturecap,plip.

  RVCFs will be included in the development of a long term evaluation strategy for venture capital programmes.



UK HIGH TECHNOLOGY FUND

SUMMARY OF PROGRAMME
  The UK High Technology Fund (UKHTF) was established to encourage institutions to invest in early-stage, high technology venture capital specialist companies and to increase the amount of finance available for investment in technology-based businesses.

  The Fund was established on a "fund of funds" basis, investing in existing high technology based venture capital firms instead of directly in high technology companies. Its aim was to raise £105 million from private sector investors alongside £20 million of Government investment. The Fund has actually raised £126.1 million in total (£106.1 million from private sector investors and the Government's £20 million investment). All investments are made on a strictly commercial basis and decisions on those funds invested in are made solely by Westport Private Equity Ltd, the appointed fund manager.

  The Government's investment in the fund is as a cornerstone investor. Private sector investors will receive a minimum rate of return on their money before any Government return.

PROGRAMME BUDGET
  £20 million

EXPENDITURE

    (a)  Total Expenditure to date
  The Government has invested, as a commercial investor, £20 million into the fund. £3 million was invested in 1999-2000 and £17 million was invested in 2000-01. The £20 million was a "one-off" investment and no further Government funds will be invested in the fund.

NUMBER OF FUNDS IN OPERATION
  One

NUMBER OF FUNDS IN PIPELINE
  N/A—see above

NUMBER OF COMPANIES RECEIVING SUPPORT
  As at 31 December 2003, £124 million of the £126.1 million raised by the Fund had been committed to nine specialist venture capital funds. These venture capital funds have in turn made investments in over 158 technology-based companies.

RESULT OF ANY ETHNICITY OR SEX MONITORING
  The Fund is managed on a strictly commercial basis. No specific ethnicity or sex monitoring has therefore been undertaken.

EVALUATION PLAN
  No formal evaluation currently planned. Fund was set up to encourage pension funds to invest in early-stage technology funds. The investor profile of the UK High Technology Fund confirms this goal has been achieved.



COMMUNITY DEVELOPMENT VENTURE FUND (BRIDGES FUND)

SUMMARY OF PROGRAMME
  The Community Development Venture Fund (CDVF), more commonly known as the Bridges Fund, is a £40 million venture capital fund which aims to widen and deepen the provision of venture capital finance and entrepreneurial support to viable SMEs, capable of growth that are located in, and have economic links with, the 25% most disadvantaged wards in England. The Fund was launched on 14 May 2002 and became operational after a fourth and final closing in September 2002.

  The Fund is made up of £20 million from institutional and private sector investors and £20 million from the Government. It is split into two separate funds:

  Fund "A"—£28 million composed as follows:

    —  Private sector investors—50%
    —  Government subordinated (first exposure and capped return) funding—35%
    —  Government "pari passu" (treated on the same basis as other investors) funding—15%
  Fund "B"—£12 million does not contain any subordinated government funds and can focus on larger investment deal sizes (eg up to £2 million). It is composed as follows:

    —  Private sector investors—50%
    —  Government "pari passu" (treated on the same basis as other investors) funding—50%
  Although capable of being used to co-invest commercially alongside or following on Fund A investments, Fund B will not be able to enhance its returns or mitigate its risk as a result of any earlier subordinated funding under Fund A.

  The Fund is a commercial venture capital fund, proposed and managed by Bridges Community Ventures Ltd, rather than a government led programme.

PROGRAMME BUDGET
  £20 million

NUMBER OF FUNDS IN OPERATION
  The Bridges Fund was launched in May 2002

NUMBER OF FUNDS IN PIPELINE
  No further funds proposed at this stage.

EXPENDITURE
    (a)  Total Expenditure to date
  As at 30 September 2004, the Fund had drawndown £10,690,255 in total from the DTI since it was launched in May 2002.

NUMBER OF COMPANIES RECEIVING SUPPORT
  As at 30 September 2004 the fund had invested in 14 SME's since it became operational in September 2002.

RESULT OF ANY ETHNICITY OR SEX MONITORING
  Bridges Community Ventures Ltd provided the following social impact statistics, as at 31 March 2004:

    —  Proportion of portfolio woman-managed—20%

    —  Proportion of management from ethnic minority—10%

    —  Proportion of workforce female—24%

    —  Proportion of workforce from ethnic minority groups—7%
EVALUATION PLAN
  The SBS attends two Investor Partner meetings each year, held in June and December each year. The meetings are attended by all investors in the Fund, including private sector and institutional investors. It is likely that a formal evaluation will be undertaken at a future date.



