Access to finance Contents

2The current landscape for finance

5.The financial crisis had a major impact on the UK business banking market.6 The banks, while still the largest form of lending to SMEs, reduced the amount of risk they were willing to take in their lending decisions.7 The manufacturers’ organisation (EEF) said the access to finance landscape had improved “only marginally” since the financial crisis and credit conditions for smaller SMEs remain constrained.8 Longstanding structural barriers remain which have a particular impact on SMEs, including the difficulty, and cost, of calculating the viability of SMEs with limited credit history.9 Some sectors, such as construction, struggle to get finance irrespective of the size of the business because the banks consider there to be greater risk in those sectors.10

6.There are signs that the problem has been easing. SME Finance Monitor 2015 showed that 6% of the SMEs surveyed thought access to finance was a barrier—down from 11 per cent in 2012.11 The supply side of the finance market is in much better shape than it was in 2008.12 Net lending to SMEs has started to improve since late 2014.13 Within this, lending has been more pronounced for medium SMEs, while net lending has remained negative for small SMEs.14 The Octopus Investment High Growth Small Business Report in 2015 found nearly one in four found it difficult to secure the funding they needed on acceptable terms, and of those, 75% said this was a significant barrier to their growth.15

Reduced demand

7.The majority of lending to SMEs is still through the high street banks—80% to 90% of SMEs still go to their current account provider for a loan,16 and banks provided two thirds of the increase in gross funding to SMEs between 2010 and 2015.17 The evidence on SME attitudes to the banks is mixed. Many business people approach their existing bank to apply for a loan or overdraft because they are already familiar with the bank and the product.18 Some SMEs were scarred by the financial crisis and there are signs that many businesses retain a negative view of the banks.19 Older business people tend to go to the bank, but do so with low expectations. Younger business people, under 35 or 40, tend to be more willing to explore non-bank options from the start, yet younger and smaller businesses are more likely to have a loan application rejected.20

8.There are range of descriptions given to SMEs and their attitude to finance. ‘Discouraged demand’—where businesses do want finance but do not approach the banks because they assume they will be rejected or have other credit facilities re-evaluated—was the main reason for would be loan seekers not applying for finance in Q3 2015, according to the SME Finance Monitor.21 The proportion of businesses who would classify themselves as a ‘permanent non-borrower’ has increased from 34 per cent in 2011 to 46 per cent in Q3 2015.22 And the majority of SMEs are ‘happy non-seekers’—81% Q3 2015 have not sought any external finance and nothing is putting them off from applying.23

9.The financial attitude of the majority of SMEs (75%) is to pay down debt and remain debt free—the value of outstanding overdrafts has been decreasing since 201124—and 80% of SMEs agree that their current plans for the business are based entirely on what they can afford to fund themselves.25 Surveys indicate there has been a decline in SME confidence in 2015 and investment intentions had reduced to the same level as 2012. Keith Morgan, Chief Executive Officer of the British Business Bank, said his bank would be “looking very closely to see whether, on the demand side, there is any subdued confidence and demand for funding.”26

Calculating a finance gap

10.In 2013, the NAO reported research that suggested there was an estimated ‘funding gap’—the difference between the funding required by SMEs and the funding available—of between £10 billion and £11 billion. They said that by 2017 this figure may rise to about £22 billion but that uncertainty over future levels of GDP meant it could be as low as £6 billion or as high as £39 billion.27 The British Bankers’ Association said estimates of the gap range from a few hundred million a year to over £30 billion.28 We did receive views that there is difficulty in meeting demand for venture capital of between £10 million and £25 million for firms looking to grow,29 and for seed and early stage market equity in the £2 million 5 million range.30 Rishi Khosla, Co-founder and Chief Executive, OakNorth Bank, said getting data on the size of the gap was difficult but his impression, from talking to business customers, was that he thought the gap was “very large”.31 Several witnesses said putting a value on any finance gap was difficult because of difficulties in measuring aspects such as discouraged demand.32

Interventions to improve access to finance

11.The Government, alongside the banks, has worked to introduce various initiatives to stimulate lending—and we received positive views on the Regional Growth Fund (RGF) and Funding for Lending.33 Enterprise Finance Guarantee (EFG) encourages lending to viable businesses that would be turned down for a loan or other form of debt finance due to inadequate security. It does this by providing accredited lenders with a Government-backed guarantee for 75% of the loan value.34 The EFG has stimulated over £2 billion of lending to SMEs.35 Anna Soubry, the then Minister for SMEs, told us that the situation around access to finance had got “a lot better”.36 Part of its response to ongoing problems on access to finance for SMEs was the establishment of the British Business Bank in 2014, to bring together and coordinate better its SME finance schemes into one place.

