Memorandum submitted by the Department for Business, Enterprise and Regulatory Reform



1. Small and medium sized businesses (SMEs) are the lifeblood of our economy and their performance will be crucial both to maintaining employment and activity through the current global economic downturn and to providing growth as we look towards recovery. Government provides a wide range of support to SMEs from the 190m per annum spent by RDAs on Business Link to the support provided through R&D tax credits, worth an estimated 600m a year[1] to small businesses. This memo focuses on the impact the financial crisis and the credit crunch, which has resulted in near complete collapse of wholesale lending markets, has had on the ability of SMEs to access to credit.


2. There is emerging evidence that SME borrowing for some parts of the market is being impacted in varying degrees with respect to terms and access through a combination of capital constraints on lenders and risk-aversion by lenders. This may prevent potentially viable businesses from accessing the finance they need. It is Government's priority to prevent viable businesses from failing as a result of this. If fundamentally viable businesses fail because of temporary short-term funding gaps, there will be substantial losses to the economy in terms of lost employment and output, as well as disruption to markets and supply chains.


3. The Bank of England and the banks themselves have reported an overall fall in demand by small business for credit and banking services, partly reflecting a curbing of growth plans and planned capital expenditure in response to the deteriorating economic conditions. Anecdotally, we also know that many SMEs are experiencing cash flow difficulties and facing a general tightening of credit conditions, with the cost of finance also increasing. Credit availability has begun to decline, with the latest Bank of England Credit Conditions Survey (Q3 2008) showing a general tightening of credit over the last three months compared to the previous three months.


Small Business Finance Package

4. The Government has therefore taken decisive and extraordinary action and will continue to act to support the banking system during this period of exceptional financial turbulence, and to strengthen the system for the future as markets stabilise. Alongside the recapitalisation package, Government has, over the last six months introduced a series of measures to help SMEs access the finance they need as well as taking steps to ensure that Government understands in a timely manner the changes in lending patterns to SMEs.


5. The pre-Budget report recognised the challenges that SMEs face in the current environment and that Government needed to take decisive action to ensure that viable SMEs struggling with short term working capital, trade and investment finance problems were supported. The package announced at pre-Budget report, worth 2 billion, will be developed for launch early in the New Year with a single high profile portal which will direct SMEs to the appropriate support made up of:


Small Business Finance Scheme enabling up to 1 billion of bank lending, for working capital guaranteed by the Government to allow small businesses to borrow sums of between 1,000 to 1 million at more flexible terms;


A separate 1 billion guarantee facility run by the Export Credit Guarantee Department to support bank lending to small exporters needing short-term trade finance to take advantage of strong overseas markets and competitive sterling;


A 50 million fund to convert businesses' debt into equity, targeted at economically viable SMEs who are currently overleveraged; and


A 25 million regional loan transition fund to help businesses over the next six months administered by RDAs.


6. The two guarantee schemes will be provided via the banks on a risk share basis giving them the confidence to lend. The scheme will be temporary and run for 12 - 14 months. The overall scheme will be developed in consultation with small businesses and banks for launch in the New Year.


7. Advantage West Midlands have already launched a transition loan fund for viable companies facing finance difficulties. The scheme is being rolled-out across the network of Regional Development Agencies, with 25 million available to businesses over the next six months.


8. UK small businesses will be able to benefit from around 4 billion lending from the European Investment Bank (EIB) between 2008 and 2011. The UK banks have now negotiated credit lines of more than 1 billion from the European Investment Bank (EIB) to become available for SME lending before the end of 2008. The EIB supports SME investment mainly through credit lines made available to national and regional intermediaries which then onward lend the finance as loans to SMEs that meet EIB criteria.


9. By encouraging UK take up of these funds, HMG also welcomes EIB proposals on a new risk sharing facility as part of the core SME loan fund. This offers to share part of the risk that banks and Government take on in commercial lending to businesses and where it is judged to represent a higher risk. The UK is also urging the EIB to provide detailed guidance on how this will work, as well as formal clarification on the use of SME loans funds, in particular the propensity for banks' use to service loans for working capital. EIB has agreed to provide clarification on both of these issues following its next Board meeting on 16 December 2008.


