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Think small for real UK growth

If Gordon Brown needs any convincing that it will take more than fine words to turn Britain into a truly entrepreneurial economy he should look no further than a report produced under the aegis of his colleagues at the Department of Trade and Industry.

The Improving Share Liquidity document points out how many of Britain's smaller quoted companies (SQCs) are being starved of the cash they need to innovate because of a lack of interest from investors and highlights how so many more companies are de-listing, or returning from the stock market to private ownership, than at any time since the early 1990s, when the last recession was at its height.

This lack of interest is not seen as a reflection of the companies' merits. Indeed, the report of an independent working party put together by the DTI's Innovation Unit under the leadership of the HMV Media Group chairman Tim Waterstone quotes a survey by Tempest Consultants of London, New York and Tokyo in which analysts, institutional investors and companies agreed the valuations did not represent the true worth of the organisations.

There appears to be widespread agreement with Mr Waterstone's view that such businesses "are an essential part of the UK economy" and that they are victims of circumstances. In particular, it is felt that fund managers - themselves under increasing pressure - have shifted their focus towards the larger FTSE 350 companies, creating a more and more restricted capital market for their smaller counterparts. The obvious response to this is for the SQCs to target private investors.

As the report published earlier this month says, the privatisations of the 1980s and the demutualisations of the 1990s have introduced millions of people to share ownership and created a much wider awareness of the stock market and its advantages and pitfalls. And 12 million people hold direct investments in shares, with millions more investing indirectly through funds managed by institutions.

These people are being driven by such factors as the relatively poor returns offered by bank and building society deposit accounts, the need for greater financial independence and general rises in the levels of disposable income to seek out good investment opportunities.

But that does not mean the SQC sector should just sit back and wait for the money to roll in. Among the recommendations made by the report is that companies should put effort into developing cost-effective communication. It shows the Internet can communicate with a large and diverse share ownership base much more quickly and efficiently.

The working party also highlights the importance of what it calls "management attitude". They say smaller quoted companies most successful at attracting private investors have tended to have a managing director and a board committed to the involvement of private investors and with a pro-active and enthusiastic attitude to attracting and communicating with them. But it is not just a case of the companies changing their approach.

The report also calls for corporate brokers to recognise the benefits of private shareholders in providing essential liquidity and promote the involvement of private investors at the initial fund raising and in the market that subsequently develops. It also wants the Financial Services Authority to ensure rules on the suitability of investments do not inhibit investment by private client brokers in SQCs, and for the Stock Exchange to promote the benefits of private investors to smaller companies and their advisers while encouraging them to think about long- term liquidity when they float.

Finally, it says the Government should consider whether the tax and legislative framework is a barrier to SQCs attracting private shareholders and examine the difficulties created by nominee accounts for effective communication between the companies and private shareholders. Whether ministers are in a frame of mind to do anything might be indicated next week, when Patricia Hewitt, small business and e-commerce minister, attends a London conference on the report's findings.

If focusing on the private investor looks too much like banking on one strategy, Tim Mocroft, the project manager, says he has not met anybody who has "demurred from the idea that private investors create liquidity".

The report says that in the United States - everybody's favourite comparison when it comes to enterprise - the smaller quoted companies have not experienced these liquidity difficulties, and private investors account for about 42 per cent of the equity market by value, more than double the figure for the UK.

Since the SQC sector accounts for about 5 per cent of the total, only a small shift in the emphasis of individuals' investments could have a marked effect, says the report, stressing that its aim is to break a circle it believes is undermining Britain's ability to be competitive.

The circle starts with the fact that large institutions do not invest in smaller companies, so brokers are not earning commission in this area and stop paying for research. That means there is little or no analysis available for private investors and others who might be interested to use in making investment decisions. It becomes a self-fulfilling prophecy, says Mr Mocroft.