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SMALL BUSINESS FINANCE MARKETS 2017/18 3 CONTENTS 3 FOREWORD 5 EXECUTIVE SUMMARY 8 INTRODUCTION 9 AGGREGATE FLOW AND STOCK OF FINANCE TO SMALLER BUSINESSES 12 MACROECONOMIC DEVELOPMENTS 14 PART A: THEMES 15 1.1 DEMAND FOR FINANCE 23 1.2 REGIONAL ACCESS TO FINANCE 28 1.3 PATIENT CAPITAL FOR SCALEUPS 31 1.4 INTERNATIONAL COMPARISONS OF SMALL BUSINESS FINANCE MARKETS 38 PART B: MARKET DEVELOPMENTS SMALL BUSINESSES 39 2.1 SME BUSINESS POPULATION 43 2.2 HIGH GROWTH FIRMS 48 2.3 USE OF EXTERNAL FINANCE FINANCE PRODUCTS 53 2.4 BANK LENDING 58 2.5 EQUITY FINANCE 64 2.6 DEBT FUNDS 68 2.7 ASSET FINANCE AND INVOICE & ASSETBASED LENDING 74 2.8 MARKETPLACE LENDING 78 GLOSSARY 82 ENDNOTES 2 BRITISH BUSINESS BANK SMALL BUSINESS FINANCE MARKETS 2017/18 FOREWORD KEITH MORGAN, CEO, BRITISH BUSINESS BANK The British Business Bank was established at the end of 2014, with a mission to improve ÿnance markets so they more e¤ectively serve the needs of smaller UK businesses. This report, our fourth Small Business Finance Markets report, highlights a continued and welcome growth in ÿnance ow to smaller business outside of traditional bank lending products. The value of equity investment (up 79% in 2017), asset ÿnance (up 12%) and peer- to-peer business lending (up 51%) used by smaller businesses all showed signiÿcant growth in 2017, while net bank lending remained relatively at. That smaller businesses are using an increased range of ÿnance options is relevant to two of the British Business Bank’s key objectives: to increase the diversity of supply by supporting new ÿnance market entrants and innovative funding models; and to build smaller businesses’ conÿdence and awareness of their ÿnance options, including through our popular Business Finance Guide, co-published with the ICAEW. Although traditional banks are still the predominant source of ÿnance, it’s encouraging to see smaller businesses considering and using an increased range of ÿnance options to meet their funding needs. We strongly believe that matching smaller businesses with appropriate ÿnance options will ultimately help them, and the UK economy, develop more successfully. The British Business Bank uses evidence and research to shape and develop our programmes. Three themes from this year’s Small Business Finance Markets report are already bringing signiÿcant change to our activities: enabling greater provision of patient capital in the forms of equity and wider growth capital; stimulating demand for ÿnance; and tackling regional imbalances in ÿnance supply. PATIENT CAPITAL This report highlights strong evidence that our scale-ups need more long-term patient capital throughout all stages of their development if we want to compete with the US, for example, in producing world-beating companies. It echoes the themes explored in detail in last year’s Patient Capital Review, led by HM Treasury and supported by a separate industry panel chaired by Sir Damon Bułni. The evidence shows there are some key areas where improvements can be made – for example, compared to their US counterparts, UK Venture Capital funds are smaller on average (£118m compared to £180m), and UK businesses that exit receive fewer funding rounds (an average of 1.9 rounds compared to 2.7 rounds). Although the Bank had already begun increasing its resources allocated to supporting equity for scale-up companies, the Autumn Budget, represented a step change in our capabilities. In an innovative package, the government allocated £2.5bn of additional resources to the British Business Bank, an increase of around two thirds on our existing capacity. Along with existing resources, this signiÿcant increase will unlock up to £13bn of ÿnance to help UK smaller businesses realise their full potential and, over time, help broaden and deepen these markets through attracting private sector capital – the central goal of the Patient Capital Review, and one we share. 4 BRITISH BUSINESS BANK 5 SMALL BUSINESS FINANCE MARKETS 2017/18 TACKLING REGIONAL IMBALANCES IN FINANCE SUPPLY Demand variations are also apparent on a regional basis, compounding the imbalance in supply of growth capital across the UK. In 2017 the volume and value of equity received by London-based businesses exceeded that for the rest of the country combined. Angel deals are also concentrated in London and the South East. Increasing such activity in regions outside London and the South East has the potential to help close well-documented imbalances in regional growth. The Bank is addressing some of these imbalances directly through our Northern Powerhouse and Midlands Engine Investment Funds – with a fund for Cornwall and the Isles of Scilly expected in 2018. Whilst these supply-side activities are important, we see a signiÿcant potential to rebalance activity through better provision of information and building capacity in the regions to support ÿrms’ growth ambitions. Awareness and consideration of di¤erent forms of ÿnance varies signiÿcantly across the country, and our renewed e¤orts to close information gaps will have a strong regional element. In response to the government’s 2017 Industrial Strategy, we are also developing an investment programme to support the development of clusters of business angels outside London, and will be putting in place a network of British Business Bank regional managers by Autumn 2018. Strong research, evidence and analysis provides the basis for our interventions to improve ÿnance markets for smaller UK businesses. This report highlights areas where we have already begun to respond to current challenges, and where we might respond further to those that lie ahead. We look forward to working with our partners and stakeholders to address the growing needs of smaller businesses as we do so. Two key elements of the Budget announcement are being implemented this year: • A new £2.5bn Patient Capital entity, incubated within the Bank, which will invest commercially into venture and growth capital with a view to œotation or sale – subject to a value for money assessment – once it has built its portfolio and track record • Using up to an additional £500m, we will cornerstone a small number of large scale, private sector managed funds of funds, which will in turn catalyse patient investment into high potential businesses. STIMULATING DEMAND Supply of ÿnance is, however, just one side of the equation and other activities need to be undertaken to build capacity and capabilities amongst SMEs. One such area is information, which is a fundamental building block for ełcient, well-functioning markets. Our research shows that this is an aspect of smaller business ÿnance markets that could be strengthened as, too often, businesses either aren’t aware of or don’t understand the variety of ÿnance choices available to them. The Bank has already taken action to address this problem. Thousands of businesses a week access the British Business Bank/ICAEW Business Finance Guide, which provides information about ÿnance options for businesses at all stages of their development. We recognise, however, that there’s more to be done. We are introducing a more targeted new digital information hub in Spring 2018, and will be backing it with a substantial promotional campaign to maximise its use by smaller businesses. The new hub, which will set out ÿnance options in a simple to use format, aims to go further in equipping businesses, and especially those with growth ambitions, with the know-how to ÿnd the ÿnance best suited to their needs, enabling them to become the global success stories of tomorrow. EXECUTIVE SUMMARY The fourth edition of our Small Business Finance Markets report comes at a time when the government’s Industrial Strategy has reiterated the productivity and regional challenges facing the UK economy, and the outcome of the Patient Capital Review has identiÿed the need for additional action to ÿnance growth in innovative ÿrms. Improving the growth and productivity of smaller businesses is central to improving the performance of the economy as a whole. This makes it even more important that ÿnance markets are e¤ective in supplying funding to smaller businesses when it is needed, and that smaller businesses across the UK have the ability and conÿdence to attain ÿnance appropriate to them. This report provides a unique, in depth picture of the smaller business ÿnance market. It is intended not only to inform the development of the British Business Bank’s own strategy, but also to inform wider developments in both the market and government policy. The report structure has been reÿned this year, to highlight the major cross cutting themes in Part A, with Part B providing a more detailed review of the small business sector and developments in speciÿc ÿnance product markets. Five key themes emerge from our analysis. EQUITY AND ALTERNATIVE FINANCE DEMONSTRATED STRONG GROWTH IN 2017, WITH BANK LENDING VOLUMES RELATIVELY FLAT Despite the modest macroeconomic environment, small business ÿnance markets have continued to provide signiÿcant volumes of ÿnance to smaller businesses. Aggregate ows of ÿnance saw signiÿcant double digit increases for many products, however bank lending was relatively at, resulting in an increasingly diversiÿed ÿnance market for smaller businesses. Most notably, values of external equity ÿnance received by smaller businesses rose rapidly, increasing by 79% in the ÿrst 3 quarters of 2017. Although deal sizes have increased across all equity stages, this was partly due to a small number of very large deals. The 10 largest equity deals alone account for over £1.6bn of the £4.5bn invested in the ÿrst 3 quarters of 2017. The number of deals however were also up by 12% compared to weaker deal activity seen in 2016. This development is particularly welcome as equity ÿnance is an important input to enabling many businesses to deliver their growth potential. Peer-to-peer business lending also showed continued rapid growth, rising by just over 50% in 2017. Such lending is challenging traditional bank- based models of lending, although it remains around only 3% of gross bank lending ows. Finally, asset ÿnance has continued the consistent low double-digit growth which has been apparent for several years. 7 6 BRITISH BUSINESS BANK This growth demonstrates increased diversity in small business ÿnance markets. As previous British Business Bank research on diverse ÿnance markets has argued, this helps small businesses get the ÿnance best suited to their needs. The Bank’s support for alternative lenders continued to grow in 2017 with the Investment Programme investing through challenger banks, debt funds, asset ÿnance providers and marketplace lenders. 