British Business Bank Small Business Finance Markets Report 2015 16

8/20/2019 British Business Bank Small Business Finance Markets Report 2015 16

1/88

SMALL BUSINESSFINANCE MARKETS2015/16

www.british-business-bank.co.uk [email protected] British Business Bank @BritishB Bank


2/88

CONTENTS

3 FOREWORD

4 EXECUTIVE SUMMARY

8 INTRODUCTION

9 CHAPTER ONEOVERALL ASSESSMENT OF MARKET DEVELOPMENTS

11 1.1 AGGREGATE FLOWS OF FINANCE TO SMALLER

BUSINESSES ARE ENCOURAGING

14 1.2 EXTERNAL FINANCE FOR SMALLER BUSINESSES

CONTRIBUTES TO GROWTH AND PRODUCTIVITY

16 1.3 ANALYSIS OF NEW DEBT APPLICATIONS

21 1.4 DEMAND SIDE AWARENESS & DEMAND FOR FINANCE

24 1.5 SUPPLY SIDE BANK LENDING

27 1.6 SUPPLY SIDE EQUITY FINANCE

30 1.7 REGIONAL PERSPECTIVE

33 CHAPTER TWO

STARTUP BUSINESSES

34 2.1 TRENDS IN START UPS

36 2.2 STARTUPS AND THE ECONOMY

38 2.3 STARTUPS DEMAND FOR FINANCE

40 2.4 ANALYSIS OF NEW DEBT FINANCEAPPLICATIONS BY STARTUPS

42 2.5 EQUITY FINANCE FOR STARTUP BUSINESSES

44 CHAPTER THREE

SCALEUP BUSINESSES

45 3.1 GROWTH PERFORMANCE OF SME SECTOR

47 3.2 DEBT FINANCE FOR HIGH GROWTH BUSINESSES

50 3.3 MIDCAP BUSINESSES

53 3.4 SMALLER BUSINESSES EXPORTS & EXPORT FINANCE

56 3.5 EQUITY FINANCE FOR GROWING BUSINESSES

61 3.6 LONGTERM FINANCE

65 CHAPTER FOURFINANCE PRODUCTS AND DIVERSITY OF SUPPLY

66 4.1 ASSET FINANCE

69 4.2 ONLINE PLATFORMS

73 4.3 DIVERSITY OF DEBT FINANCE SUPPLY

77 4.4 THE RISE OF CHALLENGER BANKS

80 GLOSSARY

84 ENDNOTES

2 BRITISH BUSINESS BANK


3/88

The British Business Bank has a clear mission: to change nance markets for smallerbusinesses, so they work more eectively and dynamically. By doing so, we playour part in supporting wider eorts to increase the UK’s productivity and long-termgrowth. This, our second ‘State of the Market’ report, shows how those nancemarkets for small businesses have developed over the past year, and the progress

we have made in achieving our ambition.

Working with over 80 nance partners, we aimto unlock nance for smaller businesses in threeways: by increasing existing sources of nance;by catalysing new channels of funding; and byimproving smaller businesses’ understandingof their nance options. By doing so, we helpstimulate competition and increase the chancesthat businesses nd the right sort of nance fortheir particular stage of development. Importantly,where we act is informed throughout by an in-depth understanding of the nance markets,as well as a thorough analysis of how thesebusinesses contribute to the UK economy.

This report is therefore vital in guiding our work.It underlines again the fundamental importanceof small businesses in the UK economy and, withthe appropriate nance and support, the potentialthey have to raise the UK’s productivit y and growthperformance. In that regard, I am pleased to seeencouraging signs across a broad range of nancemarkets. As the recovery has continued and balancesheets have been strengthened, bank lending isgradually improving, with more rms get ting thenance they asked for. Asset nance has seensolid expansion over the past year, and equity dealows are strong. And as has been well documented,the UK’s peer-to-peer sector is growing rapidly,building on the UK’s leading position in the area ofnancial technology.

Through a range of well-judged interventions, theBank has played its part in developing these markets.Examples are our support of equity investorsthrough our investments in early stage venture

capital, so important for innovative businesses withhigh growth ambitions; our new ENABLE productthat encourages participating banks to lend more tosmaller businesses; and our Investment Programmewhich has provided funding to peer-to-peer lenders

and other marketplace lenders. While these are allpositive, we fully recognise there are areas of themarket that still require attention.

One priority for the Bank is to ensure that eectivenance solutions are available for innovativebusinesses wishing to scale-up. To support thoseambitions, we are working with private sectordelivery partners to roll-out the innovative ‘Help toGrow’ pilot. A further priority is regional growth. As

the report shows, there are regional imbalances tothe nance landscape. Our research demonstratesthat no one region has a monopoly on growthbusinesses: smaller businesses with growth

potential exist in all regions of the UK. To ensure thatnance is available for such rms, we are delightedto be supporting the new £400million NorthernPowerhouse Investment Fund.

Awareness of the range of nance options isimportant too, so businesses know where to get theright nance for them. Whilst levels of awarenesshave improved, in particular for newer types of

nance, it is striking that over half of UK smallerbusinesses still go only to their main bank and donot shop around for nance. We will thereforecontinue to work with our partners to promote thesuccessful ‘Business Finance Guide’, an excellentresource for nancing options, and will nalise ouradvice to HM Treasury on the designation of newnance platforms, through which smaller businessesdeclined facilities by their banks will be referred toalternative providers who may be able to help.

I believe that alongside our existing programmes,these new initiatives will deliver further

improvements in the UK’s nance markets, makingthem more dynamic and diverse. I look forward toworking with our partners and the small businesscommunity to put these in place.

FOREWORD

KEITH MORGANCEO, BRITISH BUSINESS BANK

SMALL BUSINESS FINANCE MARKET S 2015/16 3


4/88

EXECUTIVE

SUMMARY


This report highlights the continuedimportance of smaller businesses toUK economic growth and the recentevolution of the nance markets thatsupport those businesses.

Encouragingly, ows of nance to smaller

businesses have increased since the BritishBusiness Bank’s previous Small BusinessFinance Markets repor t last year. However,our analysis nds that structural problemspersist. The continued importance of theBritish Business Bank’s objectives in addressingthese issues and unlocking nance for smallerbusinesses remains clear. We will continue to:

• Increase the supply of nance available

to smaller businesses in areas where the

markets do not work well

• Create a more diverse nance market for

smaller businesses

• Help ensure better provision of information

in the market connecting smaller businesses

and nance providers

Our understanding of nance markets forsmaller businesses as presented in this reportwill be used by the Business Bank to help reneour strategy and to further support smallerbusinesses achieve their ambitions.

SMALLER BUSINESSES ARE ESSENTIAL

TO ADDRESSING THE UK’S PRODUCTIVITYCHALLENGE

The UK economy has continued to performwell relative to other developed nations, andalthough risks remain, central annual growth

forecasts are 2.2% for 2016. This expectedgrowth has supported business sentimentover the last year – the majority of smallerbusinesses have said that they are condentabout growth, with around 56% intending togrow in 2016.

