EQUITY FUNDING FOR SMEs
Back in 2013, I began a two-year assignment for the Welsh Government to examine the key challenges for Welsh SMEs in accessing finance, an exercise which eventually led to the creation of a new Development Bank of Wales.
Since the task and finish group made its recommendations back in 2015, the environment for business has changed considerably and there has been a growing appreciation of the role that SMEs can play in growing the economy.
Understanding the environment in which SMEs operate, especially in terms of accessing finance, remains important to policymakers and that is why the recent publication of the Small Business Finance Markets report from the British Business Bank makes for some fascinating reading.
First of all, it is clear that there is an increasing flow of finance from providers to SMEs, not only in traditional debt lending but also in other forms of funding such as equity or asset finance.
But whilst there is more money available in the system, it would seem that there is a reluctance by SMEs to use finance with some stating that they would rather avoid growth than borrow money for the business.
Of course, this is not helped by the current political and economic uncertainty which means that not only are SMEs more likely to self-fund from retained profits but are more cautious in the borrowing habits. For example, only 34% used external finance in the first half of 2018, a decline on the same period in 2017 and nearly half of all SMEs say they never think about whether they could or should use more external finance.
What is interesting about these statistics is that this reduction is a direct result of micro and small firms (those with less than 50 employees) not accessing funding. Indeed, the use of finance by medium sized firms (5-249 employees) has increased.
This was a specific issue that was identified during the research we undertook for the strategic case for the Development Bank of Wales and it is good to see that their current strategy of focusing on supporting smaller firms seems to be bucking this UK trend with over half of their investments between 2018-19 being micro loans of less than £50,000.
This lack of take-up of funding (or the intention to take up funding) suggests that there needs to be a wider marketing exercise from banks, government and other finance providers to ensure that SMEs not only understand the potential benefit of finance to their business but that they get to choose the most appropriate type of finance for their business. There also needs to be a clear signposting to alternative solutions available if they are rejected by traditional sources of finance.
Another one of the key issues identified by the British Business Bank in their report is the need for fast growing businesses to gain access to equity finance, especially given that research studies show that when external finance is accessed, firms are more likely to grow especially when they are in innovative high-risk sectors.
And whilst there is evidence that high growth businesses are beginning to access equity finance, there are still issues about making the ecosystem as effective as that found in nations such as the USA or Israel where accessing venture capital is a natural part of any growing business’ journey.
This could be down to the fact that very few SMEs will use or plan to use equity in the near future, with reasons including a reluctance to give up control, not knowing where to start with an application and judging it to be unsuitable for them.
More worryingly, over half of SMEs said they did not know anything about equity finance, suggesting there is still a massive information gap that still exists amongst entrepreneurs and addressing this issue in Wales is something that the Development Bank should be doing as part of their remit for the nation although it is clearly good news that over a quarter of their recent investments have been in equity deals.
For those who do access equity finance, there seems to be increasing evidence of a gander bias in the industry with female founded businesses continuing to get a raw deal when it comes to funding from venture capitalists – only four per cent of UK deals were with all female teams and they received less than 1% of the value of these deals. In contrast, 83 per cent of UK VC deals were with all male teams receiving 89% of all the funding.
In addition, in terms of initial applications to venture capitalists, 75% of all pitchdecks received by fund managers came from businesses with no women in the founding team. Whilst is a serious issue across the whole of the UK, the Welsh Government with its diversity agenda may wish to consider focusing on addressing this through the funds it manages via the Development Bank of Wales.
I know from experience we have some excellent female-founded businesses here in Wales that need this type of support to grow and very few of the businesses on the Wales Fast Growth 50 over the last twenty years have been established by female entrepreneurs.
There are therefore still considerable challenges in ensuring that the SME sector not only accesses finance but, more importantly, the right type of finance. However, Wales is lucky to have its own Development Bank that can support the more traditional sources of funding such as banks and one can only hope that it continues to play this important role in supporting the economy in years to come.