EARLY GROWTH FUNDING

SUMMARY OF PROGRAMME
  The Early Growth Funding (EGF) programme was developed in order to encourage the provision of risk capital in amounts averaging between £50,000 and £100,000 to business start-ups and other businesses in the early stages of growth.

  Two models have been developed:

    —  Business angel co-investment—Government invests into a business on equal terms with business angels through funds specifically established for this purpose. Government expects a hurdle rate of return before sharing surplus with fund managers.

    —  Mezzanine loan fund—Government investment is leveraged by bank borrowing and then invested in high growth SMEs. Equity "kickers" on lending to SMEs used to cover gap between risk profile and rates of interest charged.
PROGRAMME BUDGET
  £31.5 million

EXPENDITURE
    (a)  Total Expenditure to date:
        To date £5,772,777 has been spent on the programme.

    (b)  Expenditure in FY 2004-05 to date:
        As at 30 June 2004, the funds have drawndown £2,229,574 from the DTI.
NUMBER OF FUNDS IN OPERATION
  Seven. These consist of six co-investment funds and one mezzanine loan fund.

NUMBER OF FUNDS IN PIPELINE
  None.

NUMBER OF COMPANIES RECEIVING SUPPORT (FIGURES AS AT 30 JUNE 2004)
    (a)  year to date
    9 SMEs.
    (b)  in total
    34 SME's.
    (c)  result of any ethnicity or sex monitoring
        Information on this is gathered annually as part of the funds' reporting process. Currently ethnic minorities founded 6% of investees receiving investment.
EVALUATION PLAN
  The funds are monitored on an ongoing basis with at least one formal meeting a year being held with SBS officials. When all the funds have been operational for a suitable period of time an external evaluation will be considered.

COMMENTS
  Figures from the first fund to complete a year's investment show the ratio of private to public sector funding within Early Growth Fund deals is running at 3.1:1 with no subordination of HMG funds. The quality of deals done appears good with four of the investments made by one fund manager making it into the annual "50 to Watch" list compiled by RealBusiness/Real Deals magazine.

  Those networks with co-investment funds are also reporting increased activity (over expectations and their knowledge of how others are doing).

LESSONS LEARNED
  Early Growth Funding kicked off with a very wide competition for proposals. This competitive process had some very useful elements; it encouraged some innovative thinking and was useful for State aid compliance. However it also had some drawbacks that will need to be considered if a similar activity is undertaken again. It was a very long process and was resource intensive in appraising bids, giving feedback and getting approval for each round of winners. It then required further resource to negotiate and contract with each project, as no two were the same.



ENTERPRISE CAPITAL FUNDS

SUMMARY OF PROGRAMME
  Enterprise Capital Funds (ECFs) will be broadly based on the US Small Business Investment Company model. They will target the equity gap facing SMEs seeking to raise up to £2 million of equity-based finance. ECFs will be privately-managed funds, though up to two thirds of the capital available for investment by each ECF will be sourced from the government. In contrast to RVCFs, public capital will be placed at no greater risk than private investors', with a view to making an ECF programme broadly cost-neutral over the medium term.

  At this stage, the government has committed only to launching a "pathfinder" round of funds, whose early progress will inform the decision on whether and, if so, how to proceed with a longer-term programme. ECF managers for the pathfinder round will be selected through a competitive bidding process, which will select the applicants whose propositions represent best overall value for money for the government's investment.

PROGRAMME BUDGET
  To be determined in the light of the applications received for the "pathfinder" round. But it is envisaged that between three and five pathfinder funds, with a maximum government commitment of £25 million each, would be sufficient to demonstrate the viability of the ECF model.

EXPENDITURE
  No expenditure to date.

NUMBER OF FUNDS IN OPERATION
  None yet.

NUMBER OF FUNDS IN PIPELINE
  See "programme budget" above.

NUMBER OF COMPANIES RECEIVING SUPPORT
  None to date.

EVALUATION PLAN
  The design phase of the evaluation plan for Regional Venture Capital Funds will inform the development of a full evaluation strategy for ECFs.