The British Business Bank

12.The British Business Bank (BBB) is a publicly-funded, development bank described by the Government as its “centre of expertise for SME finance”.37 It is owned by the Department for Business, Energy and Industrial Strategy but has operational independence.38 It does not operate as a direct competitor in the marketplace but delivers a range of products through third parties. The BBB has four objectives:

13.It can operate at the Government’s cost of capital rather than the private sector’s cost of capital, and so offer products and solutions in full knowledge that financial return may not be always positive, but this will be offset elsewhere and the overall package will have a positive impact on the economy.39 In 2015, the British Business Bank was supporting £2.5 billion of finance to over 40,000 smaller businesses, and participating in a further £3.6 billion of finance to small mid-cap businesses.40

14.The consensus view from our witnesses was to welcome the BBB and the contribution it had made for SME finance. The British Chamber of Commerce said it did good work but was underfunded.41 Andrew Sandiford, Institute of Chartered Accountants in England and Wales (ICAEW), described it as an “unsung hero” and that many of his clients had benefited from its schemes, even when they had not heard of it.42 Simon Littlewood, Grant Thornton, said the Business Bank was making an impact and that the Government should “be confident in the decisions we have made and let it grow. It is on the right track.”43

15.Calculating the gap between demand and supply for SME finance is complicated and there is a clear need for the British Business Bank to continue to gather intelligence on how the market operates. There is evidence of unmet demand for finance from SMEs, particularly at the scale-up and grow stages, where business are looking for finance of £10 to £25 million. We recommend that the Government targets its intervention at addressing this funding gap, working closely and flexibly with investors to respond to evolving demands.

16.In the few years since it was created, the British Business Bank has filled an important space in the SME finance landscape. We agree with many of our witnesses who said it has had a positive impact and should be allowed time to establish itself. Its credibility with the business community is enhanced by its independence from Government and we do not recommend changes to existing arrangements.

Assistance in accessing finance

17.The British Business Bank has identified three areas of market failure where there is scope for it to intervene: new business start-ups via the start-up loans company, scale-up/ fast growth companies, and larger companies that want to stay ahead of the competition.44 Different businesses have different ambitions: they do not necessarily wish to expand globally, and some might wish to expand quickly. Their finance needs will be different.45


18.The UK compares well against other OECD countries in terms of the number of start-up companies,46 and there is currently a record number of small businesses in the UK.47 New start-ups tend to find it difficult to demonstrate to credit-worthiness to the bank and over 50 per cent of loan applications for new start-ups are rejected.48 Those wishing to commercialise scientific research can find it difficult to access finance to fund their development.49 There is evidence of untapped demand, not least because of the number of start-ups which begin with seed funding from family and friends (and not everyone can raise funds that way).50

19.Responsible Finance, a campaigning organisation, said demand remains for SMEs seeking less than £150,000 for start-up or growth finance.51 The Start-Up Loans Company—a partner of the British Business Bank that offers loans of up to £25,000 to entrepreneurs with a new business less than two years old—said Expressions of Interest for their loans had increased year on year since they started in 2012—in that time it has provided over 35,000 loans totalling £192 million of lending. Of those applying to the Start Up Loans Company, 86 per cent had been unsuccessful in applications elsewhere, and 48 per cent had used funds from family or friends. In addition to strong demand for their loans, the Start Up Loans Company said one in three applicants said the key reason was the mentoring service and one in four said it was for the pre-loan support.52 The default rate on Start-Up loans was near 30%. (The Start-Up Loan Company target is to keep defaults below 40 per cent.)53

20.We received positive views on the British Business Bank schemes for new start-ups.54 EEF said the British Business Bank had “gone some way towards unlocking finance at the seed and growth stages” and the Alternative Business Funding Collaboration described the Start-Up Loans Scheme as “highly successful”.55 The Government said that an initial evaluation indicated that the programme was meeting its objectives and has had a “significant positive effect” on the business start-up rate.56