2018 has already seen two ENABLE Funding transactions with asset ÿnance providers. CONTINUED EXCELLENT UK PERFORMANCE IN GENERATING START¬UPS, IMPROVING IN SCALE¬UPS The UK economy has a strong track record in generating start-ups. The latest available international comparisons show the UK leading the G7 in terms of birth rates of new businesses. Although death rates have edged up slightly the UK small business population has continued to increase, rising to an estimated 5.7m businesses by the start of 2017. International comparison of the share of high growth enterprises, who are a key driver of innovation and employment, shows a slight increase in the UK, whereas it has fallen in countries such as Germany, Denmark and Sweden. There remains more to do, but it is encouraging to see some signs of better scale-up performance in the UK. The incidence of high growth enterprises in the UK has been relatively stable since the 1990s. Yet research by the Enterprise Research Centre suggests that a focus on high growth episodes experienced by enterprises over their life cycle is helpful in predicting future growth potential. Very few ÿrms have prolonged high growth, but those that have a high growth episode are more likely to do so again at a later stage. Because of their positive impact on the economy, the British Business Bank has increased its support for smaller businesses with high growth potential, by increasing funds allocated to equity schemes and debt products that are suited to those ÿrms. The Bank has also played a role in taking forward the recommendations of the Scale-Up Task Force. THE PATIENT CAPITAL REVIEW IDENTIFIED A NEED FOR MORE EQUITY INVESTMENT AT ALL STAGES The evidence included in the Patient Capital Review consultation drew on British Business Bank analysis from our 2017 Equity Tracker Report published in August 2017. Despite recent improvements in the availability of equity ÿnance in the UK, the UK external equity ÿnance to GDP ratio is lower than some of our international competitors. The Patient Capital Review focused on the availability of late stage VC, where funding provision in UK markets was noticeably below that in the US and therefore potentially hampered UK businesses’ growth potential. 2016 and 2017 have also seen relatively high aggregate amounts of fund raising, but an ongoing decline in the number of VC funds closing. This demonstrates the continued diłculty emerging fund managers have in raising new funds which our Enterprise Capital Fund (ECF) programme seeks to address. As a result of this and other analysis, the Patient Capital Review included a number of recommendations for British Business Bank equity activity to broaden and deepen markets, including: • Establishing a new £2.5bn investment fund incubated in the British Business Bank with the intention to œoat or sell once it has established a su¢cient track record • Investing in a series of private sector fund of funds of scale, with the British Business Bank seeding the ÿrst wave of investment with up to £500m • Continuing to back ÿrst-time and emerging fund managers through the ECF, supporting at least £1.5bn of new investment. NEW 2017 DATA HIGHLIGHTS REGIONAL GAPS IN SOME PRODUCTS Previous Small Business Finance Market reports have highlighted that equity investment tends to be clustered in certain cities, particularly but not exclusively London, where innovative companies, skilled labour and equity investors come together. The evidence from 2017 showed that this continued to be the case, with the volume and value of equity received by London based businesses exceeding that for the rest of the country combined. As equity is often an important ingredient for growth, increasing equity activity in regions outside London and the South East could help close disparities in regional growth. The joint British Business Bank – UK Business Angels Association survey of angel activity, published in December 2017, conÿrmed that angel investment is similarly concentrated in London and the South East. The British Business Bank is taking a number of steps to address these imbalances. It is continuing to implement the geographically focused funds in the Northern Powerhouse and Midlands Engine regions. In addition, and as announced at the Autumn Budget 2017, the British Business Bank is developing a commercial investment programme to support the development of clusters of business angels outside London. The Bank will also be developing a network of British Business Bank regional managers to be in place by autumn 2018 to ensure businesses across the UK know how to access sources of investment. That will be complemented by a new digital hub developed by the Bank, o¤ering authoritative, impartial information around access to ÿnance for ÿrms with scale-up ambitions. This is due to launch in Spring 2018. SMALL BUSINESS FINANCE MARKETS 2017/18 RECORD LOW DEMAND FOR TRADITIONAL BANK LOANS IN 2017 Data on loan application rates has showed a continuing decline in the share of SMEs seeking new loans to 1.7% of smaller businesses, the lowest ÿgure since the SME Finance Monitor began in 2011. In addition, there has been a decline in SMEs conÿdence that they will get a loan when they apply, down to 43% in the 3 months to November 2017, compared to 58% in the previous 3 months which mirrors the broad decline in smaller business conÿdence levels. This contrasts with loan approval rates which remain quite high. There is also evidence that the attitudes against borrowing are becoming more entrenched across SMEs of all size bands, with around 70% willing to accept a slower growth rate rather than borrowing to grow faster. Combined with the increase in positive cash balances held by SMEs, this suggests a broader reticence to invest to grow. This highlights that, particularly for smaller businesses with growth potential, there would be beneÿt in improving the information available to them about their ÿnance options. 9 SMALL BUSINESS FINANCE MARKETS 2017/18 8 BRITISH BUSINESS BANK • Examples, which were published in our 2017 Equity Tracker, include detailed analysis of venture capital fundraising and portfolio company exits • The British Business Bank and UK Business Angel Association commissioned a new survey of Business angel investors to give a more up to date understanding of the angel landscape in the UK • We draw on externally commissioned evaluations of British Business Bank products, most notably, our recent evaluation of the Enterprise Finance Guarantee. This report also references a wide range of evidence drawn from government, market and academic research. This year we made greater e¤ort to pull together the international evidence in the report, so that UK small business ÿnance markets are compared to the best around the world. STRUCTURE OF THE REPORT The report begins with an overall assessment of the aggregate ows of ÿnance, macro-economic developments and the implications for small business ÿnance needs. Part A provides a thematic overview looking in turn at the drivers of demand, regional ÿnance variations, the evidence on patient capital and international comparisons of small business ÿnance markets. Part B examines in more detail developments in the small business and high growth ÿrm populations. It then considers the market for di¤erent types of debt and equity ÿnance most widely used by smaller businesses, identifying where further improvements can be made. This is the fourth annual British Business Bank report on Small Business Finance Markets, setting out the latest evidence on the ways in which ÿnance markets support smaller business and help them contribute to improving productivity and growth in the UK economy. Our understanding of smaller business ÿnance markets, both in terms of demand for ÿnance and the ÿnance providers’ supply of ÿnance, is essential to shaping our business plan and the design of our programmes and products. Macro-economic developments in 2017 have reinforced the need to ensure that small business have the ÿnance they need to make a strong contribution to economic growth. NEW EVIDENCE AND ANALYSIS During 2017, the British Business Bank has developed new evidence and analysis to deepen our understanding of smaller business ÿnance markets. In particular: • Our Small Business Finance Survey has been run again to give up to date insight into smaller businesses, awareness of the ÿnance options available to them and how they go about obtaining ÿnance • We created a framework to give a better understanding of the potential impact of diversity in the supply of ÿnance for small businesses1 • A new segmentation analysis has been created to give more insight into smaller businesses who use, or are open to using, external ÿnance • We carried out more detailed analysis of the UK equity markets to inform the Patient Capital Review INTRODUCTION AGGREGATE FLOW AND STOCK OF FINANCE TO SMALLER BUSINESSES • Net œow of bank lending products remained positive This section brings together the latest data from a range in 2017 but weaker than the previous 2 years of sources on the volume and value of various types of external ÿnance provided to smaller businesses. Consistent and comprehensive data outlining the value • Equity ÿnance rebounded in 2017, whilst asset ÿnance of the aggregate stocks and ows of all forms of external and marketplace lending continue to grow, increasing ÿnance is not readily available. However, the summary the diversity in smaller business ÿnance markets table below provides a reasonable snapshot. While ows of di¤erent types of ÿnance are not directly • Small business conÿdence and demand for ÿnance comparable, the data shows that bank lending remains are declining along with the number of smaller the single largest form of external ÿnance for smaller businesses hoping to grow businesses. FIGURE 1 ESTIMATES OF THE FLOW & STOCK OF EXTERNAL FINANCE FOR UK SMEs ¯£ BILLION° ¯a° 2012 2013 2014 2015 2016 2017 Bank lending stock Source: Bank of England Outstanding Amount (b) 176 166 167 164 166 165 to end Dec 17 Bank lending œows Source: Bank of England Net ows (c) Gross ows (d) -6 38 -2 43 -2 53 2 58 3 59 1 57 to end Dec 17 to end Dec 17 Other gross ows of SME ÿnance Private external equity investments Source Beauhurst (e) 1.49 1.53 2.31 3.58 3.42 4.47 to end Sep 17 Number of reported deals 706 972 1309 1408 1148 984 to end Sep 17 Asset ÿnance œows Source: FLA (f) 12.2 12.9 14.4 15.9 16.7 18.6 to end Dec 17 Peer-to-peer business lending œows Source: AltFi Data (g) 0.06 0.20 0.41 0.73 1.18 1.78 to end Dec 17 (a) The information contained in this table should be viewed as indicative as data and deÿnitions are not directly comparable across di¤erent sources. There can be some double counting across estimates in di¤erent parts of the table. Flows data are cumulative totals for the year or to the date stated. Non-seasonally adjusted. All numbers are in billions, except number of reported equity deals, and have been rounded appropriately. (b) Movements in amounts outstanding can reect breaks in data series as well as underlying ows. (c) Net ows does not always reconcile with change in stock due to di¤erences in statistical reporting. The reported stock can include other adjustments made by banks but not detailed when reported, whereas ows data does not include these adjustments. (d ) Data exclude overdrafts and covers loans in both sterling and foreign currency, expressed in sterling. The total may not equal the sum of its components due to rounding. (e) Beauhurst is a market data provider that records visible equity deals including crowdfunding deals. (f) The Finance & Leasing Association (FLA) whose members make up 90-95% of the market. Data obtained from FLA Asset Finance Conÿdence Survey. SME asset ÿnance is assumed to represent 60% of total asset ÿnance in 2011. (g) Figures do not represent the entire market. Data obtained from AltFi Data. 10 BRITISH BUSINESS BANK NET FLOW OF BANK LENDING PRODUCTS REMAINS POSITIVE The annual net ows of bank loans (new loans, excluding overdrafts) to smaller businesses has continued to grow, albeit at a slower pace. However, following 12 consecutive quarters of positive net lending, Q4 in 2017 was slightly negative. In 2017 net lending stood at £0.7bn, well down on the £3bn for the equivalent period in 2016. Quarterly gross bank lending to smaller businesses, which reached a peak of £15.4bn in the ÿrst quarter of 2016, averaged £14.3bn in 2017. The Bank of England (BoE) Credit Conditions Review noted the availability of credit to businesses was little changed in 2017.2 The stock of bank loans and overdrafts was estimated at £165bn at the end of 2017, broadly unchanged from 2016. EQUITY FINANCE HAS BOUNCED BACK FROM A WEAKER 