Behind this positive recent performance lurklong-term challenges for the UK economy, mostnotably the importance of raising productivity.UK productivity lags those of its G7 peers andby focusing on this area of relative weakness anopportunity exists to convert growth into rising

standards of living. As SMEs employ the majorityof the UK private sector workforce, creatinga dynamic smaller business sector is critical toenhancing national productivity.

What is clear is that the rate of entrepreneurialactivity is high: the UK has seen remarkablystrong rates of new business (start-up)formation in recent years. There were around350,000 new enterprises registered in 2014and the UK now has a record population of5.4 million smaller businesses. However, thatis counterbalanced by the fact that fewer

UK smaller businesses have made the leap tomaterially grow (scale-up) than similarly sizedbusinesses elsewhere. The UK is near the

bottom of OECD tables of the percentage ofstart-up businesses that grow to more than 10employees after three years.


5/88

Research has shown that successfullyincreasing the number of rms that scale-up would substantially impact job creation,productivity and growth. Therefore, it is apriority to understand what is needed for amore supportive and cohesive ecosystem thatenhances the capability and ambition to growamongst high potential smaller businesses inthe UK.

The British Business Bank will focus more ofour attention and resources towards ndingeective nancing solutions for smallerbusinesses to allow them to scale-up andachieve their growth ambitions.

FLOWS OF FINANCE TO SMALLER BUSINESSES

HAVE IMPROVED. HOWEVER, SIGNIFICANT

GAPS IN THE MARKET REMAIN.

At an aggregate level, ows of both debtand equity nance to smaller businessesgrew in 2015 showing that nance marketshave improved. Notably, after several yearsof contraction, net bank lending to smallerbusinesses has increased for four consecutivequarters. Asset nance has also continued togrow strongly. Alternative nance businesslending, though still less than 3% of grosslending, grew by 75% to £1.26bn in 2015.

While the overall market has undoubtedlyimproved, our detailed analysis indicates that

weaknesses and structural imperfectionspersist in specic areas of the market. Evidencesuggests that a material portion of smallerbusinesses who apply for nance are stillrejected as a result of problems in small business

nance markets. This reects the likelihood ofinformation asymmetries between borrowersand lenders where it may be costly or dicultfor lenders to secure the information they needto make an informed investment decision, aswell as other structural issues. It applies tosmall businesses at all stages of development,whether they are star ting-up, scaling-up orseeking nance to stay-ahead in their particulararea of the market.

The British Business Bank will continue to reneour programmes designed to address this gap,notably through our long-running EnterpriseFinance Guarantee programme which helpsviable smaller businesses who lack sucientcollateral to borrow.

Even with an increase in the availability ofnance nationally, our research shows that

local distribution is uneven. In particular fewerequity deals occur for smaller businesseslocated in regions outside of London and theSouth East than inside. Given that nance isvital for growth, this can only entrench regionaldierences and stymie eorts to rebalancenational economic activity.

The British Business Bank will help addressthis weakness through our targeted regionaleorts, such as our support for a new £400mNorthern Powerhouse Investment Fund.

SMALL BUSINESS FINANCE MARKE TS 2015/16 5


6/88

FINANCE FOR STARTUPS CONTINUES TOBE IMPORTANT BUT INCREASING ACCESS

TO CAPITAL FOR HIGH GROWTH SMALLER

BUSINESSES IS AN EMERGING PRIORITY

Rejection rates for start-ups seeking new loansexceed 50%, in part reecting lenders’ dicultyin accurately assessing the viability of smallerbusinesses with limited track records and in partreecting the inability of very new businessesto make regular debt repayments. While friendsand family remain the most common fundingsource (used by 34% of star t-ups), not allentrepreneurs with good ideas have equalaccess to this kind of social and nancial capital.

The British Business Bank remains committed toexpand the number of Start Up Loans in order to

continue to address the structural disadvantagethat some of the UK’s newest businesses face insecuring nance to maximize their potential.

For smaller businesses looking to grow rapidly,equity nance is often the most appropriatefunding to drive their growth during the mostrisky periods of their development. Equityinvestors are typically more active than lendersin the day-to-day operations of the businessand are prepared to take on higher levels ofrisk. Increasing equity ows therefore can playa useful role in improving smaller businesses’

ability to scale-up.Markets for this type of funding have improved,with seed stage equity ows growing 48% p.a.since 2012, and UK equity providers investinga healthy £2.2bn a year in 2014. Nonetheless,the UK early equity market remains a fraction ofthe US market which is seven times larger thanthe UK market as a share of GDP and surveysshow that many entrepreneurs for whom equitymight be most appropriate remain averse totaking on external equity.

This ongoing disparity emphasises the BritishBusiness Bank’s commitment to maintain andexpand our early stage equity interventions– both the Angel Co-Fund and the EnterpriseCapital Fund – to continue to address this area

of under-development. We have also supportedthe establishment of funds through our VCCatalyst Fund.

Once established, high growth potentialsmall businesses often require additionalexternal nance to achieve their aspirations.Although, ows of UK venture and growthcapital increased in 2015, there is not a rmlyestablished market for debt-based growthnance in the UK market. Long-standinginformation asymmetries remain where abusiness’s past is not an accurate reection ofits future potential. This makes it more dicultfor rms with high growth potential to obtainenough debt nance to realise their potential.

The British Business Bank will help address this

situation through the planned pilot of our newHelp to Grow scheme targeted towards highgrowth smaller businesses in 2016.

This situation can be exacerbated wherea smaller business is seeking growth viaexporting to new markets and thus requiresmore complex nance. As our work withGoldman Sachs last year demonstrated,exports are particularly signicant becauseinternationalisation is often associated withhigher productivity; yet UK smaller businesseslag behind France and Germany in terms of the

propensity of SMEs to export.The British Business Bank is working with UK

Export Finance to help identify unmet nanceneeds of small business exporters and tocoordinate oerings to better address gaps.

In contrast, the availability of nance for mid-cap businesses (businesses with £25m-500mturnover) has improved markedly. The Europeanleveraged loan market has grown from €28.5bnin 2008 to €80bn in 2015 reecting the inowof institutional funding in recent years. Oursurvey also nds mid-cap businesses reportingrelatively little diculty in obtaining nance.

The British Business Bank will review our currentportfolio of mid-cap exposure to determinewhether our continued support is required.



7/88

THERE IS STILL LIMITED DIVERSITY IN THE

SUPPLY OF SMALLER BUSINESS FINANCE SO

NEW PROVIDERS AND NEW PRODUCTS NEED

NURTURING

The preliminary ndings of the Competition& Markets Authority retail banking marketinvestigation indicate that the four largest UKbanks had a combined market share of 80% forgeneral-purpose business loans, excluding peer-to-peer lending, in 2014. Diversity of supply oftraditional bank lending is clearly limited, but webelieve that increasing the diversity of choicegoes beyond just traditional bank lending.

Other channels provide appropriate nance forthe range of small business needs, and thereare tentative signs that the market is shifting.

Use of asset and invoice nance is increasing.Financial innovation and new delivery channelsgive smaller businesses more choice of productsand how to access them. The range of nanceproviders is also growing with new challengerbanks and technology-enabled online lendersentering markets. These grew rapidly in 2015,but from low bases, and so are still small on anabsolute scale.