21.There is evidence of substantial demand for finance from the new businesses seeking loans from the Start-Up Loan Company.57 A high proportion of those loan applications come from SMEs who have been refused a loan elsewhere. While a proportion of these new businesses default on their loan, it has helped thousands of people start their own business. A proportion of these loans will go to riskier ventures, but the role of the Start-Up Loan Company is to provide support where mainstream lenders may not, and where it sees the investment as providing a net positive gain to the economy. We agree that the Start-Up Loans Company is a good and effective way to support entrepreneurs who want to create their own business. The Government should maintain its level of funding and assess if there is potential for Start Up Loans Company to be extended.

Scale up and growth

22.Research has shown that access to the right type of finance is a key reason why companies are unable to increase in scale in the UK, and there is an enduring problem securing finance for fast growth businesses wishing to scale-up.58 The issue is especially acute among new, fast-growing companies that are too young to have a credit history (as opposed to those that have a history of bad credit).59 OECD statistics put the UK near the bottom of the table in terms of the number of firms successfully scaling-up—only 3% of UK start-ups become mid-sized companies, compared to 6% in the USA.60 Very few businesses end up employing more than 10 people in the UK.61 The Royal Society said the UK “has a scale-up problem”, partly because there was a mismatch between investor expectations and the time it takes to commercialise scientific ideas, leading to “businesses focus on selling out rather than scaling up”. This leads to a reduction in R&D spend, which contributed to why the UK had few businesses to rival those in the US in terms of size.62

23.Keith Morgan, from the British Business Bank, described the UK’s poor performance in growing start-ups to SMEs with more than nine employees in three years as “not doing very well”.63 The BBB has directed extra resources to their scale-up work through venture capital initiatives and the Help to Grow scheme—a new scheme that will use a mix of guarantees and co-investment with the private sector to support fast growing and innovative UK SMEs with investment requirements between £0.5 million and £5 million.64

24.Fast growth can bring extra risk, and as such equity investment might be a more suitable form of finance than a bank loan,65 and equity investors seeking high growth potential businesses may be able to take on a higher degree of risk.66 The UK lags behind many of our global competitors, including other EU countries, in the proportion of SMEs using equity funding.67 An internal poll of British Chamber of Commerce members found that while almost half (49%) of firms use banks or building societies for external finance, only 10% use equity.68 We were told there were investors looking for good investments, but they found it a challenge to find good businesses to invest in,69 and several witnesses commented on the need for SMEs to be ‘investment ready’ if they wished to attract potential equity investors.70

25.There are, however, signs that equity investments are growing in number and value.71 There has been an increase in equity investment flowing to UK SMEs every year since 2010, reaching a total of £3.5 billion in 2015. Total angel and venture capital equity investment SMEs increased 58% between 2014 and 2015.72 Yet several witnesses told us there was a finance gap for fast growth businesses seeking venture capital of between £10 million to £25 million.73 Gaps that appear at an early stage in the funding pipeline can lead to knock-on effects later down the line, leading to a stop-start approach to growth. The UK Private Equity and Venture Capital Association told us:

This process, by extension, often leads to innovative British companies being sold to larger American corporates when investors exit, sending intellectual property, jobs and economic growth overseas. Resolving this issue remains a priority if we are to bolster Britain’s high-growth business community.74

At present, investment for growth is more often than not forthcoming from US or European backed funds.75 The UK venture market is poor in comparison to the US.76 There is scope for more investors to be encouraged into the UK business equity finance landscape, including institutional investors such as insurance firms, pension funds, and sovereign wealth funds.77

26.Access to finance is one of the main barriers to scale-up for fast growth SMEs. There is a gap in securing finance at particular growth stages, and a lack of investors able to provide a pipeline of finance at all stages of development. It may be that the market for growth finance requires time to mature, but the Government must introduce targeted intervention to address the difficulties around businesses wishing to scale-up. The Government should set out what it is doing to incentivise further institutional investors into the private equity market.

