Few doubt the importance of providing sufficient finance to oil the cogs of the small- and medium-sized enterprises (SMEs) sector of the economy. After all, so-called SMEs employ around 24m people in the UK, and as such provide the essential life blood that will ultimately help to lead the UK economy back into health. So it came as no surprise when the government started to increase the pressure on high street banks to make finance to SMEs more available.
The flagship in the government's armada of initiatives is Funding for Lending, which, in short, gives banks access to cheap funding so long as they pass it on. However, this has only been a qualified success. For a combination of this facility and moves to free up the housing market means that most of the cheap funding has gone to provide new mortgages. So, while the 41 banks participating in the scheme expanded their loans books by £1.6bn in the second quarter of this year, net lending to companies still contracted.
Not surprisingly, the Federation of Small Businesses has reserved some scathing criticism for the big banks, claiming that half of its members feel that banks don't care about small businesses, while a third pointed to an increase in fees paid to their banks over the past year, with an average charge for a small company of £1,075 a year sometimes rising to as much as £4,000.
Obtaining finance: a low priority
However, a survey of more than 450 SMEs by venture capital group Albion Ventures has thrown up some interesting pointers as to where the barriers for growth lie. A general dislike of red tape and government interference was a widely-held sentiment, but optimism levels were impressive, with 60 per cent of respondents expecting their business to grow over the next two years, and among these the lack of availability of finance was relatively low on the agenda. This is at complete variance to public perceptions, but further research reveals that those companies that are least optimistic also tend to be the most complacent about their resources and abilities. On the other hand, those businesses that are the most positive about their prospects tend to dismiss regulatory hurdles as just one more barrier to jump. Crucially, this indicates a pattern whereby companies positive about their prospects are more likely to explore alternative means of raising new finance, while those that are pessimistic tend to resort to banking finance.
This would go a long way towards explaining the current situation whereby small companies moan about the lack of support from the banks, while the banks maintain that demand from SMEs is either not there or is confined to applications that fail to meet lending criteria. In other words, there is a clear divide between those companies borrowing to survive and those looking for finance to expand.
It also suggests that government incentives should reach beyond simply throwing lots of money at the SME sector. However, it is not exactly clear what measures could be taken to encourage small companies to adopt a more positive mental attitude. Interestingly, the level of business confidence appears to be in inverse proportion to the size of the company, so that micro-businesses - companies with two to five employees - are more optimistic about expanding. There is also a regional bias, and surprisingly it is not the relatively affluent south east with the biggest aspirations. In fact, two-thirds of businesses with the biggest growth ambitions are located in the Midlands, while Wales and the south west are the least hopeful.
There are further misconceptions that need to be cleared up, including the idea that SMEs are being stifled by a lack of finance. In fact, of those companies surveyed only one in six had attempted to raise finance in the past year. That's not surprising, given that SME cash deposits have been net positive through the financial crisis. Of those that did raise capital - and 40 per cent of applications failed - 28 per cent were looking for long-term capital while a third were looking for money just to keep the business going, with as many as nine out of 10 pessimists seeking finance to pay day-to-day bills. This takes us into the zombie economy, highlighted by the relatively low levels of bankruptcy, and where many companies would have ceased to exist without borrowing money.
Equity versus debt
For those companies looking to expand, it is also worth looking at what would be the best way forward to raise finance. At the moment, around one in 10 SMEs would be willing to give up some of the equity in return for hands-on support, and this comes down to just one in five for SMEs with turnover in excess of £20m, while around the same proportion of micro-businesses took the same view. Measures to encourage this have been introduced by the government, including extended capital gains tax relief for investors in Seed Enterprise Investment Schemes, and this is important, because as Albion Ventures points out, there are clear advantages of an equity led economy over one that is fuelled by the shackles of debt.
Management's abilities and aspirations play a crucial role in how well a company performs, but there are marked differences in the way that these are assessed and prioritised, according to how well a company is performing and how optimistic it is about its growth potential. Among those SMEs with a pessimistic outlook, management ambition was seen as a much bigger challenge than management ability, which could go some way towards explaining why they were pessimistic. By contrast, in optimistic companies management expertise was not seen as a barrier to growth prospects, but there was more likely to be a critical eye cast over their management teams' abilities to find areas where expertise and leadership could be strengthened. And growing a business into new areas also revealed another contrast. Just over half the companies questioned entered new markets in the last year, and around three-quarters found no difficulties in doing so. Of those companies that did find it difficult, the major barriers were lack of demand, competition, lack of financial resources and expertise. But while 21 per cent of optimists cited too strong competition as a major barrier, this number jumped to 79 per cent among pessimists.
When it comes to seeking help, most small companies are largely self-sufficient, but when external advice is needed, lawyers and accountants top the list. Smaller businesses with turnover of up to £100,000 are more likely to sound out friends and family for advice - not least because it’s cheaper - while companies with turnover of up to £5m tend to take a more professional route such as bank managers and business consultants. Interestingly, this trend is replicated among optimists and pessimists, with the former seeking professional advice and the latter turning to friends and relatives.
Inevitably, though, it was red tape and regulations that topped the list of barriers to growth. Particular concern was voiced over employment law, while the second-biggest concern was the difficulty in finding skilled staff. Government moves to reduce national insurance payments are a welcome step, but this does nothing to help find people with the right qualifications and attitude. Such a challenge is being felt most keenly in the Midlands, while surprisingly, companies in Scotland are the most confident in their ability to recruit the right people.
Running a small business is tough at the best of times, and until recently government legislation has been more tuned towards sucking out as much money as possible by closing loopholes such as paying salaries in dividends. Ironically, it has taken a financial crisis to bring the plight of many small outfits to the attention of the regulators. And while some initiatives have been put in place with varying degrees of success, there are still a great many hurdles that could be removed for what remains the embryo of tomorrow's economy.
