Speakers' Corner
On funding and the Small Business Service (SBS)

Posted: Wednesday, 23rd August 2006

Civil servants are an easy target for negative headlines ("Agency proves to be the wrong tool for the job" Financial Times, 24 May 2006 - registration required), particularly with a National Audit Office (NAO) report to hand (supporting Small Business, NAO, 24 May 2006). While in no way wishing to be an apologist for the SBS, I feel honour bound to set the headlines in context and question some of the assumptions - particularly in relation to access to finance - that followed the publication of the Report.

Each year a proportion of our SME population will seek external funding. The vast majority will obtain some form of bank finance (overdrafts, loans, leasing, factoring) with a small minority unable to raise all or some of the funds they have sought (a recent survey suggests about 3%). This is the starting point for a number of problems with the available statistics. It is sometimes assumed that the government's success should be judged in the context of the total number of businesses having difficulty seeking finance. To do this is to fail to make allowance for the quality of applicants, the suitability of the finance they seek or their potential for growth. In reality, only a small proportion of those having difficulty are likely to be the potentially high growth companies targeted by government programmes.

The complexity of the SME funding market also presents its own difficulties. Management often approach a variety of funders and the result is often a funding mix of grants, unsecured loans and equity. This makes it difficult to assess debt and equity programmes in isolation.

In its examination of debt financing, the NAO's starting point is a reference to up to 150,000 companies that surveys suggest have difficulties raising finance. It is this figure against which the impact of the Small Firms Loan Guarantee scheme (SFLG) is judged by commentators.

The reason only 5,800 companies received SFLG support was because commercial bankers felt that, even with a guarantee of a high proportion of the loan (now 75%), it was only worthwhile advancing loans to 5,800 SMEs. The inference drawn by commentators from the NAO report was that not enough companies were being assisted, yet the report went on to note the high default rates and also referred to earlier surveys showing high levels of displacement. The SBS is in danger of being criticised for too little and too much at the same time.

Moving on to the equity gap. It would be very easy to take the headline figures identified by the NAO of 558 companies assisted with equity and compare this unfavourably to the figure of 18,000 annually that reportedly may need equity. This is not a valid approach.

The 18,000 figure seems to be based on a statement, published in 1996, that in the US "about 50,000 start-ups per year (5%-10% of total start-ups)" are estimated to 'need' equity funding. No mention is made as to whether the proposals are commercially viable. This estimate of 5%-10% is then applied to the number of VAT registrations in the UK in 2002 (itself a questionable proxy for start-ups) to yield a figure of 9,033-18,067 per annum.

The 558 companies that the SBS is credited with helping does not take into account many of the companies assisted by other government schemes. For example, just one initiative, the Enterprise Investment Scheme (EIS) has assisted 11,694 companies since its inception in 1994. In some cases, the SBS programmes (such as the Regional Venture Capital Funds - RVCFs) can be the linchpin of the support given to such high growth companies. For example, The Capital Fund, the RVCF for London, invests alongside business angels (often EIS supported) in some 70% of cases and encourages SFLG advances in about 20% of cases. Furthermore, many of the SBS programmes are structured to leverage the taxpayers' contribution to maximum effect by requiring private sector co-investors and ensuring the public sector shares in the rewards as well as the risk - not seen in many other government programmes. The new equity programmes also offer the opportunity to monitor the success of assisted companies.

Whatever the final number of businesses assisted each year by all the governments schemes (no doubt available somewhere in Whitehall), I would suggest that it is likely to represent a high proportion of the better managed businesses amongst those companies who supposedly have difficulty raising finance.

The SME funding market is better understood than it was - the SBS deserves credit for this, along with the much-missed Bank of England reviews. The NAO report is a timely reminder that we need better statistics. It does not show that government programmes are failing to support high growth SMEs cost-effectively.

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