27.Awareness of options for finance is growing. However, awareness in areas such as equity has not necessarily led to an increase in uptake of those options. Part of the reason for this is because SMEs are not taking the steps to become ‘investment ready’ and attract potential equity investors. The British Business Bank, alongside business groups and networks, needs to focus on identifying businesses with high potential for growth, and ensuring they have access to advice about what they need to do to secure the most appropriate form of funding for their next stage of development.

The Alternative Investment Market (AIM) and encouraging investment

28.Several witnesses commented on the comparison between the investment market in the UK and the US, and the need to support fast growth businesses that can encourage a broader investment ecosystem in the UK.78 AIM is the London Stock Exchange’s international market for smaller growing companies. It is seen as important in creating an environment that encourages businesses to aspire to be listed and investors to invest in smaller companies.79 London Stock Exchange Group runs the ELITE scheme which introduces investors to companies considering seeking venture capital in the near future.80 The Alternative Investment Market is an important part of the finance ecosystem in the UK. Whatever happens with the proposed merger of the London Stock Exchange and the Deutsche Borse, we urge the Government to support the retention of AIM as a forum for companies to raise capital and grow.

Tax incentives

29.One of the ways the Government tries to encourage equity investors is to use the tax regime to incentivise private individuals to invest in growth companies. We received particular praise for the Enterprise Investment Scheme (EIS),81 the Seed Enterprise Investment Scheme (SEIS),82 Venture Capital Trusts (VCT)83 and Research and Development tax credits.84 These are managed by HMRC.

30.The SEIS helps small, early-stage companies (fewer than 25 employees and assets of less than £200,000) raise equity finance, supporting investments of £150,000 or less. Since its creation in 2012 it has helped more than 2,800 companies raise over £250m. The EIS helps unquoted companies with fewer than 250 employees raise equity finance by offering a range of tax reliefs to investors who purchase new shares in those companies. EIS underpins the majority of business angel finance in the UK and, in 2013–14, £1,529m was invested in 2,770 companies. The VCT scheme encourages individuals to invest in small, unlisted companies indirectly through the acquisition of shares in a VCT, which must be listed and approved by HMRC—the tax incentives include exemption from income tax on dividends and capital gains tax on disposals. In 2014–15, VCTs issued shares to the value of £435m and VCTs currently have investments in over 1,000 companies.85

31.We received suggestions for enhancing the range of incentives available to encourage investors, such as towards high innovation scientific companies, the creation of a VCT specifically targeted at scale-up SMEs, higher and further incentives for investors outside London and the South East, and initiatives to encourage a broader range of investors, such as developing an ISAs that can utilise EIS and SEIS investments.86 The main criticism we received was that awareness among their intended market was low and the incentive schemes should be promoted more.87 For example, Jimmy McLoughlin, from the Institute of Directors,88 said only two in three of their members had heard of EIS and only one in three had heard of SEIS.89 The other main concern was fear that the schemes would be changed or lost.90

32.The SEIS, EIS and VCT schemes received praise from many of our witnesses for their role in cultivating a UK venture capital community. It is important that the Government does not tinker with how the schemes operate. The main barrier to greater take-up of the schemes appears to be low awareness among both businesses and investors. Promotion and take-up of the schemes would be helped by HMRC carrying out an assessment of the EIS, SEIS and VCT schemes, and demonstrated their value to both SMEs and the tax-payer. We recommend that the Government directs resources towards promoting the SEIS, EIS and VCT schemes. This includes the British Business bank working with HMRC to consider how to improve promotion of the schemes.

European Investment Fund

33.The European Investment Bank supports finance initiatives for SMEs in the UK. The European Investment Fund (EIF) aims to help SMEs across Europe secure finance through various banks, lenders and investors. In 2015, the EIF contributed €655 million in equity in the UK. EIF invested into two co-investments and in 16 funds.91 One example was given to us by James Meekings, UK Managing Director and Co-founder, who said Funding Circle had a £100 million agreement with the European Investment Bank to support funding business in the UK but that such funding agreements would be at risk in the future.92 The European Investment Fund has also backed European Venture Capital funds, “maybe to the tune of 25% or 45% of a fund”. Chris Hulatt, Chief Financial Officer, Octopus Investments, said the Government needed to be ready to fill any gaps that may appear if the European Investment Fund retreats from backing aspiring British Venture Capital funds in the future.93 The then Minister for Small Business, Anna Soubry, told us that European Investment Funds would not be withdrawn, although she admitted there was a problem not knowing when the UK will leave the EU.94

34.The European Investment Bank has provided millions of euro into funds that underpin finance for businesses in the UK. Following the result of the referendum on the UK’s membership of the European Union, there are concerns that this source of finance might not be available in the future. There is a risk that structures in place to assist SME finance will have considerable shortfalls in their resources without the value of these funds. We recommend that the Government identifies the size of current European Investment Bank contribution in the UK economy, the timetable for current commitments, and make a clear statement on Government plans to ensure that the current level of funding will not be reduced.