2016 WHILST ASSET FINANCE, INVOICE & ASSET¬BASED LENDING AND MARKETPLACE LENDING CONTINUE TO GROW Equity data shows there has been a resurgence in equity markets in 2017 following a weaker 2016. The value of new equity deals with known amounts has reached £4.5bn in 2017 by Q3, up from the £3.4bn ÿgure for the entire of 2016. Data from the Finance and Leasing Association suggests that new asset ÿnance volumes with smaller businesses was over £18.6bn by the end of 2017, an increase of 12% on 2016. Total invoice & asset-based lending advances to smaller businesses continue to rise and across all sizes of smaller businesses. The value and volume of ÿnancing for smaller businesses from debt funds is not readily available. However, anecdotal evidence suggests debt funds continue to have an important role as a source of ÿnance for smaller businesses, especially for businesses that are scaling-up. Gross ows of lending to businesses via peer-to-peer platforms continue to grow reaching £1.78bn in 2017, an increase of 51%. Equity raised by businesses through equity-based crowdfunding continues to fall but remains an important source of business ÿnance and, along with the other non-bank sources of ÿnance, an important source of diversity within smaller business ÿnance markets. Part B provides a detailed discussion of the trends in volumes for di¤erent types of ÿnance. SMALL BUSINESS CONFIDENCE AND DEMAND FOR FINANCE ARE DECLINING, WITH THE NUMBER OF SMALLER BUSINESSES HOPING TO GROW DECREASING Demand for external ÿnance by UK smaller businesses has continued to decline. Our analysis of the SME Finance Monitor shows new debt application rates have fallen every year since 2012 (4% for overdrafts and 2.9% for bank loans) and H1 2017 has continued this trend with only 1.7% of smaller businesses applying, a record low.3,4 This has been matched by a build-up of cash reserves over the same period. In Q2 2017, 26% of SMEs reported holding more than £10,000 in credit balances, an increase from 16% in 2012 and 21% the same time last year. The Federation of Small Business (FSB) Voice of Small Business reported decreasing business conÿdence over 2017, with conÿdence declining in each quarter.5 The FSB Small Business Index fell from +1.1 in Q3 2017 to -2.5 in Q4. This is only the second negative index reading in 5 years with continuing cost pressures and wider economic SMALL BUSINESS FINANCE MARKETS 2017/18 11 uncertainty the key drivers. The share of businesses expecting to downsize, close or hand on the business over the coming 12 months stood at 14.6% in Q4. This is up from 9.4% a year ago, and the largest share since data collection began in 2012. The ICAEW conÿdence index has also been lower during 2017 and has been in negative territory for the last 2 quarters of the year. The domestic economy remained a major barrier to growth aspirations in Q4 2017, with 55% of small businesses reporting it as an obstacle to achieving growth aspirations. This is slightly down from 56.7% a year ago. The British Business Bank Business Finance Survey for 2017 shows a small decrease in the proportion of smaller businesses expecting to grow in the next 12 months, from 37% of SMEs in 2016 to 35% of SMEs this year. Both these numbers are well below the 2015 number of 56%. This is lower than the FSB Voice of Small Business where just under half of small businesses reported an aspiration to grow over the next year in Q4 2017. 12 BRITISH BUSINESS BANK MACRO-ECONOMIC DEVELOPMENTS • The UK economy has continued to grow over 2017, albeit at a slower pace than other advanced economies • Productivity and business investment growth both revised down • SME Conÿdence surveys suggest the picture is unlikely to change in the medium-term • A majority of SMEs expect no impact from leaving the EU though fewer than last year think they’ll grow more • Credit conditions have remained accommodative overall THE UK ECONOMY HAS CONTINUED TO GROW OVER 2017, ALBEIT AT A SLOWER PACE THAN OTHER ADVANCED ECONOMIES The UK economy has continued to grow over 2017 whilst employment rates have remained high and unemployment is at its lowest rate since the 1970s. In 2017, the ONS estimated the economy expanded by about 1.8% compared with the previous year, higher than the OBR’s Autumn forecast of 1.5%, but down from a rate of 1.9% in 2016, and the slowest pace of annual growth since 2012. The slowdown in UK GDP growth contrasts with a pick-up in other advanced economies. In the euro area, US, Canada and Japan, quarterly growth has been stronger than in the second half of 2016 and stronger than in the UK. Sterling’s fall has seen ination pick up more rapidly in the UK than in the other major economies, contributing to weaker real growth. The fall in the pound that followed the EU referendum has pushed up consumer price ination and squeezed households’ real incomes and spending whilst public spending cuts and political and Brexit-related uncertainties have also weighed on the economy. The OBR has now downgraded its growth forecasts for the medium-term, saying the UK economy would grow by just 1.4% in 2018, 1.3% in 2019 and 2020, and 1.5% in 2021. The growth ÿgure is now in line with the Bank of England’s assessment. Bank Rate increased by 0.25% in November 2017 to 0.5%, the ÿrst increase in a decade. Interest rates are expected to rise slowly. PRODUCTIVITY AND BUSINESS INVESTMENT GROWTH BOTH REVISED DOWN Leading much of the downward revision is potential productivity growth. The OBR now expects productivity growth to fall from 1.8% to 1% in 2020. Productivity has stalled since the ÿnancial crisis in 2008, with output per hour rising just 0.2% a year in the last decade, compared to an average of 2.1% a year over the preceding 35 years. This decision to revise down trend or potential productivity growth is a major reason the OBR’s growth forecast is now more pessimistic than many external forecasters. Growth is still expected in business investment, a crucial driver of long-term growth. The OBR now expects business investment to remain stable between 2.3% and 2.4% between 2018 and 2022. However, conÿdence surveys suggest that the anticipation of Brexit and related uncertainties are weighing on investment. For instance, in a recent survey on investment intentions by the Bank of England’s Agents, economic uncertainty, expected changes to future UK trading arrangements and other Brexit factors were the most commonly cited factors weighing on investment plans. SME CONFIDENCE SURVEYS SUGGEST THE PICTURE IS UNLIKELY TO CHANGE IN THE MEDIUM¬TERM During 2017, most SME conÿdence surveys were down. The Markit UK Business Outlook recorded its lowest business conÿdence since October 2011 during the summer and several other surveys recorded multi-year lows. Alongside political uncertainty, businesses faced the twin pressures of a weakening domestic economy, as well as rising costs of doing business. The former was driven by low consumer demand whilst, with regards the latter, purchase price ination hit record highs at the start of the 2017 as the devaluation of Sterling fed through. Headline ÿgures did hide a divergence between the manufacturing and service sectors however. Whilst the service sector posted multi-year low conÿdence ÿgures manufacturing ÿrms often remained more upbeat about their growth prospects as they sought to take advantage of the devaluation of Sterling and the improving world economic picture and surveys such as the Federation of Small Business (FSB) Voice of Small Business Index reported increased values of exports throughout the year. This is backed up by ołcial ÿgures which show manufacturing output is at its highest level since February 2008. SMALL BUSINESS FINANCE MARKETS 2017/18 13 A MAJORITY OF SMEs EXPECT NO IMPACT FROM LEAVING THE EU THOUGH FEWER THAN LAST YEAR THINK THEY’LL GROW MORE As with the results from 2016, according to our 2017 Business Finance Survey, the majority of SMEs expect no impact from leaving the EU. This is perhaps unsurprising given the limited number of UK SMEs that import or export. However, the number of SMEs who expect to grow as a result of the UK leaving the EU has halved this year and now stands at 5% across those that do, and do not, employ sta¤. Unsurprisingly given these ÿndings, on balance, a greater proportion of employers are looking to reduce investment and sta¤ as a result of the UK leaving the EU. In a similar picture to 2016, only 4% of respondents plan to make changes to their investment plans and 3% plan to make changes to their recruitment plans as a result of Brexit. Of these, 54% said they were looking to invest a smaller amount and 51% expected to hire fewer sta¤ than would have otherwise have been the case. In contrast only 19% expected to invest a greater amount and 10% expected to hire more sta¤ than would have been the case. DESPITE THE MODEST ECONOMIC PERFORMANCE IN 2017 CREDIT CONDITIONS HAVE REMAINED ACCOMMODATIVE OVERALL Throughout 2017, availability of credit to the corporate sector was reported to have been unchanged and broadly accommodative. However, unlike FSB’s survey, which noted improved credit conditions, a Bank of England Credit Conditions Survey and Agents Report stated some smaller companies reported greater diłculty in gaining access to banks’ relationship managers in recent months. PART A THEMES 14 BRITISH BUSINESS BANK 1.1 DEMAND FOR FINANCE • Information failures exist on the demand side • SMEs prefer to avoid external ÿnance… 1.1 DEMAND FOR FINANCE 1.2 REGIONAL ACCESS TO FINANCE 1.3 PATIENT CAPITAL FOR SCALE-UPS 1.4 INTERNATIONAL COMPARISONS OF SMALL BUSINESS FINANCE MARKETS • …and SMEs prefer to self-fund their growth where possible • Changing the narrative on control may be required to a©ect change BRITISH BUSINESS BANK ANALYSIS ACKNOWLEDGES IT IS IMPORTANT TO CONSIDER THAT: • SMEs are heterogeneous, with di©erent ambitions and aspirations to grow • SMEs who use ÿnance, or are open to using ÿnance, fall into 4 distinct segments • SME segmentation insights enable policy responses to be targeted and more e©ective SMALL BUSINESS FINANCE MARKETS 2017/18 15 FACTORS LIMITING DEMAND Smaller businesses are a vital part of the UK economy and a dynamic, growing SME sector is an essential element of future economic growth. SMEs play a key role in raising low productivity in the UK by spurring innovation, adopting new practices and encouraging ‘productive churn’ through competition. The ability of SMEs to access ÿnance is critical for funding business investment which in turn allows businesses to start-up and achieve their full growth potential. An inełcient market in SME ÿnance with fewer businesses getting the right ÿnance can constrain business development and reduce business survival rates. Lower than expected volumes of SME ÿnance transactions in the UK can reect market failures in the supply-side, demand-side, or both sides of small business ÿnance markets. As the supply of SME ÿnance has improved following the global ÿnancial crisis, the British Business Bank has turned its attention to examining in greater detail demand-related market conditions in UK SME ÿnance, and considering the best policy interventions to address these. Demand in the UK for SME ÿnance, in the form of new debt applications for bank loans and overdrafts, has been falling in the 5 years since 2012. For example, the percent age of SMEs applying for a new loan has fallen from 2.9% in 2012 to only 1.7% in H1 2017.6 There is evidence that this decline is the result of on-going demand-side market failures. INFORMATION FAILURES EXIST ON THE DEMAND SIDE There are information market failures which a¤ect the demand for SME ÿnance. For example, if key business decision makers hold imperfect or inaccurate information on the types, costs, beneÿts, and their likelihood of securing external ÿnance, then demand may be suppressed. 