Monitoring lending to SMEs

10. In addition to this package of financial support to small businesses, Lord Mandelson, Secretary of State Business, Enterprise and Regulatory Reform on 27 October 2008, announced the establishment of a new Small Business Finance Forum (written statement attached at Annex A), bringing together all banks, small business representative organisations and small businesses themselves to have an informed dialogue to discuss and resolve their concerns on business lending. This group, chaired by Lord Mandelson has already achieved several key outputs including:


The establishment of a new monitoring panel on business lending (written ministerial statement of 11 November attached at Annex B). This panel, made up of senior Government officials from HM Treasury and the Department for Business and representatives of the Bank of England will monitor and enter into a constructive dialogue with individual lenders[2] on the availability, risk and overall cost of lending to small and medium sized businesses from the five major banks;


These banks have agreed to provide, in strictest confidence, data on the availability, risk and overall cost of lending to the monitoring panel;


11. A revised Statement of Principles (part of the Banking Code), alongside the 2008 PBR announcement that the Banking Code will now be placed on a statutory footing, will define how small businesses and banks should work together as an effective relationship.


Action on prompt payment

12. In addition, Government has provided further help to help small businesses manage their cashflow by introducing a 10 day target for Government payments, which has also been widely supported across the wider public sector. Alongside this, Government is introducing a range of measures to ensure that central Government payment processes are consistent, transparent and speedy, including:


standard guidance across Government to suppliers on how to submit their invoice (including who to contact in case of delay or problems and who to contact to raise a complaint);

ready access to this guidance within the suppliers terms and conditions and all public facing websites;

a common standard for establishing when an invoice is received; and

a common standard for counting elapsed days.


Pre-Budget Report measures

13. This year's Pre Budget Report provided a further package of targeted, temporary measures which will help small businesses struggling with short term working capital and cashflow. They include:


New HMRC Business Payment Support Service to enable businesses in temporary financial difficulty to pay their tax and NI bills on a timetable they can afford, with no penalties or surcharges on agreed deferred tax payments. Interest will be charged at non punitive rates;

Overcoming barriers to public sector contracts - a new web portal for public sector opportunities over 20,000, a better deal for small business contractors and simpler systems, as recommended by the Glover Report;


More generous carry back tax relief for trading losses for businesses now making losses. Up to 50,000 of losses can be carried back for up to three years from the current one year;

Deferring the increase in the small companies' rate of corporation tax (currently 21 per cent) to April 2010;


Deferring planned changes to income shifting (where income can be shifted to another person, usually a spouse, which is then taxed at a lower rate) and keeping this issue under review;


Exemption of foreign dividends for medium and large businesses;


Reinstating empty property relief for one year from April 2009 for properties with a rateable value of 15,000 or less.


14. Business Link, the Government's business advice and support service, is now offering free personalised, confidential, business "Health checks" on how to maximise cash flow, as well as improving marketing and business planning. To date, Business Link has undertaken 8,900 health checks across England. This is in addition to its full range of services - which last year helped around 856,000 customers.




SME Finance Gap

15. The UK's finance market has been ranked second best in the world for supporting business financing needs by the Milken Institute Capital Access Index 2006, just behind Hong Kong and Singapore, and ahead of all other OECD countries. However, the performance of the UK's finance markets and measures currently in place to improve access to finance SMEs' demand for and access to external finance in more stable economic conditions needs to be viewed alongside the impact of the global credit crunch and economic downturn on the supply of finance and the demand for new finance from SMEs.


16. In more stable economic conditions finance markets provide the majority of businesses with the finance they require. Evidence suggests that only around one in eight businesses needing new finance fail to obtain any finance. However, surveys also show that many businesses who initially fail to obtain finance from one source go on to obtain it from another[3]. But whilst the general financing situation for existing business might be good in stable economic conditions, the evidence suggests that difficulties remain for a minority of viable businesses. Research evidence shows that start-ups and young businesses continue to be more likely to experience difficulties accessing finance compared to more established businesses. Those businesses aspiring to grow are more likely to seek finance and to have experienced difficulties in obtaining it.


17. It has long been recognised that market failures exist both in the debt and equity finance markets. Within debt finance markets difficulties are frequently related to a lack of available collateral against which to secure finance, or to an insufficient financial track record[4]. For businesses with very high growth potential, access to modest amounts of equity finance can be problematic[5]. The balance of evidence indicates that those seeking between 250,000 and 2 million have particular problems accessing equity finance[6]. High transaction costs associated with investing small amounts of capital and the economies of scale achieved from a smaller number of larger investments have resulted in a shift in equity investments towards larger and more established businesses[7]. Business angel investments are an extremely important source of equity finance for new and nascent businesses. In comparison to venture capital funds business angels typically make relatively modest individual investments.


18. The supply of finance is an important element of improving access to finance, but it is also important to address weakness on the demand side. If businesses are to be able to take full advantage of the range of finance available it is important that they are finance and investment ready. Research has shown that SMEs that would otherwise benefit from external finance or investment miss out because they do not know how to make their business proposals into attractive investment opportunities and are often unable to present a convincing business case to investors. In addition, many smaller businesses do not have their finances managed by a qualified individual; and confidence in dealing with finance is not high compared to other aspects of running a business[8]. Some entrepreneurs can therefore lack the skills and confidence to access external finance. Small businesses in the UK also appear to be less aware of the possibilities of different forms of risk finance than their US counterparts[9].