Angel CoFund

35.The Angel CoFund is a private company limited by guarantee, with a board and investment committee made up of people with industry expertise. It has about 60 investments providing £130 million, co-invested alongside a syndicate of angels to small, growing companies.95 The Angel CoFund co-invests alongside individual angel investors to help businesses raise money early on in the development and give them more time to get up and running. An assessment of the CoFund in 2014 “showed the rationale for the Angel CoFund to be valid” and that it was providing finance to young, innovative businesses expecting rapid growth, and enabling firms to progress more quickly or on a larger scale.96 Chris Hulatt, from Octopus Investments, described it as “part of what is now, to me, a strong functioning ecosystem for early stage companies”.97 If anything, demand for the Angel Cofund outstripped supply.98

36.The Angel CoFund is a strong and positive part of the finance landscape for new businesses. It helps secure funding for new businesses through sharing risk, but also brings new businesses with potential and business angels, with their experience and networks. We recommend that the Government and the British Business Bank build upon the success of the Angel CoFund, ensure it is funded adequately to meet demand, and consider how it could be expanded.

Regional imbalances

37.There are regional disparities in several aspects of finance for SMEs.99 The Royal Academy of Engineering said London ranks sixth out of 20 global start-up ecosystems, second only to Silicon Valley in the US, while the East of England, the South West, Wales and Northern Ireland all experienced a fall in the amount invested between 2014 and 2015.100 The number of new business start-ups (25%) is over represented in London compared to its proportion of the UK population (13%).101 Research into start-ups and existing businesses by Local Enterprise Partnership between 2009 and 2012 found above average proportions of fast growing firms in London, the South East and Leicestershire. London came first or second in four out of the five metrics used to assess growth.102

38.The British Business Bank has recognised the regional imbalance in equity investments, and is using its own resources alongside those from the European Investment Bank to create two funds: a Northern Powerhouse Investment Fund and a Midlands Engine Investment Fund. The British Business Bank and LEPs in these two regions, are developing an investment strategy to deliver equity, debt and micro-finance to small businesses.103 The British Business Bank was considering how further funding of the Angel CoFund could be used to address the regional imbalance in small business equity investments—most of which are in London and the south-east while the Midlands and the North were under-represented.104 Similarly, 65% of SEIS and EIS transactions are happening in London and the South east.105

39.The new Prime Minister has already spoken of her desire for opportunity and economic success to be more fairly distributed across the UK, and we look forward to learning how the Government intends to use the various levers at its disposal to make this happen. Enabling entrepreneurs to start their own business, and ensure they can access finance as they grow, can have an important role in rebalancing economic growth across the UK. The willingness of the Government to intervene where there are identifiable market failures in the business finance landscape across the whole UK, represents a test and an opportunity in the context of its new industrial strategy.

40.The British Business Bank, as the Government’s centre of excellence on these matters, needs to be at the heart of proposals to address the regional discrepancies in SME finance. We welcome the intention of the British Business Bank to use the Angel CoFund to stimulate equity investment beyond London and the South East. The development of the Northern Powerhouse Investment Fund and a Midlands Engine Investment Fund will be important routes to focus investment away from the South East of England. We recommend that the Government introduce a fifth performance indicator for the British Business Bank to assess its effectiveness in incentivising lending and investment activity in all parts of the UK.