16 BRITISH BUSINESS BANK FIG A.1 AWARENESS OF PRODUCTS AND SPECIFIC PROVIDERS Source: British Business Bank 2017 Business Finance Survey - Ipsos MORI Base = all SMEs (n=2,070 in 2017) Credit cards Leasing/Hire purchase Government/LA grants Invoice ÿnance/ factoring Crowd funding Trade ÿnance Venture capital P2P lending Business angels Mezzanine ÿnance 0 20 40 60 80 100 Per cent Awareness of providers Awareness of ÿnance type FIG A.2 AWARENESS OF TYPES OF FINANCE BY REGION Source: British Business Bank 2017 Business Finance Survey – Ipsos MORI Base = all SMEs (n=2,070 in 2017) 0 10 20 30 40 50 60 70 80 90 100 Credit cards Leasing/Hire purchase Government/LA grants Invoice ÿnance/ factoring Crowdfunding Trade ÿnance Venture Capital P2P lending Business angels Mezzanine ÿnance Per cent North Midlands South (excl. London) London Anecdotal evidence suggests that some UK entrepreneurs do not fully consider the di¤erent options available to them to support their long-term growth. This reduces the ełciency by which capital is allocated to growing ÿrms, meaning that high growth potential ÿrms sometimes struggle to obtain the right ÿnance that they need to grow to scale. This is corroborated by survey data which has consistently shown that most UK SMEs are not aware of ÿnancial products beyond standard term bank loans, overdrafts and credit cards. And, even where they are aware of a product, often they may not practically know a trusted provider of that product to contact (ÿgure A.1). Furthermore, there are regional variations to awareness. Awareness of alternative ÿnancial products is generally lower outside of London and the South East (ÿgure A.2). This may reect a lack of availability of such products, or could be one of the contributing factors for the lack of critical mass to support product availability, or both. Product (and provider) awareness is necessary for a functioning market, but not sułcient. An SME should also understand the costs and beneÿts of a ÿnancial product before being willing to use it. A survey carried out by the Wesleyan Bank suggests that SMEs often don’t have a good enough understanding of the ÿnancial options available to them to make sound borrowing decisions.7 The 2016 Wesleyan Bank SME Attitudes to Finance survey highlights only 24% of SMEs would feel comfortable to borrow from an alternative ÿnance provider in comparison to 63% who would feel comfortable borrowing from a bank. Even then, only 45% and 37% stated that they had a full understanding of overdrafts and bank loans respectively. Furthermore, conÿdence amongst SMEs planning to apply for bank ÿnance has declined towards the end of 2017. In 2016, 55% of SMEs planning to apply for bank ÿnance were conÿdent of success, with conÿdence increasing in the latter half of the year. During 2017 conÿdence has been more volatile, but declined to 43% in the 3 months ending November 2017.8 Even amongst those SMEs who are conÿdent that they understand which ÿnancial product is best suited to their needs, there may be imperfect information around their self-assessed probability of successfully applying for that product. Surveys show that smaller business owners systematically view getting ÿnance as diłcult and over-estimate their probability of being rejected. Such perception gaps may not reect reality at present, with around 80% of bank loan and overdraft applications being approved (the rate for ÿrst time applications is lower, at around 50%).9 The 2016 British Business Bank Business Finance Survey highlighted 56% of SMEs reporting a perception that obtaining external ÿnance is ‘diłcult’. Data shows that a small but signiÿcant proportion of SMEs who say that they require ÿnance remain discouraged from applying for ÿnance because they believe they will be rejected. This translates into 1% of all SMEs.10 Taking external advice when seeking external ÿnance, given the lack of awareness and understanding of the products available, would appear to be one solution to addressing these demand-side market failures. However, British Business Bank survey data shows that most SMEs do not seek advice when applying for ÿnance (ÿgure A.3). SMEs PREFER TO AVOID EXTERNAL FINANCE… Lack of awareness and understanding of ÿnancial products can also reect a more fundamental apathy and perceived absence of relevance to business owners. There is, after all, no reason for an entrepreneur to take the time to educate themselves on forms of ÿnance if they have no intention of ever requiring or applying for external ÿnance. Not least, doing so is time consuming and any ultimate ÿrst-time application is fraught with the real possibility of rejection. Also, there is a proportion of smaller businesses who have a perception that obtaining ÿnance takes a lot of e¤ort. In Q2 2017, 7% of future would-be seekers of ÿnance cited the hassle of borrowing as the reason for not planning to seek ÿnance, despite having a need to do so. Indeed, we ÿnd that a perceived lack of relevance is the case for a large portion of the UK SME population. For some business owners, this is driven by a general aversion to external ÿnance options even if that means sacriÿcing growth opportunities. For other business owners, this is driven by access to other more attractive ways of funding their growth plans. There is signiÿcant reported aversion to external ÿnance amongst UK SMEs. 42% of surveyed UK SMEs do not currently use ÿnance and are unwilling to do so (ÿgure A.4). This aversion is concentrated amongst SMEs with no employees, but even amongst SMEs with 50 to 249 employees, 21% neither use nor express a desire to use external ÿnance in the future. For many UK SMEs, their ultimate aspiration is to be debt free. In 2016, 68% of smaller businesses agreed that “their aim was to pay down debt and remain free if possible”.11 SMALL BUSINESS FINANCE MARKETS 2017/18 17 FIG A.3 WHAT WAS THE FIRST THING YOU DID WHEN YOU REALISED YOU HAD A FINANCING NEED? Source: British Business Bank 2017 Business Finance Survey – Ipsos MORI Base = all SMEs that sought ÿnance in the last 3 years (n=932) Went directly to main bank Spoke to supplier/dealer/manufacturer Researched ÿnance types and products on internet Used a credit card/overdraft/existing facilities Went to ÿnance provider other than bank Sought advice from other businesses/friends Spoke to ÿnance adviser Spoke to board/directors/seniors Spoke to accountant Looked into ÿnance options Examined expenses/cash ow/company accounts Looked into ÿnancing myself internally Went directly to another bank 0 5 10 15 20 25 30 35 40 Per cent FIG A.4 USE OF EXTERNAL FINANCE AND WILLINGNESS TO USE IN THE FUTURE Source: BDRC Continental, SME Finance Monitor Q2 2017 Total 0 1-9 10-49 50-249 emps emps emps emps Use external ÿnance and willing to use in future 19% 16% 27% 35% 39% Use external ÿnance but not willing to use in future 20% 19% 21% 26% 28% Do not use it but willing to 19% 19% 19% 15% 13% Do not use it and not willing to 42% 45% 34% 26% 21% 18 BRITISH BUSINESS BANK FIG A.5 PROPORTION OF SMEs HAPPY TO USE EXTERNAL FINANCE FOR GROWTH AND DEVELOPMENT Source: BDRC Continental, SME Finance Monitor Q2 2017 Total 0 1-9 10-49 50-249 emps emps emps emps Strongly agree 7% 6% 9% 10% 13% Agree 31% 29% 36% 40% 39% Neither/nor 23% 23% 22% 25% 29% Disagree 28% 29% 24% 20% 15% Strongly disagree 11% 12% 9% 6% 3% Total “Agree” 38% 35% 46% 49% 52% FIG A.6 CREDIT BALANCES HELD OVER TIME FOR ALL SMEs Source: BDRC Continental, SME Finance Monitor Q2 2017 2012 2013 2014 2015 2016 H1 2017 None 4% 4% 5% 3% 3% 4% Less than £5,000 66% 64% 58% 55% 57% 52% £5,000 to £10,000 14% 15% 17% 18% 18% 19% £10,000 to £50,000 11% 12% 14% 17% 15% 18% More than £50,000 5% 4% 6% 7% 6% 8% Average balance held £25k £24k £31k £39k £30k £40k That said, ÿnance aversion amongst UK SMEs does not dominate in actual practice with many SMEs who express a desire to avoid ÿnance still using it. 40% of small businesses currently used some form of external ÿnance in Q2 2017, increasing by size of SME. 76% of medium sized businesses (50-249 employees) made use of it in comparison to 52% of micro businesses (1-9 employees).12 Fundamentally, ÿnance is a means to enable growth plans (through for example purchasing assets) or to bridge cash ow shortfalls. Overall, 66% of SMEs who applied for external ÿnance over the last 3 years did so to acquire working capital or cash ow, and 41% applied to invest in their business. Medium-sized SMEs (50 to 249 employees) were more likely to apply for external ÿnance for investment purposes than small (10 to 49 employees) and micro businesses (1 to 9 employees) and were less likely to need ÿnance for working capital.13 …AND SMEs PREFER TO SELF¬FUND THEIR GROWTH WHERE POSSIBLE Only 38% of UK SMEs agree with the statement “as a business we are happy to use external ÿnance to help the business grow and develop” (ÿgure A.5).14 This suggests that the remaining 62% of businesses will turn to other alternatives ÿrst, in line with pecking order theory, and fund growth internally before using external debt and then external equity (see section 2.3, Use of external ÿnance). Almost all SMEs hold some credit balances, but the number holding larger credit balances has increased over time. This has enabled more business owners to self-fund, in line with their preferences. SMEs holding balances of £10,000 or more increased from 16% to 26% between 2012 and H1 2017 (ÿgure A.6). This increase in credit balances is also reected in the average balance held by SMEs which increased from £25,000 to £39,000 between 2012 and 2015. In 2016, it was lower at £30,000 but then increased again to £40,000 during H1 2017. SMEs of all sizes have seen an increase in credit balances of £10,000 and above during this period. Generally, the larger the SME the more likely it is to hold such sums. As one might expect, the SME Finance Monitor revealed that holding credit balances of £10,000 and above from Q3 2015 reduced the need for 8 in 10 SMEs to use external ÿnance. Furthermore, 81% of smaller businesses in Q2 2017 agreed that “our current plans for the business are based entirely on what we can a¤ord to fund ourselves”. However, we might also expect that given a choice between tapping external ÿnancing to achieve proÿtable growth and forgoing growth by avoiding external ÿnancing, then business owners would choose ÿnance. This is not necessarily the case. 70% of SMEs report that they are prepared to accept slower growth if it could then be self- funded. This holds less true for medium sized businesses (50-249 employees) where only 55% were willing to accept slower growth (ÿgure A.7). CHANGING THE NARRATIVE ON CONTROL MAY BE REQUIRED TO AFFECT CHANGE The evidence, whilst not conclusive, suggests that there is a demand-driven gap between optimum levels of investment in a fully functioning market and the levels found today. Root causes for this gap can be found in the preferences and practices of UK business owners. Fear of external ownership is real in the case of external equity: 55% of SMEs state that they would be worried about loss of control and 45% did not want to give a share away.15 Other academic research shows that founders of ÿrms appear to be more motivated over the long-term by the autonomy of being an entrepreneur and being in control of their ÿrm rather than through ÿnancial incentives.16 Although debt poses less obvious risk of loss of control, it can still be viewed as reducing the autonomy of a business owner. An alternative way of viewing the trade-o¤ between business owner control and the pursuit of growth opportunities may be