Margareta Pagano: Time to tackle lack of risk-taking with enterprise

Venture capital invests less than the Manchester clubs spend on footballers’ salaries
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The UK's venture capital industry invested less in British business last year than the combined salaries of Manchester City and Manchester United's footballers. To be precise, the VC industry invested only £344m in 431 UK small cap companies – some £20m less than the football teams forked out on stars such as Rio Ferdinand (pictured). Only £5m of that VC money went on seed capital and £25m for start-ups.

It's one of the dizzy facts that beggars belief; not because the footballers earn so much, more that the amount of money being invested in our entrepreneurs by VCs has been falling since the crash and continues to decline.

Luckily, VC money is not the only source. Bigger by far is the money invested by the UK's private business angels, although even this remains static. While accurate figures are hard to extract, Jenny Tooth, head of the UK Business Angels Association, reckons that with those registered for enterprise investment scheme relief, the total could be £1bn plus – not bad but less than the salaries of all our football clubs and peanuts if the next generation of small businesses is to fly.

As the Breedon review on non-bank lending showed so vividly, there is a "financing" gap of between £84bn and £191bn for small and medium-sized enterprises over the next three years. Bank finance is still the main source for most SMEs: 55 per cent use credit cards, 44 per cent loans and 35 per cent overdrafts. But this is proving harder to get than before the crash as the banks – quite sensibly, despite Vince Cable's latest attack on the Bank of England for acting like the Taliban – are bolstering their balance sheets and deleveraging.

If anyone needs reminding about how vital it is we get new sources of funding, they should read the latest report from Warwick University and GE Capital, The Mighty Middle.

This showed that the UK's 27,850 mid-market companies – those with turnover of between £20m and £1bn – contribute a third of all private sector revenues. That's an astonishing number. And while these companies make up only 1.67 per cent of the private sector, they provide 11.2 million people with jobs, and it's rising.

What's more, these companies reported a productivity increase from £154,000 in revenue per employee in 2010 to £196,000 in 2011. If this were a report on German industry, we would be drooling at such increases. There's more to applaud: the UK mid-market has a higher number of "growth champions" – companies with sales growing at over 10 per cent a year – than Germany, France or Italy. Yet they all warn about the difficulties in finding finance to fund expansion.

So what's to be done? The answer is switching the UK's obsession away from debt towards equity. Xavier Rolet, head of the London Stock Exchange, put his finger on the problem in another excellent report, The New Equity, published last week, when he warned that we will be failing our entrepreneurs if more equity finance isn't made available to them. As he also said, raising equity rather than bank debt is far more effective for them as it aligns incentives between the owner and the investor.

Mr Rolet is spot on. Companies are far too hooked on bank finance and it's not actually good for them. All too often, it creates a mismatch between the risk that entrepreneurs take, and that taken by the banks as their incentives are not growth but a fixed return. Nor is it suitable for high-growth firms that often need external capital before they start producing income – a time when they can't make regular loan payments.

A survey of 451 businesses by the think-tank New City Network showed how bad this addiction has become. Half the firms had failed to raise finance because they only went to a bank; more worrying, they thought growth capital was only available from banks. That's plain wrong, but the banks should also be doing more to steer them towards the alternatives – like the angel networks.

Filling this education gap is essential to filling the financial one and reconnecting the debate about risk finance with growth. Maybe our entrepreneurs should visit Old Trafford to find out from the maestros.