Although we have seen positive momentum interms of market diversity, some new entrantsface structural disadvantages when oering

small business loans relative to incumbentsrelated to funding costs and capital eciency,slowing down their development. More timeand further nurturing of the market is neededbefore these newer oers become everydayalternatives for smaller businesses of all sizesacross the UK.

The British Business Bank will help improvediversity of supply of nance for smallerbusinesses by expanding our support forchallenger banks, non-bank debt funds, onlineplatforms, invoice and asset nance providers.

Our ENABLE programmes have now supportedover £225m of lending and our InvestmentProgramme has committed £353m of support tothese growing participants.

REAL DIVERSITY AND CHOICE IN SUPPLY

WOULD BE ACCELER ATED BY GREATER

AWARENESS OF, AND CONFIDENT DEMAND

FOR, FINANCIAL ALTERNATIVES

Awareness of the range of nance options hasrisen amongst smaller businesses, in particularfor newer types of nance and providers,including peer-to-peer lending (up from 24% in2012 to 40% in 2015) and crowd funding (upfrom 13% to 49%). Awareness of alternatives isaecting behaviour as well, with the percentageof smaller businesses who contact only oneprovider having fallen from 71% in 2012 to 66%in 2014 and now 61% in 2015.

But even with recent improvements, over halfof UK smaller businesses immediately go to their

main bank when they rst identify a nancingneed and do not shop around for nance. It isclear that more can be done to increase smallbusiness engagement with the market. For

example, only a minority of smaller businessesuse external advisors when applying for nance.

This emphasises the importance of the BritishBusiness Bank’s commitment to improving theunderstanding of nance options amongstsmaller businesses in the UK. We continue

to collaborate with partners such as theICAEW to develop and distribute information

guides to smaller businesses and with HMTreasury to implement new information-basedinterventions such as the referral of rejectedsmaller business applicants to new nanceplatforms.



8/88

INTRODUCTION

This is the second annual British BusinessBank report on Small Business FinanceMarkets, setting out the latest evidence onthe ways in which nance markets support

smaller business and help them contributeto improving productivity and growth inthe UK economy1.

Our understanding of smaller business nancemarkets, both in terms of smaller businessdemand for nance and the nance providers’supply of nance is essential in shaping ourbusiness planning and the design of ourprogrammes and products.

The Business Bank aims to support businesses,whether they are looking to start-up, grow to

the next level or stay ahead of the competition.Therefore, this year we have focused on thedierent market segments that the BusinessBank seeks to serve, namely Start-Up, Scale-Upand Stay Ahead rms.

NEW EVIDENCE

As well as drawing on established data sources,the British Business Bank looks to add to theevidence base by bringing new evidence to thedebate on smaller business nance markets. In particular:

- The Customer Journey survey from 2012and 2014 has been refreshed and run againin 2015 to give fresh insight into smallerbusinesses experience in accessing nance

- New calculations have been producedusing data from the SME Finance Monitorto investigate rejection rates for core banklending products

- The Business Bank has commissionedupdated private equity market data fromBeauhurst which focuses on visible smaller

businesses external equity deals

This report also draws on the evidencegathered for the recent report “UnlockingProductivity Internationalisation andInnovation in SMEs” on which the British

Business Bank collaborated with GoldmanSachs and the Enterprise Research Centre.

Chapter 1 provides an overall assessment ofthe small business nance markets, reviewingdevelopments on both the demand and supplysides of the market to assess whether, as theeconomic recovery continues, nance marketsare improving.

Chapter 2 looks at the market for nancefor start-ups in more detail, recognising theadditional diculties these rms encounter in

raising nance.Chapter 3 presents an analysis of externalnance sources that are appropriate forgrowing rms that are looking to scale uprapidly, with a focus on debt funds and equitymarkets. The role nance plays in helping smallbusinesses export, the experience of mid-capbusinesses and the role of long-term nanceare also explored.

Chapter 4 considers take-up of nance that isused widely across all the Business Bank marketsegments such as asset nance and alternative

nance. It then looks at the latest evidence onthe diversity of supply of nance and therise of the challenger banks.



9/88

CHAPTER ONE

OVERALL ASSESSMENT

OF MARKET

DEVELOPMENTS

Chapter 1 provides an overall assessmentof a number of smaller business debtand equity nance markets, reviewingdevelopments on both the demand sideand the supply side of the market toassess whether, as the economic recoverycontinues, nance ows are improving.

The overall picture, set out in section 1.1, isan encouraging one with ows of nance tosmaller businesses increasing across a widerange of nancial products.

However, there is a still unmet demand fornance from smaller businesses. Section 1.3presents a new approach to calculating thevalue of rejected applications for traditionalbanking products. We will be developing thismethodology to increase our understandingof the market for small business nance andwelcome input from interested parties.

Section 1.4 looks in more detail at the demandfor nance from smaller businesses. Goodprogress continues to be made in awarenessof nance products amongst smaller business,

although the evidence suggests increasedinformation about the suitability of specicproducts and how to apply for them wouldincrease eective demand.

Subsequent sections look at developments inthe main bank lending (section 1.5) and equitynance markets (section 1.6). These are usedby smaller businesses across all three of themarket segments used by the Business Bank.Bank lending has shown further signs ofrecovery in 2015 compared to previous years.In equity nance there has been strong growthin 2015. Other products are explored in moredetail in subsequent chapters.

The chapter concludes with regional analysisof smaller businesses and nance ows(section 1.7). This evidence provides supportfor Business Bank involvement in supportingprovision of nance in regions.

Despite the positive developments in smallerbusiness nance markets structural problemsremain that demonstrate the need forthe Business Bank’s continued role. Thesestructural problems result in nance marketsnot functioning eectively, with an allocationof nance to smaller businesses at less thanoptimal levels, resulting in lost output and

growth. The structural problems arise in anumber of ways.

SMALL BUSINESS FINANCE MARKETS 2015/16 9


10/88

1. Information problems between small businesses

and nance providers

Lenders or investors need information on smallerbusinesses to make sound investment decisions.Information asymmetry between business and nanceproviders necessitates costly due diligence in advance ofany deal; this cost is relatively xed, meaning it accounts

for a greater share of smaller deals, which drives fundstoward larger deal sizes and larger/less risky rms. In thecase of start-ups, lack of track record makes it even moredicult for nance providers to assess the riskiness ofthe nance sought by small businesses.

Smaller businesses may also lack information that isneeded for them to understand the nancial productsavailable to them and how to access them.

2. Market competition

Lack of competition between market participants mayprevent markets operating eectively. This may leadto a lower availability of nance, or a rise in the price ofnance resulting in less nance being provided to smallerbusinesses.

3. Spill-overs

These arise from the dierence between private andsocial returns to investment. Investment generatespositive externalities, or spill-overs, to the rest of theeconomy in the form of innovation or knowledge transfer.These spill-overs are particularly signicant for smallerrms, which nd it more dicult to appropriate the valueof their new knowledge, and high-tech rms, which rely

more on innovation for their protability.

The external benets are not taken into account in thedecision-making of private investors. This results in anunder-provision of equity nance in societal terms, toprojects which do not oer sucient returns to privateinvestors but generate signicant social benets.