required to address these demand- side market failures. Entrepreneurs must be convinced that it is preferable to own a smaller share of a larger, more valuable entity with the additional ÿnance, support and expertise this could provide, than it is to remain in sole control of a smaller, less valuable business. SMALL BUSINESS FINANCE MARKETS 2017/18 19 FIG A.7 WILL ACCEPT A SLOWER GROWTH RATE RATHER THAN BORROWING TO GROW FASTER Source: BDRC Continental SME Finance Monitor, Q2 2017 50-249 employees 10-49 employees 1-9 employees 0 employees All 0 10 20 30 40 50 60 70 80 90 100 Per cent Strongly agree Agree Neither Disagree Strongly disagree 20 BRITISH BUSINESS BANK SME ATTITUDINAL AND NEEDS BASED SEGMENTATION SMEs ARE HETEROGENEOUS, WITH DIFFERENT AMBITIONS AND ASPIRATIONS TO GROW SMEs WHO USE FINANCE, OR ARE OPEN TO USING FINANCE, FALL INTO 4 DISTINCT SEGMENTS The British Business Bank worked with existing survey data of UK SMEs and commissioned a cluster-based analytical segmentation of the population based on SME attitudes and needs towards ÿnance (see Use of external ‘CONTENTED’ The largest of the 4 segments, the ‘Contented’ make up 32% of SMEs and are broadly unworried and undemanding (ÿgure A.9). They self-report being ÿnancially conÿdent but objectively have lower levels of ÿnancial qualiÿcation and lower rates of awareness/understanding of ÿnancial SMALL BUSINESS FINANCE MARKETS 2017/18 21 FIG A.9 BRITISH BUSINESS BANK SME SEGMENTS, PERCENTAGE OF BUSINESSES Source: British Business Bank analysis of SME Finance Monitor 10 quarter dataset ending Q2 2017 Quicksilvers Permanent non-borrowers Contented 9 Fighters 47 32 7 Savvy Entrepreneurs 6 ÿnance section 2.3 for more detail on our technical approach). Notably, this segmentation did not consider need for any single type of ÿnance, but rather overall need for and use of di¤erent types of ÿnance and non- ÿnance support. It also overlaid an SME’s openness to external information about ÿnance and how to secure it. This attitudinally based approach suggests that UK SMEs can be usefully divided into 4 distinct groups that currently use external ÿnance or are open towards using ÿnance, in addition to a large group which neither currently uses nor intends to use any form of ÿnance. products. Relative to other groups, the Contented are least likely to be innovative and internationally oriented businesses and have substantially lower growth ambitions. Contented have the lowest proportion of SMEs (16%) that have plans to grow by more than 20% over the next year (ÿgure A.10). Notably, this group is also among the least happy to use external ÿnance to grow and is least interested in new external information (ÿgure A.11). This may reect the reduced relevance of ÿnance given low growth ambitions. ‘QUICKSILVERS’ It is at this point where speaking of smaller business owners as a single entity becomes less useful for generating insights. What may be true is not to speak of average ambition levels found across a heterogenous population of 5.7m smaller businesses in the UK, but rather the percentage of that population which does have high ambition and a growth mindset. The British Business Bank has undertaken SME segmentation analysis so that interventions can be targeted to the highest potential and most receptive sub-group. Further details about the results of this This latter group of ‘Permanent non-borrowers’ (PNB) is very large and makes up approximately half (47%) of all UK smaller business owners. In general, a disproportionate percentage of these companies are small, with no employees. They are also less likely to expect to grow or be international or innovative. For the purposes of our segmentation, this group has been excluded; however, it has not been established yet how durable PNB intention not to use external ÿnance is, and whether some proportion of this group shifts each year within their group in terms of needs and attitudes towards ÿnance which make them distinct from the other groups on average (ÿgure A.8). The segment most likely to have high growth ambitions are ‘Quicksilvers’, which make up 9% of SMEs. Although not all Quicksilvers have achieved 20+% growth on average over 3 years, nearly all such companies have the growth mindsets consistent with the Quicksilver attitudinal segment. Quicksilvers have the largest proportion (37%) of smaller businesses planning to grow more than 20% over the next year and Quicksilvers (62%) are also most open towards use of external ÿnance to help growth. most ambitious growth plans, and could have the largest potential positive impact on UK economic and job growth. However, as they try to scale-up, many have issues with 15 ÿnance applications, experiencing rejection, and an inability to borrow and raise equity. These smaller business owners are relatively well informed about ÿnancial products but FIG A.10 PLANS FOR BUSINESS TURNOVER OVER THE NEXT YEAR, BY SME SEGMENTATION Source: British Business Bank analysis of SME Finance Monitor 10 quarter dataset ending Q2 2017 50 45 40 35 30 Per cent 25 20 10 5 as their circumstances change. These are the fastest growing businesses, with the segmentation analysis, and its application to policy The 4 segments amongst UK smaller business owners can be found in this section. who use external ÿnance demonstrate commonalities FIG A.8 SME MARKET SEGMENTATION, EXCLUDING PERMANENT NON¬BORROWERS Source: British Business Bank CONTENTED FIGHTERS Undemanding and unworried. The least likely to Trying to overcome obstacles and grow. be innovative and international, and with the Tend to be somewhat ambitious, international lowest growth ambitions. Relatively ÿnancially and innovative. Most likely to report obstacles to conÿdent, but not informed. running their businesses, including those relating to cashœow, skills, politics, the economy and access to ÿnance. SAVVY ENTREPRENEURS QUICKSILVERS in their own abilities, but also the highest levels of Innovative, international and formal. The most conÿdent in their own abilities to assess ÿnance options. Most likely to have a ÿnancial qualiÿcation. conÿdence that their banks would provide ÿnance if Growing, successful, but somewhat vulnerable. The fastest- applied to. Perhaps consequently, ‘Savvy Entrepreneurs’ growing businesses with the most ambitious growth plans. tend to be less open to external information and believe Relatively international and innovative. Somewhat conÿdent that they already know what they require. in their abilities to assess ÿnancial options and relatively more likely to employ someone with a ÿnancial qualiÿcation. Nevertheless, have had some issues with previous rejections by a bank. less so than Savvy Entrepreneurs. Quicksilvers, furthermore, are also more open to seeking out and absorbing external information that helps them which suggests an opportunity exists to target them with useful support. ‘SAVVY ENTREPRENEURS’ In contrast, the ‘Savvy Entrepreneurs’ segment (which is 6% of SMEs), are the most ÿnancially informed and most likely to have a ÿnancial qualiÿcation. These business owners either are or have run more than one business either in parallel or are serial entrepreneurs. These businesses tend to be more innovative, international and run with formal processes than average. Their experience and track records are valuable, visible, and veriÿable. This group not only self-reports the highest conÿdence 0 Contented Fighters Savvy Quicksilvers Entrepreneurs To grow more than 20% To grow but by less than 20% To stay the same FIG A.11 ATTITUDES TOWARDS GROWING A BUSINESS AND USE OF EXTERNAL FINANCE Source: British Business Bank analysis of SME Finance Monitor 10 quarter dataset ending Q2 2017 80 70 60 50 Contented Fighters Savvy Quicksilvers Entrepreneurs Will accept slower growth rate rather than borrowing to grow faster Are happy to use external ÿnance to help grow and develop the business Per cent 40 30 20 10 0 22 BRITISH BUSINESS BANK SMALL BUSINESS FINANCE MARKETS 2017/18 23 1.2 REGIONAL ACCESS TO FINANCE FIG A.12 SHARE OF SMEs LIKELY TO HAVE A NEED FOR MORE EXTERNAL FINANCE / APPLY FOR MORE FINANCE IN THE NEXT 3 MONTHS Source: British Business Bank analysis of SME Finance Monitor 10 quarter dataset ending Q2 2017 35 30 25 ‘FIGHTERS’ Not all segments show such conÿdence. 7% are ‘Fighters’ and they are deÿned heavily by their perception of facing many obstacles. These include managing cashow, customer late payment, skills, political shocks, economic headwinds, as well as access to ÿnance. Nevertheless, beyond their daily concerns, some of these businesses are still trying to achieve their ambitions, including through innovation and international activity. Fighters are the most likely to identify a need for external ÿnance (30%), or apply for more external ÿnance (25%) (ÿgure A.12). Clearly, not all Fighters will succeed in overcoming their immediate issues but as a group they are also very open to external information and practical support. SME SEGMENTATION INSIGHTS ENABLE POLICY RESPONSES TO BE TARGETED AND MORE EFFECTIVE At this point in the UK economic cycle, we believe that the Quicksilver segment is the most attractive to target from an information provision policy perspective. This is because their attitudinal openness means they have the • Where a smaller business is based can be an important factor in their search for ÿnance • Bank lending is largely distributed in the UK in line with the overall business population in most areas • Equity deals are concentrated in London Where a smaller business is based can sometimes have a signiÿcant impact on their ability to ÿnd the ÿnance they need. The Beneÿts of Diverse Smaller Business Finance Markets publication highlighted place as one of the key issues to consider when thinking about diversity from both a demand and supply perspective.18 This section brings together the latest data from a range of sources on the volume and value of various types of external ÿnance provided to smaller businesses in di¤erent areas highest potential to be inuenced by policy interventions. 20 and highlights recent bank analysis that helped inform • However, clusters of equity activity do exist Per cent a new programme to support developing clusters of Improving the level of awareness and understanding of throughout the country business angels outside of London. BANK LENDING IS LARGELY DISTRIBUTED IN THE UK the full range of ÿnancial products available to this group 15 is likely to also improve the ełciency of capital allocation • Business angel activity is also concentrated within the UK economy. 