Small Talk: Give them credit if we want the minnows to do big things

Do this week's third-quarter GDP figures represent an opportunity? Ask any fund manager where in the stock market you should place your bets in the event of an economic recovery and the answer is likely to be the same: most statistical analysis suggests that smaller companies tend to outperform during the first stage of an upswing.

That's logical enough: by their nature, smaller companies have greater growth potential than their larger peers. So, when the prevailing economic winds are fair, they ought to do better. The flipside is they may not have sufficient scale or breadth to show resilience during a downturn.

Assuming, then, that Thursday's update from the Office of National Statistics confirms the consensus forecasts of economists that the UK moved out of recession during the third quarter of the year, we should expect to see evidence that smaller companies, both quoted and unquoted, are beginning to power ahead. That certainly appears to be what the stock market is expecting. The FTSE SmallCap Index was up by more than 9 per cent during the third quarter of the year, while the FTSE 100 Index's gains were less than 2 per cent. From the perspective of investors, it looks as if smaller companies have already begun to repeat the pattern of share price outperformance seen in previous recoveries.

There's a problem, however. For that outperformance to be maintained smaller companies will have to begin producing some tangible results – real evidence that the fairer economic winds really are pushing them along. And, so far, that evidence is in short supply.

In fact, the early signs are that smaller companies found the going very tough during the third quarter. Begbies Traynor, the insolvency specialist, puts it this way: "The UK has a twin track economy with SMEs in the slow lane" – exactly the opposite of what we should be seeing, in other words.

Its research, based on its clients' experience, plus a wide range of financial and legal data, suggests that while there was a 61 per cent decrease in the number of large companies in financial distress during the third quarter, the corresponding figure for SMEs was actually a 10.5 per cent increase.

"Unfortunately the outlook for many of these SMEs is poor," says Julie Palmer, a partner at Begbies Traynor. "Whilst many may survive with the benefit of low interest rates and creditor forbearance, they are in no position to deal with unexpected costs, lost orders or bad debts or to fund increases in working capital and invest in growth."

So what is different about this recovery (assuming that is what we have?). Well, one problem for SMEs is that larger companies have sought to pass on their difficulties – we have seen the late payments problem, which hits smaller businesses, grow very rapidly during this depression. Also, higher costs have arrived at just the wrong time – inflation has been far higher than expected for much of the past two years, with soaring energy prices now biting particularly hard.

The really big issue, however, is poor credit availability, with the lending environment continuing to deteriorate on every indicator you study. When the economic backdrop was squeezing SMEs so hard, limited access to credit finished off many businesses. Now that backdrop is improving, the lack of credit availability threatens to prevent smaller companies participating in the recovery.

Those prevailing winds may indeed be getting fairer, but too many SMEs will not be able to take advantage.

Lending scheme 'is failing small building companies'

The Enterprise Finance Guarantee scheme (EFG), one of the Government's small business lending programmes, is failing to boost the crucial construction sector, a leading firm of accountants is warning.

Wilkins Kennedy says bank lending to small construction firms via the EFG, where the Government guarantees up to 75 per cent of loans, "has dwindled to almost nothing". Just £3.5m was lent to construction businesses during the second quarter of the year, down from a peak of £25m in the second quarter of 2009.

"Lack of funding for small construction businesses has serious implications for the construction industry and the wider economy," said Nick Parrett, Wilkins Kennedy's head of construction. "In 2011 alone, over 3,500 construction companies went bust".

The results will add to pressure on ministers over funding for smaller businesses.

HMRC sets its sights on small businesses

Small businesses whose tax affairs are not in order are at much greater risk of being caught out amid a drive by HM Revenue & Customs to chase down uncollected revenues.

Research from the accountancy firm UHY Hacker Young shows that HMRC investigations into small and medium-sized enterprises produced an extra £434m of tax and fines in the 2011-12 tax year, almost 40 per cent more than the £311m netted in 2010-11.

Roy Maugham, a tax partner at the firm, said HMRC was targeting SMEs much more closely, having itself been set more demanding tax yield targets by the Chancellor.

"Small businesses have found that they are an easy target for HMRC's crackdown," Mr Maugham said. "The other hidden cost to businesses is the amount of time it takes to deal with a tax investigation – an SME is also going to find it hard to afford a full-time accountant to deal with or challenge a tax investigation, so is more likely to concede, unnecessarily, to demands for extra tax."

Small business woman of the week: Clippy McKenna, founder, Clippy's

It all started with the two apple trees in my back garden and my love for cooking – and for apples in particular.

I wanted to combine those passions and I needed a product which would have a real shelf life. I started selling my apple jams, relishes and chutneys at farmers' markets near my home in Manchester, but the business really took off in 2007 when I got my first order from Harvey Nichols – it was then that we set up as a limited company and I persuaded my fiancé to join me.

"In order to grow, we needed to get to the giants who account for 85 per cent of the grocery market, so we went to pitch to all of them. Someone said to me that we'd never make it into the big supermarkets and I just thought 'I'm going to do this'. Now we supply Tesco, Morrisons, Asda and Ocado and we're hoping to turn over £1.5m next year.

"We're also expanding overseas – we got funding from UK Trade & Industry to go to the San Francisco Food Show, which enabled us to find a company in the US that now distributes our products there. And having been invited to a similar show in Shanghai, we're selling to China too. People are nervous about exports, but it's really just fear of the unknown and there's no need to be frightened.

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