SUPPORT FOR COMMUNITY DEVELOPMENT FINANCE INSTITUTIONS

SUMMARY OF PROGRAMME

  Community Development Finance Institutions (CDFIs) are organizations that lend to start-ups and established enterprises that traditional lenders consider too risky, often for reasons such as lack of business experience or security to offer to the lender. Businesses supported by CDFIs nevertheless need viable business plans and should also have a positive impact on the community in which they operate, for example, in terms of creating enterprise and employment opportunities.
  Most CDFIs operate in a specific disadvantaged community, whether defined geographically or thematically, and they generally support start-ups, or developing for-profit businesses and social enterprises.

  The £146 million Phoenix Fund is the Government's main funding instrument for promoting enterprise in disadvantaged communities. Just over £40 million of this has been committed to the CDFI sector, through the Phoenix "Challenge" Fund strand, to stimulate its development and growth. This support is mainly provided through capital (for on lending), revenue and a loan guarantee mechanism.

PROGRAMME BUDGET
  £48.9 million. (CDFI element from 2000 to 2006).

EXPENDITURE
    (a)  Total Expenditure to date:
        £18 million.
    (b)  Expenditure in FY 2004-05 to date:
        £5 million.
NUMBER OF FUNDS IN OPERATION
  Currently 63.

NUMBER OF FUNDS IN PIPELINE
  Round 3 bids for 2004-06 closed last year and the successful winners now notified. (Many "building on the best"). However, bids for exploratory awards or loan guarantee mechanisms remain open. SBS is assessing CDFI activity to maximise financial take up of the Phoenix Fund in line with objectives.

NUMBER OF ENTERPRISES RECEIVING SUPPORT FROM CDFI ON LENDING:
    (a)  Year to date:
        279.
    (b)  In total:
        1,692.
    (c)  In comparison with last year:
        Total for FY 2003-04 was 857.
    (d)  Result of any ethnicity or sex monitoring:
        Approximately 25% ethnic minority and 40% women.
EVALUATION PLAN
  Evaluation has been completed. While recognising that the majority of CDFIs supported are still relatively young organisations the evaluation confirmed the value of supporting CDFIs with regard to their impact on the businesses they provide finance to.

COMMENTS
  £500,000 Phoenix Fund also provided to support first three years of operation of a trade body, the Community Development Finance Association (CDFA), to represent CDFIs and support their development.

  SBS has worked closely with CDFA to support its development work with Banks, Social Enterprises, OGDs, RDAs and BLOs.



COMMUNITY INVESTMENT TAX RELIEF (CITR)

SUMMARY OF PROGRAMME
  CITR is a collaborative project between HMT, Inland Revenue and the SBS. It enables duly accredited CDFIs to raise finance from the private sector through the issue of CITR certificates to individuals and corporate bodies that loan to, or invest in, the accredited CDFIs for an intended five-year period.

  The CDFIs, in turn, must on lend or invest in a qualifying profit distributing or community enterprise. The tax relief available to the investor in the CDFI is 5% per annum of the amount invested and may be claimed in the tax year in which the investment is made, and in each of the four subsequent years.

PROGRAMME BUDGET
  N/A—tax relief measure. (Estimated that for every £100 million, potential cost to the Government in lost tax revenue over five-year period is £25 million. Original thinking was for a tax loss ceiling around £250 million but subject to review.)

EXPENDITURE
N/A—see above.

NUMBER OF "CITR ACCREDITED" CDFIS IN OPERATION
Since CITR was launched in March 2003, 22 CDFIs have been "CITR accredited". Collectively, they hope to raise over £80 million over the next three years.

NUMBER OF "CITR ACCREDITED" CDFI APPLICATIONS IN PIPELINE
Three. (Rolling programme).

NUMBER OF COMPANIES RECEIVING CITR FINANCED SUPPORT
123 loans advanced totalling almost £6.9 million.

EVALUATION PLAN
Awaiting first year's results before deciding on the design of the evaluation.

  Close monitoring will take place to ensure CITR monies raised are on-lent in accordance with 25%, 50% and 75% requirements over first three years.

COMMENTS
Pleased by take up response from CDFI sector as use of CITR seen as important to embedding long term commercial sustainability of CDFI loan funds. Early returns indicate variations in performance of capital raised and initially on lent.


INVESTMENT READINESS

SUMMARY OF PROGRAMME
  The SBS established six demonstration projects to test a range of approaches to helping SMEs with growth potential to become investment ready. We also provided funding to enable an existing investment readiness service, fit4finance, to be rolled out to other Regions. The six projects and fit4finance have been subject to a full evaluation in order to assess their effectiveness and to identify good practice that might be replicated more widely.

PROGRAMME BUDGET
  £1.7 million.

EXPENDITURE
  £1.3 million.