10 in London and displays di©erent investment IN LINE WITH THE OVERALL BUSINESS POPULATION characteristics to those located outside of London It is worth noting that Quicksilver companies are found IN MOST AREAS 5 0 Contented Fighters Savvy Quicksilvers Total Entrepreneurs (excluding permanent non-borrowers) Very or fairly likely to have a need for more external ÿnance in the next 3 months Very or fairly likely to apply for more external ÿnance for the business in the next 3 months in all industries and regions of the UK, and amongst companies of all ages and sizes. This is consistent with the ÿndings of the ScaleUp Institute Review which found that scale-up companies that had achieved more than 20% growth over 3 years are geographically spread across the UK.17 Further work has been done to understand how to quickly and reliably identify which segment a company belongs to, technical details are discussed in section 2.3 (Use of external ÿnance). BRITISH BUSINESS BANK DEMAND SIDE RESPONSE To tackle information failures which a¤ect demand for • Increasing the number of Business angels o©ers a potential solution to address regional di©erences in the availability of equity ÿnance FIG A.13 SHARE OF VALUE AND VOLUME OF BANK LENDING AND BUSINESS POPULATION ACROSS GREAT BRITAIN Source: BEIS 2017 Business population estimates, UK Finance (year ending Q3 2017) and British Business Bank calculations 25 20 Bank lending is an example of a product where the regional distribution of lending more closely matches the distribution of the business population. Of the 11 English regions and devolved administrations bank lending is close to or exceeds the share of the overall business population (ÿgure A.13).19 The 2 notable exceptions are London and the South East which have proportionately lower shares of bank lending in terms of the number of loan facilities approved compared to the share of businesses in the region. For London this also extends to the value of the loan facilities approved, with the South East having a slightly higher share of business population compared to share of loan value approved. The lower share of bank lending in London and the South 15 Per cent SME ÿnance the British Business Bank is implementing a new targeted information strategy. This new ‘targeted East (compared to business population) does not imply these regions have proportionately less access to bank approach’ is intended to complement the Bank’s ongoing 10 lending. Two main factors are likely to drive this result, ‘whole of market’ activities which provides ÿnance discussed below. information aimed at all smaller businesses. 5 A recent OECD report highlighted the challenges posed To deliver this new targeted information strategy we are developing a digital hub which will contain best in class content. We are initially focussed on the needs of when analysing regional data. Business population data can be susceptible to headquarter bias.20 This is due to the 0 misallocation of ÿgures to the region of the headquarters (rather than to the region of location of the economic activity). The report notes this is particularly the case for capital city regions. Using London as our example, it is likely the number of businesses reported as being in London signiÿcantly overstates the actual number of businesses carrying out their day-to-day business in London. London South EastSouth West East MidlandsWest Midlands East of England Yorkshire & the Humber North EastNorth West Wales Scotland potential and high growth SMEs. A targeted approach for information delivery will not sideline or replace the Bank’s existing work to provide information for the market as a whole. It represents a ÿrst step towards a more dynamic and intelligent framework for delivery of SME ÿnance information. We will learn from No. of loan Value of loan GB business facilities facilities population the early experience of the digital hub to continuously improve how ÿnance information is delivered to SMEs. approved approved 2017 24 BRITISH BUSINESS BANK FIG A.14 SHARE OF EQUITY DEALS, INVESTMENT AND HIGH GROWTH FIRMS BY REGION AND DEVOLVED ADMINISTRATION Source: Beauhurst, ONS and British Business Bank calculations22 70 60 50 This is partly due to the increased number of software deals in recent years, which may have contributed to the increased concentration of deals in London over time. For instance, the number of software deals (by unweighted count) increased by 304% between 2011 and 2015 compared to 144% for non-software. The report found 61% of all software deals are in London, compared to 43% of non-software deals. SMALL BUSINESS FINANCE MARKETS 2017/18 25 Whilst the overall UK market, dominated by London, has developed over the last few years, in areas outside of the capital, demand and supply side factors are likely to interact leading to a ‘thin market’. Limited numbers of investors and entrepreneurial growth ÿrms have diłculty ÿnding and contracting with each other at reasonable costs. Thick markets are characterised by high levels of repeated interaction between VC and high-growth ÿrms, so that human capital is built up in the sector, with a large enough market for an ecosystem of supportive activities to develop. HOWEVER, CLUSTERS OF EQUITY DEAL ACTIVITY DO EXIST THROUGHOUT THE COUNTRY English regions and devolved administrations obscure A second reason is that businesses in London and the South East may have greater access to, and awareness of, alternative sources of ÿnance, such as equity, when compared to those in other regions so are less reliant on banks for ÿnance. The diverse spread of bank lending does not mean that all The distribution of non-software deals is more nuanced with London having a higher density of earlier stage and smaller deals (less than £1m), but growth stage deals in non-software sectors are slightly more spread out throughout the UK and are closer to the wider distribution of HGFs. For instance, London’s share of debt ÿnance products are utilised to a similar level across growth deals in non-software sectors is 28% which is 40 Per cent the large variation in equity deal numbers that occur within these areas. Equity deals tend to be grouped in the UK. Marketplace lending platforms are accessible by more in line with the region’s share of HGFs. 30 both funding providers and borrowers online, so distance 20 The Equity Tracker report identiÿed speciÿc supply side geographic clusters where innovative companies, skilled should be less important. However, survey evidence 10 and demand side factors that have contributed to the labour and equity investors locate close together to suggests funders and borrowers on these platforms are 0 di¤erences in the availability and use of equity ÿnance minimise time and travel costs and share the beneÿts London South EastScotland East of England North West South West Wales Equity Deals (Q4 2016-Q3 2017) Yorkshire and Humberside West Midlands North EastNorthern Ireland East Midlandsconcentrated in London and the South East.21 Furthermore, a diverse regional spread of bank lending across regions and devolved administrations. The from greater networking. following numbers are updated from those previously The British Business Bank 2017 Equity Tracker report does not imply that all smaller businesses across the UK published in the 2017 Equity Tracker report, reecting showed the top 25 Local Authority Districts by number of receive the appropriate level of debt ÿnance. The market the latest available data: deals in 2016. Whilst Boroughs in London formed nearly failures that underpin the British Business Bank’s debt interventions still apply. half of the top 25 areas, there are important equity hotspots SUPPLY SIDE outside of the capital. This includes the established equity • A lack of equity fund manager presence in areas eco-systems of Oxford and Cambridge, but also cities like outside of London could explain some of the lower Edinburgh, Manchester, Cardi¤, Bristol, Glasgow, Shełeld, Equity Investment (Q4 2016-Q3 2017) EQUITY DEALS ARE CONCENTRATED IN LONDON HGFs (2015) Equity is a key part of the funding mix for High Growth Firms (HGFs) so rather than comparing the usage of equity to the total business population it is better to look at the usage of equity compared to HGFs for regional comparisons. HGFs are located in all areas of the UK. Only a small proportion of HGFs are likely to be using equity ÿnance, but for some high growth potential ÿrms, equity ÿnance is the only funding source that can enable them to achieve their growth. It is therefore important that high growth potential ÿrms have access to equity ÿnance in order that they can reach their potential. Despite this wide dispersion of HGFs, equity investment continues to be geographically concentrated in London with 52% of total deals and 65% of investment value over the past 12 months occurring in the capital city. London’s share of equity investment by both number of deals is signiÿcantly overrepresented when compared to its share of HGFs (20%) (ÿgure A.14). The 2017 Equity Tracker report identiÿed regional disparities in equity ÿnance have worsened over time with London and the South East having increased their share of equity investment over recent years. In 2011, 44% of the UK’s equity deals were completed in London and the South East, but by Q3 2017 this had risen to 63%. availability. This is especially the case as investors often prefer to invest locally to minimise their time and travel costs.23 British Business Bank analysis of PitchBook in January 2018 shows of the 626 active investors24 with VC listed as one of their investment strategies, 74% have their head o¢ce listed with a London address (461).25 There are 165 investors (including public sector backed fund managers) listed with a head o¢ce located outside of London. This may underestimate the presence of equity investors in areas outside of London as many large investors have regional o¢ces. DEMAND SIDE • Smaller business awareness of equity ÿnance from VCs and business angels is lower in areas outside of London compared to the capital. Lower awareness of equity funding options may lead to lower willingness to use equity ÿnance, even if supply was increased. The 2017 British Business Bank Finance survey shows 69% of SMEs in London are aware of VC as a source of external ÿnance compared to 58% in the North and 61% in the Midlands. Leeds and Birmingham. The continued development and expansion of these technology clusters around the UK is important, as they provide the focal point for increasing the amount of equity ÿnance throughout the whole UK. Tech City acknowledges that the “face-to-face networking that these [accelerators, a¤ordable co-working spaces and experienced mentors] enable is hugely important to the growth and success of digital businesses”.26 Networks can also beneÿt equity investors, as greater deal syndication is found to increase the likelihood of successful exit outcomes, especially for geographic or sector speciÿc networks of investors.27 BUSINESS ANGEL ACTIVITY IS ALSO CONCENTRATED IN LONDON AND DISPLAYS DIFFERENT INVESTMENT CHARACTERISTICS TO THOSE LOCATED OUTSIDE OF LONDON Business angels are High Net Worth Individuals that invest their own money in small growing businesses through an equity stake. Business angels are an important source of ÿnance for SMEs. Quantifying the number of deals involving business angels is diłcult as business angels are less likely to be driven to seek publicity on completing investments, and so are largely missing from investment numbers in data sources like Beauhurst. SMALL BUSINESS FINANCE MARKETS 2017/18 27 26 BRITISH BUSINESS BANK FIG A.15 SHARE OF EIS AND SEIS DEALS, HIGH GROWTH FIRMS, NUMBER OF BUSINESS START¬UPS AND NUMBER OF HIGH NET WORTH INDIVIDUALS BY REGION AND DEVOLVED ADMINISTRATION Source: HMRC, ONS, Barclays and British Business Bank calculations 50 40 Many business angels use Enterprise Investment Scheme (EIS) tax relief within their investments, which can provide an estimate for the total amount of business angel activity in the UK. The Angel Spotlight report produced by British Business Bank and UK Business Angel Association conÿrms that 87% of angels who invested in 2016 used EIS or SEIS. HMRC data shows that 3,470 companies raised a total • Di”erences in factors a”ecting investment decision: Investee companies’ management team’s skills and experience, the potential for growth and the expected ÿnancial returns are the main factors inœuencing the decision to invest for businesses angels wherever they are based. However, angels based outside of London are more likely to look for investments where Business angels provide non-pecuniary beneÿts through the expertise they share which can beneÿt their investee companies. Business angels often have direct sector or business experience which they share with their investment