Accessing debt finance

19. Around one in five businesses use debt finance to start up their businesses, making bank loans the main source of external finance for start up businesses.


Small Firms Loan Guarantee

20. The Small Firms Loan Guarantee (SFLG) is currently the Government's principal debt finance instrument. It is an established mechanism through which the Government provides participating lenders with an alternative form of security, underwriting 75% of the loan, to small businesses with viable business plans who meet the bank's normal lending criteria but do not have the collateral or track record against which to secure that lending. The SFLG is available to a wide range of businesses through high street lenders. The Government's Enterprise Strategy, published with the Budget in March 2008, announced a number of measures to further broaden and strengthen the scheme. The Government announced that the banks SFLG lending allocations would be increased by 20 per cent for one year, increasing the amount of lending available by 60m to a total of 360m, providing greater SFLG capacity at a critical time for SMEs. The Government also extended the eligibility of SFLG to businesses with growth ambitions who are more than five years old, including, but not limited to, those that have changed ownership. Since 1981, around 100,000 loans valued at 5 billion have been guaranteed through the SFLG. Government provides a report to Parliament on the performance of SLFG on an annual basis.


21. The Government also directs targeted debt finance support to people and businesses from disadvantaged communities through the Community Development Finance Institutions.


Community Development Finance

22. Community Development Finance Institutions (CDFIs) are independent financial institutions, normally serving a specific disadvantaged geographic area or disadvantaged group (e.g. charities, non-profit distributing social enterprises or organisations supporting specific groups such as ethnic minorities). They lend to start-up companies, individuals and established enterprises from within that area or community who are unable to access finance from mainstream banks. Enterprises supported by CDFIs are nevertheless viable and benefit the community in which they operate, for example, in terms of jobs and services provided.


23. The Government's Enterprise Strategy (published March 2008) included a commitment that more businesses and individuals in deprived areas who are unable to access finance from commercial banks will be supported by CDFIs. The Government continues to support CDFIs through the Regional Development Agencies (RDAs) and the Community Development Finance Association, the trade association for CDFIs.


Equity Support

24. On the supply of equity, since 2000 the Government has supported programmes to address an equity gap which showed that SMEs seeking relatively small amounts of finance (between 250,000 and 2million) were disadvantaged by the lack of private sector venture capital funds operating at that size.


25. Government equity funds have been established under a variety of programme to:


Encourage risk funding for start-ups through Regional Venture Capital Funds and Early Growth Funds;

Encourage investment in the most deprived wards through the Bridges Community Development funds; and

Encourage specialist investment through the UK High Technology Fund.


26. Enterprise Capital Funds (ECFs) are the most recent to be launched, in 2006. ECFs operate on a commercial basis, mixing private and public money in small high growth businesses that are seeking up to 2m of risk capital. The Government provides up to two thirds of the capital in each Fund and takes only a limited share of profits in order to encourage private investors to participate where they would not otherwise. The Government has now committed over 141m to ECF funding with a further 150 million earmarked for future funds over the next three years.


27. All of the above programme use standard capital market disciplines and the skills and experience of professionals in the private sector to meet both their and public goals via hybrid fund structures. Since 1997 these programmes have provided over 247 million funding, leveraging another 400 million of private funding.


28. Capital for Enterprise Ltd, a wholly-owned BERR NDPB, was established from 1st April 2008 to take responsibility for managing the Government's venture capital and loan activity. The third round of ECF investment is currently underway, with Capital for Enterprise aiming to commit around 50 million of Government capital per year in the next two years.


29. The Enterprise Strategy, published in March 2008 alongside the Budget, set out a longer term vision for ensuring that SMEs can access the finance they need. It built on the steps Government had already taken to ensure that finance would be available to SMEs through a period of financial market disruption. The Enterprise Strategy announced:


a 20% increase in lending allocations under the Small Firms Loan Guarantee to a total of 360 million for this financial year and eligibility extended to businesses with growth ambitions over 5 years old, from 1 April 2008.


an additional 30 million through Enterprise Capital Funds with the aim of stimulating Mezzanine Finance.


launch of the third round of Enterprise Capital Funds (Enterprise Capital Funds) to help high growth businesses seeking risk capital launched 1 April 2008 as part of 150 million earmarked for future rounds of ECFs.


lifting of restrictions on the assignment of debt in Government contracts, which hitherto had restricted SMEs' ability to use factoring (which can be an important source of finance for many businesses) have been removed.


launched the Aspire Fund - a 25 million investment fund for women led businesses on 19 November 2008. The Aspire Investment Fund is the first of its kind and will receive over 12.5 million in funding from the Department for Business to be matched by a further 12.5 million from private sector investment.


a doubling of funding (by Government and Banks) for the Money Advice Trust's Business Debtline service by 2010-11. The service provides free confidential independent advice to small businesses with cash flow or debt problems.