NUMBER OF FUNDS
  Six (plus Fit4Finance).

NUMBER OF FUNDS IN PIPELINE
  N/A—SBS funding for the pilots has now ceased.

NUMBER OF COMPANIES RECEIVING/RECEIVED SUPPORT
  Around 1,100 SMEs/entrepreneurs attended information/awareness raising seminars 500 received diagnostic reviews.

  180 made presentations.

  At the time of the evaluation, 96 participants had obtained finance (mainly equity) and a substantial number of others were still in the process of negotiating a deal.

EVALUATION
  SQW Ltd were chosen by competitive tender to carry out the evaluation and their report was published in July.

COMMENTS
  The SBS will be working with the RDAs to build on the good practice identified by the evaluation in order that this kind of support can be made available to many more SMEs/entrepreneurs.



SMALL FIRMS LOAN GUARANTEE
Purpose

  Guarantees loans from the banks and other financial institutions for small firms that have viable business proposals but who have tried and failed to get a conventional loan because of lack of security.

  Started in 1981. Eligibility criteria widened and other changes in April 2003.

Main terms and conditions

    —  UK wide, available to both new and existing businesses.
    —  Loan terms two to 10 years.
    —  Staged drawdown and capital repayment holiday possible.
    —  Loan size:

Minimum—£5,000.

Maximum—£250,000 for established business trading for two years or more.

          —£100,000 for all other businesses.

    —  Guarantee: 75% for all businesses.
    —  Premium: 2% pa on the outstanding loan for all lending.
    —  Businesses: Sole Traders.
    Partnerships.

    Limited Companies.

    —  Activities: Many business activities are eligible, but there are exclusions.
    —  Size: Overall maximum of 200 employees:
    Turnover £5 million pa maximum for manufacturers.

    Turnover £3 million pa maximum for all other eligible sectors.

    —  Purposes: Most business purposes are eligible, except buying shares, buying out members of a partnership, replacing existing borrowing and finance solely for export purposes.

    —  Applications: Direct to one of the lenders who are responsible for all commercial decisions.
SUMMARY STATISTICS

Notes:

*  Costs to 31 March 2003 only (cash cost)

**  Cash cost

***  Forecast cost at year end (31 March 2004) is c £53 million. Change in accounting regime from April 2003. Previous year's costs were cash only—current year costs will be full resource costs—net cash plus non-cash resource elements applied at year-end to account for movement in provision and cost of capital credits (non-cash costs are dependent on final year-end take-up and estimates of forward default rates).

CURRENT DEVELOPMENTS

    —  Exercise underway to add further lenders (first new lenders to become operational during 2004-05).

    —  SBS will also seek to increase awareness and understanding of SFLG and simplify administration.

    —  Independent review led by Teresa Graham announced 10 December 2003. Interim report published 17 June 2004 and final recommendations on 4 October 2004 (both available on www.hm-treasury.gov.uk). Existing lenders and small business representative bodies were fully engaged with the Graham Review.

DETAILED APPLICATION STATISTICS (SEPTEMBER 2004)
Number in
Month
Number
Cumulative
Loan Value in
Month (£m)
Loan Value
Cumulative (£m)



National:
Total Guarantees Issued:664 3,78446.531255.325
Established Businesses:227 1,18911.97658.989
Existing Businesses:227 1,18911.97658.989
New Businesses:1921,185 10.99663.293
Fixed Interest Rate:29 1421.4668.098
Variable Interest Rate:635 3,64245.065247.227
Loans over 100k81479 14.96782.837
Loans over 30k up to 100k419 2,21127,904147.324
Loans up to 30k1641,094 3.66025.165
Regional:
East Midlands37237 2.27314.112
Eastern62358 4.41725.495
Greater London108506 7.36637.414
Merseyside1070 0.9174.449
North East24130 1.7048.097
North West5837 5.00126.243
Northern Ireland319 0.3522.107
Scotland52349 3.56223.783
South East102569 7.27239.687
South West66386 4.84023.490
Wales29189 1.72511.540
West Midlands53341 3.12520.962
Yorks and Humberside60 2933.97917.948
26 October 2004





9   Bridging the finance gap-next steps in improving access to growth capital for small businesses, HM Treasury and Small Business Service, December 2003, www.sbs.gov.uk/financegap Back

10   The UK government and the devolved administrations have concurrent powers in this area: the DAs operate a number of measures in their respective territories, while some SBS-managed interventions operate on a UK-wide basis and others are specific to England. Back


 
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