companies. This will have a positive impact on business growth in addition to the funding the company receives. of £1.9bn of funding in 2015-16 under the EIS scheme.28 they can add their skills and experience (46% cited it 30 The 2017 Autumn Budget announced that the British An additional 2,360 companies also received investment as important compared to 25% in London). Location Business Bank will shortly launch a commercial investment 20 through the Seed Enterprise Investment Scheme (SEIS) of investments is a consideration for business angels programme to support developing clusters of business 10 in 2015-16 raising £180m of funding. This shows the outside of London (10%), whilst no angels in London angels outside of London. importance of angel funding to UK companies, which reported this as an important factor inœuencing their 0 Per cent exceeds the number of companies funded by VC funds. EIS and SEIS deals are highly concentrated in London and the South East with 46% and 17% of all deals located in these regions respectively in 2015/16. This is despite London accounting for only 26% of start-ups and 20% of HGFs (ÿgure A.15). decision to invest. INCREASING THE NUMBER OF BUSINESS ANGELS OFFERS A POTENTIAL SOLUTION TO ADDRESS REGIONAL DIFFERENCES IN THE AVAILABILITY OF EQUITY FINANCE This will add to the range of regionally focused activity in the British Business Bank’s portfolio. The role out of regional funds such the Northern Powerhouse Investment Fund and the Midlands Engine Investment Fund is continuing, enabling more businesses in those regions to access debt and equity ÿnance. The British Business Bank is also establishing the Cornwall & Isles of Scilly Investment Fund in partnership with the Cornwall & Isles of Scilly Local Enterprise Partnership. As announced in the government’s Industrial Strategy the British Business Bank will be rolling out a network of regional managers by autumn 2018 to ensure businesses across the UK know how to access sources of investment. London South EastEast of England South West North West West Midlands Scotland East MidlandsYorkshire & the Humber Wales North EastNorthern Ireland Number of EIS & SEIS deals (2015-16) Number of HGFs (2015) Number of business start-ups (2015) Number of HNW individuals The Angel Spotlight Survey also conÿrms a lack of angels located in areas outside of London and the South East. 57% of business angels responding to the survey were located in London or the South East, with just 7% based in the Midlands and 7% in the North.29 The survey also identiÿes interesting di¤erences between angels located in London and those located outside:30 • Di”erences in experience: Business angels located outside of London are likely to be older and more experienced than angels located in London. The average time spent investing as an angel in London is 5.8 years (median 4 years) compared to 9 years (median 7 years) for angels located elsewhere. • Di”erences in involvement in investee companies: Angels in London are more likely to have a passive shareholder role (87%) compared to angels outside of London (63%), which reœects a lower proportion sitting on the board (30% compared to 58%). This may be due to London based business angels being more likely to use crowdfunding platforms to make investments (47% of angels in London have invested through a crowdfunding platform in 2016/17 compared to 32% outside of London). Equity investors, especially those making smaller investments into smaller companies often prefer making investments in business that are geographically closer. This is because they can spend signiÿcant amount of time with their portfolio company getting to understand the business. Anecdotally, it is often reported that a two-hour travel time is often used as a guide for investing. Therefore, the supply of equity ÿnance is likely to be linked to the location of where equity investors are based. Encouraging higher levels of business angels o¤ers a potential mechanism for addressing regional imbalances in the availability of equity ÿnance. This is because business angels have the potential to be more geographically dispersed throughout the UK than other equity investors. Out of the estimated 625,000 total number of millionaires in the UK, ÿgure A.15 shows 74% are located outside of London.31 Not everyone will have the skills, experience or desire to become a business angel, but it does suggest the potential ow of individuals that could become business angels is more regionally dispersed than the current location of equity investors where 74% have a head ołce based in London. 28 BRITISH BUSINESS BANK 1.3 PATIENT CAPITAL FOR SCALE-UPS • Patient capital is long-term investment in innovative ÿrms looking to scale up • Analysis conÿrms there is a shortage in the availability of patient capital to UK high growth potential ÿrms leading to fewer businesses scaling up • The British Business Bank will increase the amount of longer-term ÿnance available to innovative, high-growth smaller businesses through the package of support announced at Autumn Budget The Government has recently published its response to the Patient Capital Consultation.32 This section summarises the evidence on the availability of patient capital to high growth innovative ÿrms from the Patient Capital Consultation including contributions from the British Business Bank. The section will then explain how the British Business Bank will use the additional funding it received to increase the availability of patient capital to growing businesses. PATIENT CAPITAL IS LONG¬TERM INVESTMENT IN INNOVATIVE FIRMS LOOKING TO SCALE UP The consultation deÿned patient capital as “long-term investment in innovative ÿrms led by ambitious entrepreneurs who want to build large-scale businesses”.33 Finance is typically provided through an entrepreneur’s own long-term commitment to their business and in some instances through equity investment from external investors, such as business angels, venture capital funds or public markets. It is diłcult to classify the investment time horizon as this varies by sector, from 3 to 5 years in some sectors like ICT to as long as 10 to 15 years in others. Patient capital supports smaller businesses enabling them to grow into large businesses, which has an important impact on UK productivity through the di¤usion of new ideas into the economy. A lack of suitable patient capital investment can hold back UK businesses from successfully commercialising their innovation leading to missed opportunities and lower economic output. The UK has a high business birth rate and high proportion of businesses exhibiting high growth compared to other European countries, but the UK and Europe has generally performed poorly compared to the US in the process of scaling up successful start-ups.34 The Consultation describes how this is seen in the lower number of unicorn businesses and wider evidence that the UK and other European economies show a signiÿcantly higher proportion of static ÿrms that do not shrink or grow compared to the US.35 ANALYSIS CONFIRMS THERE IS A SHORTAGE IN THE AVAILABILITY OF PATIENT CAPITAL TO UK HIGH GROWTH POTENTIAL FIRMS LEADING TO FEWER BUSINESSES SCALING UP The UK funding eco-system is currently not fully connected and able to support high growth businesses from early stage through to listing on a public market, despite recent improvements in the availability of seed stage funding in recent years. The historic shortage of risk capital available in the UK is well-documented with successive Government reviews identifying a lack of long-term capital in the UK and a shortage of investors able to make larger investments. Empirical analysis published in last year’s (2016/17) British Business Bank Small Business Finance Markets report quantiÿed the extent to which UK VC backed companies received fewer later stage follow on rounds compared to US companies (ÿgure A.16).36 The report also identiÿed subsequent deal sizes for follow on rounds are smaller in the UK compared to their US counterparts (ÿgure A.17). This suggest UK VC backed companies could be underfunded compared to their US counterparts, which could impact on their ability to grow and scale up. More recent analysis contained in the British Business Bank 2017 Equity Tracker report show UK VC investors appear to exit their investments at a relatively early stage compared to investors in the US, which reduces the ability of businesses to scale up (ÿgure A.18).37 UK VC backed companies that successfully exit receive fewer funding rounds on average compared to companies in the US (1.9 compared to 2.7) companies with di¤erences existing across all the main exit routes. Developing a company to be a position to be able to IPO requires more funding than developing a company for a trade sale. The analysis showed that it takes 3.5 funding rounds on average to exit via an IPO compared to 2.4 for a trade sale. Respondents to the Patient Capital Consultation conÿrmed a gap in follow-on investment for businesses that had already received initial investment. This was sometimes deÿned by stage of investment, focusing on Series “B” to Series “D” funding rounds. Other respondents referred to investment size, with £5 million to £50 million being quoted most often as the weakest range of investment. The Patient Capital Review Industry Panel also identiÿed a speciÿc problem for companies requiring more than £5m of equity investment.38 SMALL BUSINESS FINANCE MARKETS 2017/18 29 FIG A.16 COHORT ANALYSIS OF COMPANIES RECEIVING SERIES A/SEED FUNDING IN 2008¬10 Source: British Business Bank analysis of Preqin FIRMS WITH SUBSEQUENT FUNDING ROUNDS 62% 32% 9% 3% 0% 0% (After Seed/Series A, 2008-10 cohort) FIG A.17 B 68% C D E F G 23% 10% 3% 1% UK US 43% AVERAGE DEAL SIZE BY FUNDING ROUND Source: British Business Bank analysis of Preqin 75 50 25 25 50 75 £ million 3.1 4.6 8.3 16.9 4.1 7.2 12.7 22.6 A B C D E F 23.1 67.8 41.6 71.1 UK US FIG A.18 AVERAGE NUMBER OF FUNDING ROUNDS BY EXIT ROUTE Source: British Business Bank analysis of Preqin 4 3 2 1 0 IPO Trade Sale Secondary Sale All successful exits UK US Rest of Europe All Areas 30 BRITISH BUSINESS BANK The UK (and Europe) has a thinner VC market than the US. Last year’s Small Business Finance Markets report noted that the European VC industry is trapped in a sub-optimal investment cycle with low ÿnancial returns, smaller fund sizes and smaller deal sizes. The British Business Bank 2017 Equity Tracker report conÿrmed:39 • UK VC funds are around 1.5 times smaller on average than the average US VC fund (£118m compared to £180m), which limits their ability to do larger deals • The vast majority (98%) of US VC fundraising comes from institutional sources like pension funds, insurance companies, foundations/endowments, etc., whilst in the UK it is much lower (55%) • The UK has fewer Limited Partner (LP) investors investing in each VC fund compared to the US. The average US VC fund has 5.2 LP investors compared to 2.9 in UK and 3.0 in Rest of Europe. This was veriÿed by the Patient Capital Industry Panel that observed institutional investors currently allocate most of their capital to listed (and therefore liquid) assets, with a lower exposure to equity compared to a decade ago. Only a small percentage of their assets are allocated to ‘alternatives’, of which a smaller proportion still is allocated to venture capital. The panel observed several reasons for the low level of investment into VC by institutional investors. The UK was perceived to have too few large VC funds and relatively unattractive ÿnancial returns. To be attractive to investors, the panel suggested VC returns need to show a premium over listed equities of at least 2-3%, to compensate