4. Unintended consequences of regulation

The introduction of regulations or other governmentinterventions may have unintended consequencesleading to inecient outcomes in markets. For example,whilst regulations designed to improve nancial stabilityare required they may raise the cost of nance resultingin less use of nance by smaller businesses.

It is important to recognise that in many cases businessesinability to obtain nance does not represent a problem inthe market.


11/88

1.1

AGGREGATE FLOWS OF FINANCE TO

SMALLER BUSINESSES ARE ENCOURAGING


This section brings together the latest data from arange of sources on the volume and value of varioustypes of nance provided to smaller businesses.Consistent and comprehensive data outliningthe value of the aggregate stocks and ows of allforms of external nance to smaller businesses isnot readily available however the table provides areasonable snapshot of the situation.

While ows of dierent types of nance are not directly

comparable, the data shows that bank lending remainsthe single largest form of external nance for smallerbusinesses, albeit with other forms of nance continuingto increase their share.

NET FLOW OF ‘CORE’ BANKING LENDING PRODUCTSTURNS POSITIVE

The net ows of bank loans (new loans, excludingoverdrafts) has turned positive with four consecutivequarters of growth totalling £1.6bn through to Q3 2015.This suggests a recovery in net lending, however theimprovement in credit availability is less pronounced

amongst smaller SMEs and driven by improvements innew nance ows to medium-sized businesses.

The stock of bank loans and overdrafts was estimatedat £163bn at end of November 2015, reecting a declinein the value of loans whilst overdraft levels were morestable.2

OTHER TYPES OF FINANCE SHOW STRONG GROWTH

More positively, data commissioned by the BritishBusiness Bank shows that the value of new equitydeals with known amounts grew to £2.2bn in 2014, and

expanded further in 2015 with nearly £2.4bn in the rstthree quarters of 2015, continuing the strong upwardtrend since the data series began in 2011.

• Net ow of ‘core’ banking lending productsturns positive

• Other types of nance show strong growth

• Usage rates amongst SMEs has stabilised


12/88

2011 2012 2013 2014 2015

Bank Lending Stock Outstanding Amount {c} 189 176 166 167 163 to Nov 15

Source: Bank of England {b}

Bank Lending Net ows £ billions {d} - -8 -4 -4 2

Source: Bank of England {b} Gross ows £ billions {e} - 38 43 53 53 to Nov 15

Other Gross Flows of SME Finance

Private external Equity £ billions 1.04 1.32 1.62 2.20 2.39

Source: Beauhurst {f} No. of Reported Deals 386 625 863 1060 870

No. of Deals (Known Amounts) 279 435 612 804 699 to Sep 15

Asset Finance £ billions - 12.7 13.5 14.8 16.3 12 monthsSource: FLA {g} to Nov 15

Peer-to-Peer Business Lending £ billions 0.02 0.06 0.25 0.72 1.26 to Dec 15

Source: Alt Fi Data {h}

{a} The information contained in this table should be viewed as indicative as data and denitions are not directly comparable across dierent sources. Therecan be some double counting across estimates in dierent 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 and have been rounded appropriately.

{b} Statistics taken from Bank of England B ankstats Table a8.1 - Available: http://www.bankofengland.co.uk/statistics/Pages/bankstats/2015/nov.aspx

{c} Amounts outstanding data include overdrafts and loans in both sterling and foreign currency, expressed in sterling. Non-seasonally adjusted. Movementsin amounts outstanding can reect breaks in data s eries as well as underlying ows. For further details see w ww.bankofengland.co.uk/statistics/Pages/iadb/notesiadb/Changes_ows_growth_rates.aspx. For changes and growth rates data, please use the appropriate series or data tables from

Bankstats, available at ww w.bankofengland.co.uk/statistics/Pages/bankstats/current/default.aspx.

(d) Data includes overdrafts and loans in both sterling and foreign currency, expressed in sterling. Net ows does not always reconcile with change in stockdue to dierences in statistical reporting. The reported stock can include other adjustments made by banks but not detailed when reported, whereas owsdata does not include these adjustments.

{e} Data exclude overdrafts and covers loans in both sterling and foreign currency, expressed in sterling. The total may not equal the sum of its componentsdue to rounding.

{f} Beauhurst is a market data provider that records visible equity deals including crowdfunding deals. Data will be available in forthcoming Business Bank /Beauhurst publication.

{g} The Finance & Leasing Association (FLA) whose members make up 90-95% of the market. Data obtained from FLA A sset Finance Condence Survey.{h} Figures do not represent the entire market. Data obtained from AltFi Data.

ESTIMATES OF THE FLOWS OF SOME TYPES OF EXTERNAL FINANCE FOR UK SMES A


FIG 1.1


13/88


Data from the Finance and Leasing Association suggeststhat new asset nance volumes with SMEs was almost £15billion in 2014, an increase of more than 9% on 2013. Thelatest data points toward continued strong growth in 2015.

The value of invoice nance advances outstanding atend of September 2015 totalled £15.9bn, althoughthe published data series does not separate out SME

recipients from other rms.3 It should be noted that giventhe short-term nature of invoice nancing, the totalvolume of funding within a quarter is much higher thanthe advances outstanding at the quarter end.

It is dicult to quantify the value of smaller businessnancing from debt funds, although evidence of theincreased number of deals suggest it is an increasinglyimportant source of nance.

Gross ows of lending to businesses via online platformscontinue to grow at a strong rate. reaching £1.26bn in2015. However the value of these non-bank sources of

nance remain small in comparison to traditional sourcesof bank nance.

USAGE RATES AMONGST SMES HAS STABILISED

Survey evidence suggests that the share of SMEs usingnance has stabilised. The SME Finance Monitor surveyshows that across all SMEs, the number using ‘core’ bankproducts has declined from 40% of SMEs in Q1 2012 to29% in Q3 2015, but this has been stable since the end of2013, indicating that the decline in use of such productshas tailed o.

The share of SMEs using any other forms of nance,e.g. leasing or invoice nancing, also remains relativelystable. On the value of the stocks and ows of credit cardlending to smaller businesses, survey evidence suggeststhat around 15% of smaller businesses use credit cards.However nearly 80% of these credit card users pay othe full balance each month. This suggests that a greaternumber of smaller businesses use credit cards for short-term working capital rather than for long-term nancingneeds.

In terms of other nancial products, 17% of smallerbusinesses use leasing or hire purchase and loans from

directors or family & friends. Invoice nance is onlyestimated to be used by 2% of smaller businesses. Use ofleasing or hire purchase and invoice nance is signicantlymore common amongst small and medium sized businessthan it is amongst micro businesses.


14/88


SMALLER BUSINESSES FORM A LARGE PART OF THE UK

ECONOMY AND MAKE AN IMPORTANT CONTRIBUTION TO

ECONOMIC GROWTH

Smaller businesses4 continue to account for 99.9% of theUK business population and are an important part of theUK economy. At the start of 2015, private sector smallerbusinesses:

• Employ an estimated 15.6 million people which

forms more than half of total UK private sector

employment (60%);

• Create a high share of new jobs - between 2008 and2013 85% of new jobs in the UK were created by

businesses with fewer than 50 employees5; and

• Account for almost half of UK private sector

turnover (47%).6

The ability of businesses to access external nance isimportant for facilitating new business start-ups aswell as funding business investment and expansion,ensuring businesses reach their full growth potential. Alack of nance can also constrain cash ow and hamperbusinesses’ survival prospects. Access to the right nanceis particularly important for innovative businesses andhigh-growth businesses. By increasing the supply ofexternal nance to viable businesses aected by problemsin nance markets, the British Business Bank can inuenceimprovements in the underlying drivers of productivitysuch as investment, as well as facilitate start-ups andbusiness expansion.

