David Prosser: Reasons to be cheerful about the prospects for small business finance

Small Talk

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It’s easy to be gloomy about small business finance. The amount of money banks have lent to small businesses this year looks set to be even lower than in 2013, despite a growing economy and the concerted efforts of policymakers to persuade banks to lend more. We don’t yet have figures for fourth-quarter small business lending from the Bank of England’s Funding for Lending scheme, but the first three quarters were so far down on 2013 that it would take a miracle for 2014 as a whole to be up.

Before despairing, it’s worth considering the quality of lending as well as its quantity. The British Business Bank, launched two years ago as the Government sought to provide small businesses with new sources of finance, says that while businesses may not be borrowing any more money today than when it was launched, their reasons for borrowing have changed. Its research suggests a shift towards growth-oriented credit over the past couple of years.

Two years ago, 45 per cent of small business borrowing was used to boost cash flow, the British Business Bank says, but the figure today is more like 33 per cent. Meanwhile, the number of companies borrowing in order to buy fixed assets, or to expand in another way, has risen from 39 per cent in 2012 to 54 per cent today.

Keith Morgan, the bank’s chief executive, believes these shifts are evidence of “increasing confidence among businesses and an appetite for growth”. That’s a logical conclusion: in an improving environment, you would hope to see small businesses taking on additional financial firepower in order to gear up for growth, rather than to be borrowing to keep their day-to-day operations on track.

Still, there’s a more fundamental discussion point here. Is bank debt even the right option for small businesses looking to the future in this way? Britain’s economy has been fuelled by credit for so long that it’s easy to forget that borrowing money isn’t the only way to raise finance; for many small businesses, persuading investors to put up growth capital may be a better option.

There are all sorts of reasons why this is the case. For example, what growing businesses often need just as badly as finance is support and advice – equity investors are more likely to provide this than a bank, whether through formal structures such as seats on the board, or more informally through mentoring, networking and other types of help.

Also, bank debt is often an inhibitor of growth rather than a catalyst. Over-borrowed companies find themselves caught out by restrictive covenants on their debt that leave them unable to invest for growth. Equity capital, on the other hand, leaves companies with room to operate.

The good news is that more small companies are embracing growth finance. Research by the analyst Beauhurst has revealed that growing businesses raised £1.62bn of equity capital during the first three quarters of the year alone – 9 per cent more than in the whole of 2013.

Similarly, the Business Growth Fund, the bank-financed equity funding scheme set up by the Government three years ago, is enjoying its busiest year yet, funding more growing companies than ever before.

Nevertheless, the shift towards an equity culture is a slow one. Research from the Confederation of British Industry suggests that while half of Britain’s small and medium-sized companies use bank debt, only 3 per cent have ever raised growth capital. By contrast, the average across Europe as a whole is 7 per cent.

Part of the problem is that many entrepreneurs are suspicious about equity investors – above all they are reluctant to cede control of their companies, though not all providers of growth capital require them to do so.

The bigger issue is that small businesses have relied on bank debt for so long that Britain now lacks a culture of equity investment. Building that culture will take time, but if we want to provide more businesses with a stable and sustainable foundation for growth, it is worth making the effort.

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