9 December 2008

Annex A




Lord Mandelson, Secretary of State for Business, Enterprise and Regulatory Reform 27th October 2008


Support for business


Effective credit is key to helping small businesses survive during the current financial climate. The Government is on the side of small and medium-sized businesses and understands that they are facing tough times. We want to help businesses to plan for the difficult times ahead.


On Thursday, the Chancellor and I met with the main banks responsible for lending to small and medium sized businesses. I am pleased to announce to the House that we have agreed the establishment of a new forum where banks and small business organisations will meet regularly to discuss and resolve their concerns. I will chair this forum, but the agreements reached will be owned and taken forward by banks and small businesses.


Both the Chancellor and I understand the concerns of small businesses. We are committed to ensuring that both new and existing small businesses have access to the finance that they need to help them survive during the financial downturn. Communication between banks and small businesses can promote a shared understanding and enhance business confidence.


This agreement demonstrates the Government's continuing commitment to maintain and raise awareness of the availability of finance for small and medium sized businesses through the Small Firms Loan Guarantee scheme and the European Investment Bank.


Further details on the Forum will be available on the Department for Business, Enterprise and Regulatory Reform website ( ).




Written Ministerial Statement


Rt.Hon. Ian Pearson, Economics and Business Minister, Department for Business, Enterprise and Regulatory Reform


27th October 2008


Annex B


Written ministerial statement


Lord Mandelson, Secretary of State Business, Enterprise and Regulatory Reform

11th November 2008


Small Business Finance Forum


The Government is committed to doing everything it can to ensure that appropriate lending to businesses continues. The Chancellor has already announced the creation of UK Financial Investments Ltd which, in respect of those banks recapitalised by Government[10], will monitor compliance with the conditions we set to maintain the availability and active marketing of competitively priced lending to small businesses and homeowners.


I am today hosting the first meeting of the Small Business Finance Forum. This forum, the establishment of which was announced to the House on 24th October, brings together all banks, small business representative organisations and small businesses themselves to have an informed dialogue to discuss and resolve their concerns on business lending.


I am pleased to announce to the House that today we have agreed the establishment of a new monitoring panel on business lending. This panel, made up of senior Government officials from HM Treasury and the Department for Business and representatives of the Bank of England will monitor and enter into a constructive dialogue with individual lenders on the availability, risk and overall cost of lending to small and medium sized businesses from the five major banks[11].


These banks have agreed to provide, in strictest confidence, data on the availability, risk and overall cost of lending to the monitoring panel.


The establishment of this panel, and the agreement of the five major lenders to enter into a dialogue with Government on this basis, demonstrates our continuing commitment to ensure that appropriate levels of finance are available for SMEs in the UK.




Written Ministerial Statement


Rt.Hon. Pat McFadden, Minister of State for Employment Relations and Postal Affairs, Department for Business, Enterprise and Regulatory Reform


11th November 2008



[1] Annual Innovation Report November 2008

[2] Barclays, HBOS, HSBC, LloydsTSB and RBS

[3] Financing UK Small and Medium Enterprises: The 2007 Survey, Cosh, A , Hughes, A., Bullock, A. and Milner, I., Centre for Business Research, University of Cambridge, 2005; Annual Small Business Survey, 2006.

[4] Finance for Small and Medium-Sized Enterprises: A Report on the 2004 UK Survey of SME Finances, Fraser, S., University of Warwick, 2005

[5] Bridging the Finance Gap: next steps in improving access to growth capital for small businesses, HMT/SBS, 2003

[6] Bridging the Finance Gap: next steps in improving access to growth capital for small businesses, HMT/SBS, 2003

[7] A mapping study of venture capital provision to SMEs in England, Almeida Capital, 2005; Bridging the Finance Gap: next steps in improving access to growth capital for small businesses, HMT/SBS, 2003; Factors Determining the Performance of Early Stage High Technology Venture Capital Funds, Stockholm School of Economics, 2005.

[8] Fraser, S. (2005), Finance for Small and Medium-Sized Enterprises: A Report on the 2004 UK Survey of SME Finances. Warwick, University of Warwick. BERR (2008).

[9] Enterprise Britain: a modern approach to meeting the enterprise challenge, SBS/ HMT 2002

[10] HBOS, LloydsTSB, RBS

[11] Barclays, HBOS, HSBC, LloydsTSB and RBS