THE UK FACES A MAJOR PRODUCTIVITY CHALLENGE BYHISTORICAL AND BY INTERNATIONAL STANDARDS

Although, GDP and employment in the UK have recoveredsince the recession with GDP now 6.1% above its pre-

recession level, it has been accompanied by relativelypoor productivity performance, which threatens long-term prospects for the UK’s standard of living. As is welldocumented, a signicant productivity gap exists bet weenthe UK and most other leading advanced economies,which worsened in 2014 compared to the previous year.

1.2

EXTERNAL FINANCE FOR SMALLER BUSINESSES

CONTRIBUTES TO GROWTH AND PRODUCTIVITY

• Smaller businesses continue to form a largepart of the UK economy and make an importantcontribution to economic growth

• Whilst the UK performs well in terms of creatingnew start-up businesses, it is less eective atgrowing them compared to other countries

• The UK faces a major productivity challengecompared to historical and internationalcomparisons.

• Increased innovation and exporting could help toincrease productivity amongst smaller businesses


15/88

A reduction in productivity is expec ted to happen during

a nancial crisis and deep recession, as businesses reduceproduction by more than the fall in their work force. Therecovery in the UK’s productivity performance has beenparticularly weak following the recession.

That weakness in productivity performance is clearlyillustrated by output per hour worked across countries.For every hour worked, the US produced 32% more outputrelative to the UK in 2014 and G7 countries (excluding theUK) are on average 20% more productive than the UK.7 Given that SMEs employ most of the labour force, overallimprovements in UK productivity will require improvedSME productivity, especially as larger businesses tend to

be more productive than smaller businesses. Recentlypublished productivity data shows micro-businesses offewer than 10 employees have experienced faster growthin output per worker than larger businesses since 2009.Productivity levels (as measured by output per worker) oflarger businesses in 2014 is still below 2008 productivitylevels, but since 2013 medium sized businesses havebeen more productive per worker than large businesses.8 Smaller businesses can play a vital role in raisingproductivity in the UK economy by spurring innovation,facilitating productive churn, and stimulating strongercompetition.

WHILST THE UK PERFORMS WELL IN TERMS OF CREATING

NEW STARTUP BUSINESSES, IT IS LESS EFFECTIVE ATGROWING THEM COMPARED TO OTHER COUNTRIES

The UK is ranked third out of 14 OECD countries in terms ofthe proportion of start-up businesses less than two yearsold in the business population.9 21% of the UK businesspopulation is made up of business less than two yearsold, which is higher than the US (19%). However, the UK isranked 13th when it comes to the proportion of star t-upbusinesses with 1-9 employees that grow to 20 employeesplus within three years. Just 3% of start-up businesses

grow to having more than ten employees compared to5.5% of businesses in the US. Raising the productivit y ofthe whole economy depends on facilitating the growth ofnew and existing businesses with the greatest potential.

INCREASED INNOVATION AND EXPORTING MAY HELP TO

INCREASE PRODUCTIVITY AMONGST SMES

The challenge then is how to increase productivityfor SMEs so as to build a strong foundation for long-term prosperity. Recent research10 indicates a positiverelationship between businesses that engage ininternational activity and innovation and business

performance – including productivity performance.However, UK SMEs lag behind their international peers inmany of these areas, giving room for improvement. Theperformance of UK small business sectors in exporting isdiscussed in more detail in chapter 3.

START-UPS AS A PROPORTION OF ALL BUSINESSES ANDPROPORTION OF START-UPS THAT GROW BEYOND 10EMPLOYEES IN THREE YEARS

FIG 1.3

Source: OECD

2

1

4

3

6

5

8

7

9

N Z L

U K

N L D

I T A

A U T

F R A

F I N

S WE

C A N

U S A

B E L

L U X

N O R

B R A

% of start-ups with 1-9 employees that grow to 10+ within 3 years

%

10

5

20

15

30

25

40

35

45

F I N

I T A

N O R

B E L

C A N

S WE

U S A

A U T

N Z L

N L D

L U X

U K

F R A

B R A

Start-ups (0-2 years old) as a proportion of all firms

%

[CHART X:PRODUCTIVITY PER

HOUR WORKED IN G7

COUNTRIES

PRODUCTIVITY PER HOUR WORKED IN G7 COUNTRIES

FIG 1.2

Source: ONS

20

60

40

100

120

140

Current price GDP per hour workedUK=100

80

J a p a n

U K ( =1 0 0 )

C a n a d a

I t a l y

G 7 ex . U K

G er m a n y

U S

F r a n c e

2014

2013



16/88


1.3

ANALYSIS OF NEW DEBT APPLICATIONS

Problems in access to nance markets for smallerbusinesses have been discussed earlier in thischapter. They focus on reasons why nancemarkets may not work eciently for some smallerbusinesses, for example: information asymmetriesbetween a business and a lender, levels of marketcompetition, and unintended consequences ofregulation. These problems are typically structuralin nature, but can be exacerbated by cyclicalissues. Often, in a commercial context, the rejecteddecision may have been the correct outcome, but

the commercial decision does not incorporate thewider economic impacts that may arise as a result ofthe provision of nance to viable smaller businesses.This can mean that not all productive smallerbusinesses’ demand for nance is met, which canlead to sub-optimal levels of economic activity.

It is useful to consider the outcomes of nanceapplications. Where applications are rejected, it isworthwhile to consider a measure of ‘viability’, i.e. wherea potentially productive or viable small business couldhave received nance, but a structural problem in nancemarkets for smaller businesses meant that this nance

was not available. However, it is recognised that manyrejections will have been based on a rational commercialdecision and, in many cases, the economic and commercialdecisions on nance are likely to be aligned.

This section summarises the results of our proposed newmethodology for quantifying the volume of SMEs rejectedfor new debt (loan and overdraft) applications and thevalue of those applications. SME Finance Monitor data isused for the purpose of this analysis,11 drawing on a tenquarter dataset (period ending Q2 2015) to determinethe number of SMEs rejected for a new loan or overdraftand multiplying these by the mid-point of the application

value band. The underlying methodology is explained ina separate note, which also contains a discussion on apotential approach to estimating ‘viability’. The BritishBusiness Bank would welcome discussions on such amethodology with any interested stakeholder.

• Survey evidence suggests nearly 100,000 SMEsand approximately £4bn worth of applicationsfor debt are estimated to be rejected each year

• Start-ups are more likely to be unsuccessfulin their applications for new debt facilities,compared with scale-up and stay ahead rms

• However, by value of rejected applications,start-ups are the smallest segment

• Assessment of the potential viability ofrejected loans is inherently dicult


17/88

Furthermore, we recognise that there are other

methodologies that aim to calculate the size of the nancegap for debt funding. Some of these other approaches areconsidered in the benchmarking discussion. It should benoted that our methodology focuses on new applicationsfor traditional debt products and, therefore, does notconsider the extent of an ‘equity gap’ or specic gaps forother lending products, nor where smaller businesseshave been discouraged from applying. Therefore, thisis a starting point from which we aim to develop themethodology further for valuing nance gaps.