for the lack of liquidity and lack of control, but historically, the average UK VC fund has been unable to achieve this. The UK pensions market was also judged to be heavily fragmented relative to other G7 countries and so less able to invest in risky or illiquid assets. There are also barriers on the demand side. Some high growth businesses do not use equity ÿnance because they fear losing control, thinking it is not a suitable form of ÿnance. In addition, many reported not really knowing much about equity ÿnance as a reason for not using equity funding.40 THE BRITISH BUSINESS BANK WILL INCREASE THE AMOUNT OF LONGER¬TERM FINANCE AVAILABLE TO INNOVATIVE, HIGH¬GROWTH SMALLER BUSINESSES THROUGH THE PACKAGE OF SUPPORT ANNOUNCED AT AUTUMN BUDGET Following the Chancellor’s announcement at Budget 2017, the British Business Bank welcomes the £2.5bn of additional funding that has been made available to it to support UK smaller businesses looking to scale-up and realise their growth potential, in order to tackle the patient capital funding gap.41 The Bank will work to increase patient capital through the following new and existing programmes: • A new £2.5bn Patient Capital entity will be incubated within the Bank to commercially co-invest alongside private sector investors into venture and growth capital funds. The entity will be designed from the outset with a view to a future sale into the private sector once it has built its portfolio and track record, subject to a value for money assessment • British Business Investments – the Bank’s existing commercial arm – will cornerstone a small number of large scale, private sector managed fund of funds, which will increase the availability of patient capital investment into high growth potential businesses. A ‘Request for Proposals’ to manage the ÿrst phase of these funds (up to £500m) will be issued early 2018, and 2 subsequent phases are possible subject to the market response • The Enterprise Capital Fund (ECF) programme will be maintained, and will continue its important role in backing new and emerging fund managers unlocking at least £1.5bn of new investment. This will provide stability to the market, and publicly recognises the central role this programme plays in the Bank’s equity o©ering. The overall aim of these measures is to increase access to longer-term ÿnance for innovative, high-growth smaller companies so they can achieve their full growth potential. The British Business Bank aims to achieve this by crowding in private capital, expanding investor diversity, and utilising and developing private sector fund management expertise. This will help break the current sub-optimal investment cycle by creating funds of sułcient size that can make follow on investments in their most promising companies. We aim to use the Bank’s position as the second largest Limited Partner in the UK venture capital market to demonstrate the attractiveness of this market to investors, with the longer-term ambition of supporting the development of sustainable private sector expertise in the UK.42 SMALL BUSINESS FINANCE MARKETS 2017/18 31 1.4 INTERNATIONAL COMPARISONS OF SMALL BUSINESS FINANCE MARKETS • UK smaller business population concentrated in service sector and growing relatively rapidly • The UK economy is successful at generating start-ups • Improved performance in translating start-ups into scale-ups • UK SMEs have similar patterns in obtaining ÿnance to our major competitors • Equity ÿnance is twice as large in the US compared to the UK, but the UK performs relatively well compared to other European countries FIG A.19 SHARE OF ENTERPRISES BY SIZE Source: OECD, Entrepreneurship at a Glance, 2017 100 80 60 40 20 0 France United Germany United Kingdom States 1-9 10-19 20-49 50-249 250+ Employees Per cent This section explores UK small business ÿnance markets in comparison to those in major competitor countries. First, the current structure of the economy is examined by ÿrm size showing that the UK has a similar concentration in micro and small businesses as in major competitors. Second, the dynamic nature of the small business population is considered, looking at births, growth performance and deaths. This highlights the strong performance of the UK economy in generating start-ups, while the record of translating those into high growth ÿrms has improved in recent years. Third, the use of external ÿnance is compared, with UK SMEs similar in their use and experience of most types of debt ÿnance, but usage of equity ÿnance to support scale-ups, whilst improving, still falls behind the US. Comprehensive data allowing direct international comparisons of small businesses has traditionally been limited, not least because of di¤erences in the precise deÿnition of small businesses. Data availability is, however, improving. First, the OECD produces regular publications on the overall partners of entrepreneurship43 and ÿnance used by SMEs. Second, the European wide survey run by the European Commission and the European Central Bank called Survey on access to ÿnance of enterprises (SAFE) o¤ers good insight into the experience of small businesses using external ÿnance. 44, 45 However, relatively small individual country sample size mean that some caution is required in highlighting international di¤erences. Where SAFE is used in this report data refers to the latest wave of the survey taking place in September and October 2017 unless otherwise stated. The approach taken in this chapter is to make comparison with the UK’s major international competitors, ie the US, Germany and France, bringing in other countries where relevant. UK SMALLER BUSINESS POPULATION CONCENTRATED IN SERVICE SECTOR AND GROWING RELATIVELY RAPIDLY Unsurprisingly, smaller businesses, and more speciÿcally micro-businesses (those with fewer than 10 employees), account for the overwhelming majority of enterprises in all OECD economies.46 The UK has a higher share of micro-enterprises than Germany and the US47 but a lower share than France (ÿgure A.19). 32 BRITISH BUSINESS BANK THE UK ECONOMY IS SUCCESSFUL AT GENERATING START¬UPS International comparison shows that the UK has been e¤ective at starting up active employer enterprises. In 2014, the UK had the highest number of births in terms of employer enterprises with nearly 300,000 births. Figure A.24 shows birth rates48 in the UK exceeding that in France, SMALL BUSINESS FINANCE MARKETS 2017/18 33 FIG A.23 SIZE DISTRIBUTION OF MANUFACTURING FIRMS ¯NUMBER OF EMPLOYEES° Source: OECD, Entrepreneurship at a Glance, 2017 80 70 60 1-9 10-19 20-49 50-249 250+ FIG A.20 The OECD data also allows comparison of the value added Germany and the USA. Amongst the wider OECD dataset 50 40 Per cent VALUE ADDED BY ENTERPRISE SIZE ¯NUMBER OF EMPLOYEES° by enterprise size. Figure A.20 shows a similar pattern only Hungary and Poland exceed the UK on birth rates. Source: OECD, Entrepreneurship at a Glance, 2017 for value added as that observed for share of enterprises. A high birth rate may not be a sign of success if the survival 60 Compared to Germany, the UK has a higher share of value rates of those businesses is low. The UK however, also has 30 added in micro and large businesses. France, however has a 50 a high one-year survival rate with rates in the US and the 20 slightly greater share of value added than the UK in micro UK signiÿcantly above France and Germany (ÿgure A.25). 40 and small businesses, but less in medium and large businesses. 10 And not only do the UK’s start-ups have relatively good Per cent 30 Following a decline in enterprise numbers in 2009, there survival rates, but they also make a signiÿcant contribution 0 has been an upward trend in the number of SMEs in major 20 to employment. The UK is the only country in the OECD economies since 2012. The latest available data in the United Kingdom Germany database where start-ups, deÿned here as those up 10 OECD database reports that the UK SME population was to 2 years old, account for more than 35% of employer FIG A.24 6% higher in 2014 than in 2008 (ÿgure A.21). See section 0 enterprises, with those enterprises accounting for just EMPLOYER ENTERPRISE BIRTHS AS A SHARE OF ACTIVE 1-9 10-19 20-49 50-249 250+ 2.1 for a discussion on more recent trends in the UK SME United Kingdom Germany France population which shows further rapid growth since then. EMPLOYER ENTERPRISES over 10% of employment. Source: OECD, Entrepreneurship at a Glance, 2017 Finally, international comparison of death rates of employer FIG A.21 16 There is also some di¤erence in the size and sector businesses, shows the UK mid-table with the 10.1% of INTERNATIONAL TRENDS IN SME POPULATION distribution of SMEs in some of our major competitor 14 Source: OECD, Entrepreneurship at a Glance, 2017 employer enterprises dying in 2014. In summary, this countries. The high-level sector distribution is shown demonstrates the success of the UK economy in generating 12 140 in ÿgure A.22. The UK is similar to the US, albeit with a new start-ups which survive and contribute signiÿcantly 10 slightly lower share of manufacturing in the UK (6.9% vs to UK employment. Per cent 130 7.8%) and a higher share of construction (14.9% vs 13.9%). 8 Index: 2008 = 100 120 In comparison to France, the UK has a higher share IMPROVED PERFORMANCE IN TRANSLATING START¬UPS 6 110 100 90 80 2008 2009 2010 2011 2012 2013 2014 UK USA FRA CAN ITA FIG A.22 of service sector enterprises (78.2% vs 73.8%) with construction accounting for a higher share of enterprises in France (18.6% vs 14.9%). As is well known, the UK has a lower share of manufacturing than Germany (6.9% vs 8.6%). Manufacturing enterprises in Germany are less likely than those in the UK to be micro business, but more likely to be small businesses, particularly 10-19 employees (17.4% vs 10.4%), and medium sized enterprises (7.8% vs 4.9%) as shown in ÿgure A.23. It is a consistent ÿnding across SME Finance surveys, that INTO SCALE¬UPS International comparisons of scale-ups are diłcult as comparative data is limited, but there are numerous potential deÿnitions of scale-up. OECD deÿnes high-growth enterprises as those with average annualised growth in the number of employees greater than 20% per year, over a 3-year period, and with 10 or more employees at the beginning of the observation period. Based on this OECD deÿnition, there has been an improvement in the share of high growth enterprises 4 2 0 United Kingdom Germany United States France FIG A.25 SURVIVAL RATE OF ONE¬YEAR OLD EMPLOYER ENTERPRISES Source: OECD, Entrepreneurship at a Glance, 2017 100 SHARE OF ENTERPRISES BY MAIN SECTORS the larger the ÿrm, the more likely they are to make use in the UK between 2012 and 2014, with the number of Source: OECD, Entrepreneurship at a Glance, 2017 of certain types of external ÿnance. The di¤erence in 80 high-growth ÿrms returning to the long-term average 90 distribution of manufacturing enterprise size, suggests range of 10 to 12 thousand high growth enterprises The relatively strong performance of the UK is conÿrmed 20 30 in the latest Eurostat data for 2015.49 Using a deÿnition of 10 20 high growth ÿrms growing employees by 10% or more on 0 average over 3 years, the UK share of high growth ÿrms 0 United Germany United France exceeds that of Germany and France. United United France Germany Kingdom States Kingdom States Manufacturing Services Construction Industry Services Construction 80 that German manufacturers may be more frequent users per year. Other OECD countries, such as Germany, have 60 70 of external ÿnance than UK manufacturers. Per cent seen a fall in the share of high growth enterprises in 60 the economy demonstrating the relatively better UK Per cent 50 40 performance since 2012. 40
