News: Financing of small and medium sized enterprises
29th January 2015
The problem of the financing of small and medium enterprises (SMEs) has been in the public domain for six years, following the credit crunch that began with the collapse of Lehman Brothers in 2008. The general perception is the associated constraints on lending are less binding than they were then but still SMEs complain about the extent to which they are able to access external funding.
In an extremely political, pre-election Autumn Statement, the Chancellor George Osborne (pre)announced a number of measures designed specifically to help in the financing of SMEs. While this may seem like good news for the 791k SMEs that are located in the South East, many of the measures involve carefully calibrated state guarantees for limited periods rather than actual giveaways. This reflects the limited funds available to directly boost economic growth generally and that of SMEs in particular, given the Chancellor’s focus on fiscal consolidation.
New Measures to Support SMEs
The Chancellor has proposed new measures to help alleviate specifically the financing constraints SMEs still face. In particular, he introduced three measures which ideally should be able to support the growth of the SMEs at different points of their life-cycle
• Boost to funding through the British Business Bank
• Extension of the Funding for Lending Scheme
• Measures to stimulate peer-to peer (P2P) lending schemes
There is an additional injection of £900m to the state-backed British Business Bank that was established by Vince Cable in 2013. Some £400m will go to state-backed venture capital funds to invest in high growth SMEs. An additional £500m was allocated to new lending guarantees under the Enterprise Finance Guarantee scheme.
The Chancellor also announced a one-year extension of the Funding for Lending Scheme (FLS) to boost bank lending until the end of January 2016. The FLS is a joint Bank of England and Treasury initiative set up in August 2012 with the aim of making cheaper funds available to lenders. Under the FLS, banks can borrow funds cheaply from the Bank of England before on-lending them to customers. In November 2013, the incentives were refocused away from mortgages and now the scheme is to focus exclusively on lending to SMEs.
Finally, the Chancellor gave a boost to new non-bank sources of finance for SMEs such as P2P lending and crowdfunding where financing is raised through an online funding platform like Kickstarter. From 2016 individuals lending to established SMEs through P2P platforms like Funding Circle will be able to offset for tax purposes losses from bad loans against other P2P income. The government is currently consulting on whether to include loans provided through crowdfunding platforms for startup and early stage SMEs within tax-free individual savings accounts.
While these three measures go in the right direction, our concern is whether they really address the financing gaps that SMEs face. The financial support given to the activities of the British Business Bank goes in the right direction. The proposed financing measures to support venture capital funds to invest in high growth SMEs is welcome. However, detail is lacking: it would be good to have a better understanding of how these additional funds are allocated. While interfering with the way private lenders make their decisions on what funds support is not the right things to do, we still think that it is in the public interest to understand whether small firms with high-growth options benefit from these additional funding streams.
There are also some doubts about the effectiveness of the FLS. Recent Bank of England data showed that lenders using the scheme cut net credit to SMEs by £128m in the quarter to September, even if this was the smallest reduction so far in 2014. Research conducted by the ESRC Business and Local Government Data Research Centre shows that high-growth firms (which should be a potential target of the FLS scheme) tend to be young, entrepreneurial ventures mostly operating in sectors whose financing needs cannot be easily addressed by traditional lenders given the fact that their profile makes them relatively risky for a bank loan. We think that to improve the access to finance for this supplement their existing models. Research that the ESRC Business and Local Government Data Research Centre is conducting in this area shows that SMEs may benefit from these enhanced credit scoring models as they may permit more access to external finance than do the current models.
By contrast, the measures around P2P lending and crowdfunding in principle seem more interesting. There are positive options to support nascent ventures but we would like to see these measures made more incisive than they are now (for instance, why not introduce P2P tax relief from 2015?). Also, we would like to see more immediate support for crowdfunding to provide funds to young SMEs that are seen as too high risk by the banks.
A separate issue which is a source of concern is the geographical spread of P2P lending even if in theory it is designed to overcome spatial barriers. A quick glance to the Open Data Institute data shows that the take-up of P2P is relatively low in the East of England and the North despite the fact that P2P platforms are designed to overcome spatial barriers. This suggests that, thus far, P2P lending is not solving the problems of access to non-bank finance in these regions.
Will the new measures boost SME growth? Well, the jury is still out! While the measures go in the right direction, the overall verdict is that the Chancellor has missed a great opportunity to provide a bigger boost to overall SME growth and thus to UK output.
The Business and Local Government Data Research Centre is a consortium of research and data analysis specialists from the universities of Essex, Kent and East Anglia. The Centre is analysing datasets from different sources to shed light on how local economic growth can be encouraged by, among other things, identifying potential high growth SMEs, encouraging new sources of funding (like crowdfunding) and by bringing the shoppers back to our ailing High streets.