SURVEY EVIDENCE SUGGESTS NEARLY 100,000 SMES AND

APPROXIMATELY £4BN OF APPLICATIONS FOR DEBT AREESTIMATED TO BE REJECTED EACH YEAR

SME Finance Monitor data indicates that 16%12 of SMEshad any ‘borrowing event’ in a 12-month period. A fundingevent can be initiated by the SME or the SME’s bank andrelate to existing or new nance. The proportion of SMEsapplying for a new debt facility is smaller still (less than 3%for each of loans and overdrafts).

Applications for new debt facilities have much lower

approval rates on average than those relating to renewalof existing facilities. For example, SME Finance Monitor13 analysis of combined loan and overdraft applicationsindicates that success rates for renewed facilities areconsistently high (>94%). Success rates for new moneyare more variable over the period (and are relatively highin 2014 – equal to or above 65%). Provisional results forQ1 2015 indicate that 55% of SMEs were successful inapplying for new money.

In quantifying the value of rejected debt applications, wefocus on new facilities, where the lower than averagesuccess rates suggest that structural problems in accessing

nance markets are more likely. For example, where abusiness is renewing an existing facility, we assume thatthe relevant nance provider has additional informationor insight to make the credit decision (e.g. information onprincipal and interest payments) and it is less likely thatthere are information asymmetries between borrower andlender.14

Our specic analysis of SME Finance Monitor data suggeststhat of all SMEs seeking a new loan facility, roughly 55%were successful whilst 45% were unsuccessful in obtainingexternal nance for their business over the 10 quarterperiod.15 This equates to around 55,00016 SMEs rejected for

new loans in a 12-month period. Using data on the mid-point of value bands applied for, this equates to roughly£3.7bn worth of rejected loan applications. This compareswith around £24bn of loan approvals reported by the BBAin the four quarters to Q2 2015.



18/88

A slightly lower proportion of SMEs applying for a newoverdraft are unsuccessful (c40%, compared with nearly60% that were successful) in obtaining some form ofexternal funding for their business following their newoverdraft application. This equates to a similar numberof SMEs being rejected for a new overdraft in a 12-monthperiod than for loans (c55,000). However, the value ofthose rejected applications is signicantly lower than forloans at c£0.8bn, reecting lower average applicationvalues. This compares with around £5bn of overdraftapprovals reported by the BBA in the four quar tersto Q2 2015.

Some SMEs apply for both loans and overdrafts in a12-month period. For prudence, we exclude the rejectionfor one type of facility (where the other applicationwas successful) or the ‘duplicate’ rejection (where bothapplications were unsuccessful) from the analysis.Approximately 15,000 SMEs are excluded on this basis,with an equivalent rejected application value of c£0.5bn.Therefore, the total number of SMEs rejected for newdebt applications is just under 100,000 per year and theequivalent value of rejected nance is c£4bn per year.

STARTUPS ARE MORE LIKELY TO BE UNSUCCESSFULIN THEIR APPLIC ATIONS FOR NEW DEBT FACILITIES,

COMPARED WITH SCALEUP AND STAY AHEAD FIRMS

The British Business Bank focuses on three mainsegments of SMEs:

• Start-up – SMEs trading up to 5 years.17

• Scale-up – SMEs trading for more than

5 years with some ambition to grow.

• Stay ahead – SMEs trading for more than

5 years with no ambitio n to grow.

Cutting the SME Finance Monitor data in line with theabove denitions indicates that c40% of SMEs are

classied as start-ups, just over 20% are scale-ups, withthe remaining being stay ahead SMEs. Start-Ups weredened as up to 5 years to reect nance providers’preference for several years nancial track record whenconsidering applications.

The application rate amongst start-ups for new loansis in line with their proportion of the population (i.e.c40% of new loan applications are made by start-ups).Scale-ups are over-represented (making up about one-third of applications) and stay ahead businesses under-represented (about one quarter of applications).

Both scale-ups and stay ahead SMEs are more likely tosee their new loan application approved (success ratesare around 60%), while start-ups are more likely to beunsuccessful. Again this is consistent with economictheories of information problems for lenders attemptingto assess loan applications.


NUMBER OF SMES AND VALUE OF REJECTED DEBT APPLICATIONS

FIG 1.4

Source: BBB analysis, SME FM

40,000

20,000

80,000

60,000

120,000

100,000

Loan Overdraft Overlap Total

No. of SMEs

2

1

4

3

5

Loan Overdraft Overlap Total

£ billion

NEW LOANS – SHARE OF POPULATION / APPLICATIONS / SUCCESSFUL AND REJECTED APPLICATIONS BY BBB SEGMENT

FIG 1.5


20

10

40

30

60

70

80

90

100

%

50

Population Applications Successful Unsuccessful

Scale-up

Stay ahead

Start-up


19/88

When considering new overdrafts applications, a similar

trend is evident where scale-up and stay ahead SMEs aremore likely to be successful.

HOWEVER, BY VALUE OF REJECTED FINANCE, STARTUPSARE THE SMALLEST SEGMENT

Given the share of unsuccessful applications between thesegments, start-ups account for the largest share of newloan rejections by volume. However, scale-ups and stayahead businesses are more likely to apply for higher loanvalues on average. Therefore, by value, start-ups havethe smallest share of rejected new loan applications.

Start-ups also represent the largest share of rejectedoverdraft applications by volume. Due to lower variancesin average application values for new overdrafts betweenthe segments, start-ups are also the largest group byvalue.

The combined volumes and values of rejected debtapplications (loans and overdrafts with overlap removed)mirror the trend for unsuccessful loan applications.

ASSESSMENT OF THE POTENTIAL VIABILITY OF

REJECTED LOANS IS INHERENTLY DIFFICULT

In many cases, the decision made by the bank (orother lending provider) will be legitimate based ontheir assessment of an SME’s ability to service theloan requested. However, there will be a proportion offacilities that were declined due to structural problems inthe market, meaning that there is a mis-match betweensupply and demand.

It is inherently dicult to determine potentially ‘viable’demand from ‘non-viable’ demand (i.e. those rejectedbased on sucient information about the viability of theloan) – if this were an easy exercise, costs associated withassessing creditworthiness would be minimal and loanapplications would not be rejected due to informationasymmetries or other structural problems.

The established theory suggests that an SME’s lack oftrack record (ability to prove they can service the nancebased on historic performance) and lack of collateral(to de-risk the lending) are symptomatic of a lack ofinformation in the credit decision process. This can beparticularly problematic for young businesses, or SMEslooking for a step-change in their business performance.In both cases, the relevant track record and, in somecases, value of security is still being accumulated.