6 HSBC ATF039, Community Investment Coalition ATF023

7 Q56

8 EEF ATF029

9 British Business Bank, Small Business Finance Markets 2015–16, February 2016

10 Qq20–21

11 SME Finance Monitor 2015, April 2016

12 Q189

13 Department for Business, Innovation and Skills ATF054

14 Department for Business, Innovation and Skills ATF054, Asset Based Finance Association ATF027

15 Octopus Investments ATF062

16 Q82

17 British Bankers Association ATF052

18 Q170

19 Institute of Directors ATF035, EZBob ATF022

21 SME Finance Monitor 2015, April 2016. Institute of Directors ATF035

22 Bibby Financial Services ATF055

23 Permanent non-borrowers are those SMEs that are not using external finance and show no appetite to apply. Happy non-seekers are SMEs who have not tried to secure finance, and nothing had stopped them applying for funding in the previous 12 months.

24 Department for Business, Innovation and Skills ATF054

25 SME Finance Monitor 2015, April 2016

26 Q189

28 British Bankers Association ATF052

29 Q23

30 SQW ATF017

31 Q82

32 Qq18–20, Q23, Q98

33 Finance and Leasing Association ATF008, HSBC ATF039, Greater Birmingham & Solihull LEP ATF028

34 Royal Academy of Engineering ATF061

35 Community Investment Coalition ATF023

36 Q207

37 British Business Bank and Department for Business, Innovation and Skills ATF054

38 Q198

39 Q164, Q167

40 Department for Business, Innovation and Skills ATF054

41 British Chamber of Commerce ATF058

42 Q76

43 Q76

44 Q165. Start-ups are SMEs trading up to five years, Scale-up are SMEs trading more than five years with ambitions to grow, and stay ahead are SMEs trading for more than five years with no ambition to grow

45 Q144

46 Q165

47 BBB, Small Business Finance Markets 2015–16, February 2016. Grant Thornton ATF036

49 Royal Society ATF041

50 Qq6–7. Funding Knight ATF047

52 Start Up Loans Company ATF025

54 Q9

56 Department for Business, Innovation and Skills ATF054

57 Department for BEIS Press Notice, £250 million milestone for Start Up Loans, 31 August 2016

58 Scale-up report on UK economic growth, an independent report commissioned by the Information Economy Council, a joint industry and Government body. See also Q9 or Royal Society ATF041

59 Q2

60 Institute of Directors ATF035

62 Royal Society ATF041

63 Q165

64 BBB, Small Business Finance Markets 2015–16, February 2016. The Help to Grow Scheme

65 Equity investment is a payment by individuals or firms, in return for a share of the company stocks and where profits are in the form of capital gains or dividends

66 Q73

67 Q123

68 British Chamber of Commerce ATF058,

69 Qq66–67

70 SQW ATF017, Grant Thornton ATF036, UK Business Angels ATF032, Royal Academy of Engineering ATF040, Creative England ATF053

71 BBB, Small Business Finance Markets 2015–16, February 2016. British Bankers Association ATF052

72 Q226 [The BBB point out that the figures are distorted by a small number of pharma companies with deal sizes exceeding £10m, and including one pharma company receiving funding of £205m in 2015.]

73 Qq23–24, Q34, Q123

74 British Private Equity & Venture Capital Association ATF011

75 Q71

76 Alternative Business Funding ATF003

77 British Private Equity & Venture Capital Association ATF011

78 Qq118–119, Q121

79 Octopus Investments ATF062

80 Q82, Qq 108–109

84 Qq26–28, Q33.Greater Birmingham & Solihull LEP ATF028, Institute of Directors ATF035, ADS Group ATF037, Funding Knight ATF047

85 Department for Business, Innovation and Skills ATF054

86 Q139. Bio-industry Association ATF033, Funding Knight ATF047,

87 ATF035, Q161.

88 On 15 August, the Prime Minister appointed Jimmy McLoughlin to be her Head of Business Liaison.

89 Q29

90 Q49

92 Qq160-Q161

93 Q128

94 Q223

95 Q185

96 Department for Business, Innovation and Skills ATF054

97 Q141

98 British Private Venture & Equity Capital Association ATF011

99 SQW ATF017, Responsible Finance ATF030, UK Business Angels ATF032, Cornwall Council ATF034, Grant Thornton ATF036 ,

100 Royal Academy of Engineering ATF061

102 Enterprise research Centre & Growth Accelerator, LEP Growth Dashboard, June 2014

103 Q186

104 Q75, Q185

105 Q32

28 October 2016