The cost to the lender of verifying the credit worthiness

of a smaller business and/or the required return due topotential higher risk can start to outweigh the incomethat can be derived from lending. In a commercial sense,the rejected loan outcome is therefore reasonable,particularly where some SMEs will have higher risk

VOLUME AND VALUE OF TOTAL REJECTEDNEW DEBT (LOAN AND OVERDRAFT)APPLICATIONS BY BBB SEGMENT

FIG 1.7


Start-up Scale-up Stay ahead

20

10

40

30

60 2

1

50

Value (RHS)

Volume (LHS)

No. of SMEs (000s) £ billion

VOLUME AND VALUE OF NEW LOAN REJECTIONS BY BBB SEGMENT

FIG 1.6


Volume: Value:

Stay ahead 18%

Scale-up 30%

Start-up 52%

Stay ahead 41%

Scale-up 38%

Start-up 21%



20/88

ratings. However, this does provide a rationale forgovernment intervention, where the wider economicbenets of nancing these businesses outweigh the

costs of doing so.

We would therefore expect that potentially viabledemand within rejected new debt applications would behigher for the start-up segment compared with scale-upor stay ahead businesses. However, we would also expectthat scale-up businesses would be prone to structuralproblems, particularly information asymmetries, wheretheir existing track record does not verify their intendedperformance.

BENCHMARKING AGAINST OTHER METHODS

In putting forward this methodology as a startingpoint for estimating the value of rejected new debtapplications, we recognise that other methodologies andattempts have been made.18,19 There are also ways inwhich the results of our analysis can be sense-checkedagainst other benchmarks.

A 2013 sta working paper from the EuropeanCommission makes an ex-ante assessment of the EU SMEInitiative. In the report, there is an assessment of SMEnancial gaps in the EU. This methodology also drawsfrom survey data, noting that, “Survey data, with all theirlimitations, are used extensively in studies on nancing

gaps when time and data constraints prevent thequantitative assessment of demand and supply throughdeep analyses of the data.”

The methodology adopted in the working paper aimsto identify the number of nancially viable SMEs –benetted from turnover growth in the last six months– that were unsuccessful in obtaining loan nancing.Unsuccessful is determined by need and, therefore,does not dierentiate between SMEs that have or havenot applied for a loan20. The value of the nancing gap isdetermined by deriving an average loan amount that is orwould have been requested.

The working paper indicates a comparatively highernance gap for the UK than that suggested by ouranalysis, bearing in mind that the £4bn value for rejectednew debt applications is not adjusted for ‘viability’. Thisdierence may be partly explained by the earlier time


period for which the analysis was undertaken, whencyclical factors were compounding underlying structuralissues in SME access to nance. The estimated interval

for the SME loan nancing gap was €1.3bn - €8.8bn forthe UK during 2009 - 2011. It is worth noting that theupper bound reects the denitions outlined above(e.g. positive turnover growth in last six months andunsuccessful, where unsuccessful is based on need). Thelower bound represents the debt nance needs of highgrowth SMEs unsuccessful in obtaining loan nance.

A dierent approach was considered in the RBSIndependent Lending Review (2013), completed by SirAndrew Large. Here, the funding gap was estimated byassessing UK SME debt capacity compared with actualbank lending to UK SMEs. UK SME debt capacity was

considered in the context of the level of bank debt thatSMEs could prudently support, based on Debt ServiceCoverage Ratio of 1.5 and pricing at economic cost . Thismethodology estimated that the funding gap in 2013 wasc£30bn -£35bn. Again, cyclical factors were likely to haveincreased the size of the gap in 2013, so it is reasonable toexpect that this gap would have reduced since 2013.

Data on the appeals process, which commenced in 2011,is another way of assessing a possible benchmark forpotential viability within rejected applications. Datacollection is in its fth year, with the report noting that,“Appeals numbers continue to be steady and the overturn

rate continues to fall.” The report indicates that in year1 (Apr 2011 – Mar 2012), the overturn rate was 39.5%(32.6% excluding credit cards) compared with 24.4%(17.5% excluding credit cards) for the six months endingSeptember 2015, giving support for the view that a smallbut signicant percentage of rejected loans may be viable.

Furthermore, the 2014 full year appeals process reportnotes that, “In terms of the size of lending, size ofcompany and the relation that this has to the number ofdeclines, appeals, and overturns, […] those SMEs whohave the resource and the experience to have moreinformed discussions with lenders tend to do better thanothers.” The data suggest that overturn rates are highestfor smaller businesses with a turnover of less than £100kand for businesses that request lending values of lessthan £10k. Indeed, the reasons for rejection appear to bedierent for loan requests below and above £25k.


21/88


1.4

DEMAND SIDE – AWARENESS& DEMAND FOR FINANCE

For nance markets to work eectively, both thesupply and demand side need to interact eciently.This chapter summarises new survey evidence

which provides an overview of demand for externalnance from smaller businesses.21

AWARENESS OF ALTERNATIVE SOURCES OF FINANCE

OUTSIDE OF BANKS CONTINUES TO INCREASE OVER THE

YEAR, BUT ONLY A SMALL PROPORTION OF BUSINESSES

ARE ACTUALLY USING THESE ALTERNATIVE SOURCES

There have been signicant increases in businessawareness of nance products such as venture capital,crowd funding platforms and Peer to Peer platforms since2014, which builds on the previous increases seen fromthe 2012 survey. For instance, 49% of SMEs have now

heard of crowd funding platforms in 2015, a signicantincrease from 13% recorded in 2012.

Whilst awareness of sources of nance has improved,roughly half of businesses that are aware of the type ofnance are actually aware of a specic supplier of thattype of nance, suggesting better awareness is needed.For instance, whilst 60% of smaller businesses are awareof Venture capital as a nance type, only 22% are awareof a specic fund to approach. Similarly 40% are awareof peer to peer lending but 19% are aware of a specicplatform.

Importantly higher awareness has not translated intohigher use of these alternative sources of nance, whichremains low compared to other sources. For instance, only1% of businesses had used equity nance and 1% hadused nance from a peer to peer lender in the previousthree years.

INCREASED INFORMATION ABOUT SUITABLE TYPES OF

FINANCE AND HOW TO APPLY COULD HELP TO MAKE SME

FINANCE MARKETS WORK MORE EFFECTIVELY

Information is needed for SME nance markets towork eectively, but only a minority of SMEs (19%)

use external advice when applying for nance, largelyunchanged from previous years. Whilst SMEs are largelycondent in assessing nancial products oered bytheir own bank, they are less condent assessingother providers’ products. This may explain why 61%

AWARENESS OF DIFFERENT TYPES OF EXTERNAL FINANCE

FIG 1.8

Source: British Business Bank 2015 Finance Survey

20 40 60 80 100%

2014

2013

2015

Credit cards

Leasing/HP

Gov./LA grants

Venture capitalists

IF/Factoring

Crowd funding platforms (a)

Trade finance (b)

P2P lending platforms

Business angels

Mezzanine finance

• Awareness of alternative sources of nanceoutside of banks continues to increase, but onlya small proportion of businesses are actually

using these sources of nance

• Increased information about suitable types ofnance and how to apply could help to makeSME nance markets work more eectively

• Smaller businesses reduced their use ofexternal nance during the recession, but thereis some evidence that demand for nance hasbegun to increase

• Business condence has increased and themain reason for seeking nance is to fund working capital

• Businesses continue to underestimate thelikelihood of obtaining nance, with a smallbut signicant proportion of businesses beingdiscouraged from seeking nance


22/88

of SMEs only contact one provider of nance whenseeking nance. Though high, this is a decline from66% contacting one provider in 2014 and 71% in 2012,suggesting more SMEs are engaging with the market andare shopping around for external nance than previously.

SMALLER BUSINESSES REDUCED THEIR USE OF

EXTERNAL FINANCE DURING THE RECESSION, BUT

THERE IS SOME EVIDENCE THAT DEMAND FOR FINANCE

HAS BEGUN TO INCREASE

Demand for external nance from smaller businessesreduced during the recession, as businesses becamemore cautious about taking on additional debt and scaledback their expansion plans. Furthermore, as the recoverytook hold, businesses have increased cash reserves in thebusiness, which has further led to a decline in the use ofexternal sources of nance.22

Condence is needed for a sustained increase in the

number of businesses investing for expansion. This maybe beginning to happen as the latest British BusinessBank Finance survey shows there has been an increase inthe proportions of businesses using external nance to60% up from 56% in 2014. This increase is seen acrossboth zero employee businesses and businesses withemployees. This is likely to be driven by the proportion ofbusinesses seeking nance in the last 12 months. This hasincreased from 12% in 2014 to 18% in the latest surveygiving further evidence of the change in demand, albeit tothe same level seen in 2012.23

However, this increase must be put into context as a large

proportion of the observed increase is due to the greateruse of credit card nance (28% up from 22% in 2014)and also loans from increased borrowing from family andcolleagues (23% up from 13% in 2014). These are likelyto be exible short term borrowing on already agreedfacilities and informal sources of nance, which are notlikely to show up in other lending data sources.

BUSINESS CONFIDENCE HAS INCREASED AND

THE MAIN REASON FOR SEEKING FINANCE IS TO

FUND WORKING C APITAL

Furthermore, survey evidence suggests overall business

condence continues to improve with businessespositive about future economic conditions. For instance,44% of businesses expect trading conditions willimprove in the next 12 months, compared to only 11%expecting them to get worse. This has contributed to a


higher proportion of businesses planning to grow theirturnover in the next 12 months compared to a year ago.56% of small businesses plan to grow their turnover inthe next 12 months, a signicant increase from 46% ayear ago. However, it is important to note most (68%)will not use any external nance to fund this growth.

The previous 2014 survey identied a change24

in theprole of demand for nance, shifting away from nancefor working capital to nance to fund xed assets. Thislatest survey shows a swing back to seeking nance forworking capital, which is predominantly being driven bySMEs with no employees which make up the majority ofthe business population by number, but have dierentcharacteristics to employer businesses. It is toosimplistic to assume the increase in businesses seekingnance for working capital implies a deterioration ofbusinesses seeking funding for investment and growth.

Working capital covers a wide range of dierent

reasons, including cash ow to fund growth, as wellas cash ow to cover unexpected expenses. Of thoseseeking working capital, there has been an increase inbusinesses seeking working capital to fund businessgrowth (33% up from 27% in 2014), which is consistentwith an expansionary macro-economic climate.

Whilst the overall proportion of businesses seekingnance for working capital has increased from 33% to53% of those seeking nance, there has not been adecline in the proportion of businesses with employeesseeking nance for assets as this remains at 38%of those seeking nance in 2015 compared to 2014.

Therefore, it is not the case that fewer employerbusinesses are investing than previously.

Recent ONS data supports the robust trends in businessinvestment as business investment has increased by6.6% compared to a year ago in Q3 2015.25 This wasthe fourth consecutive quarter of positive growth inbusiness investment.

The reversal in the reason for seeking nance has alsoled to a decline in the proportion of businesses seekingbank loans, which are predominantly used to fundassets. There has been an increase in the proportions

of businesses seeking grants and loan / equity fromfriends and other providers, which may explain some ofthe increase in nance sought seen in this survey, butnot seen in other data sources.


23/88


MAIN REASON FOR SEEKING FINANCE(LAST OCCASION IN LAST THREE YEARS)

FIG 1.9

Source: British Business Bank Fi nance Survey

20

30

40

10

60

%

50

W or k i n

g c a

pi t a l /

c a s h fl

ow

P ur c h

a s e

fi x

e d a s s e t s

S t a r t

b u s i n

e s s

B ei n

g

pr o

a c t i v e

E x

p a n

s i on

R efi n

a n

c i n

g

O t h er

2012

2014

2015

TYPE OF FINANCE SOUGHT(LAST OCCASION IN LAST THREE YEARS)Source: British Business Bank Finance Survey

10

15

20

5

30

35

%

25

B a nk

ov er d r a f t

C r e d i t c a r d

fi n a n c e

F a mi l y /

c ol l e a g u el o a n

B a nk l o a n/

m or t g a g e

T r a d e

fi n a n c e

A s s e t

fi n a n c e

E q ui t y

fi n a n c e

P 2 p

l en d i n g

L e a s i n g/ H P

G r a n t s

2012

2014

2015

BUSINESSES UNDERESTIMATE THE LIKELIHOOD OF

OBTAINING FINANCE, WITH A SMALL BUT SIGNIFICANT

PROPORTION BEING DISCOURAGED FROM SEEKING

FINANCE

Following the recession and on-going coverage of lendingconditions in the media, there remains a continued

perception amongst smaller businesses that banks arenot lending suciently. For instance, 55% of businessesperceive that it is fairly, or very dicult to obtain funding,a slight improvement from 58% in 2014. In 2015 smallbusinesses perceived that (on average) 38% of thosethat apply for bank nance were successful in gettingit, slightly lower than the level reported in 2014 (42%),but higher than levels reported in 2012 (32%). This isdespite the majority (over 70%) of smaller businessesthat actually applied for nance in the three years priorto 2015 getting the full amount requested from the rstprovider they approached (86% getting some nance).

Other survey evidence from the SME Finance Monitorsurvey shows 75% of SMEs aim to pay down debt andremain debt free, and less than half (44%) are happyto use external nance to help business growth.26 Thisconrms that many smaller businesses remain cautiousabout using external sources of funding.

A mismatch in perception remains and is likely to be abarrier holding some businesses back from applyingfor nance. A small but signicant proportion of thesesmall businesses are discouraged from applying fornance. The latest Brit ish Business Bank nancesurvey estimates this to be around 4% of all SMEs,

predominantly micro businesses.

FIG 1.10


24/88


1.5

SUPPLY SIDE – BANK LENDING

THE AVAILABILIT Y OF BANK LENDING FOR SMALLER

BUSINESSES IS IMPROVING

Bank lending remains the single largest form of lendingto smaller businesses, and thus developments in thissector have a major impact on SMEs’ access to nance.This section explores how bank lending has developed asthe UK economy continues to recover from the recession.Recent debate has focused on whether lending markets

are improving. The Bank of England noted in its Q3 CreditConditions Review27 that both its Credit Conditions Surveyand the Federation of Small Businesses Voice of SmallBusiness Index were consistent with reports from theBank’s Agents that credit availability for smaller rmshad increased, and was approaching normal, although itremained tighter than for other rms.

This section reviews the evidence, which supports theconclusion that small businesses bank credit marketshave improved over 2015. But accepting the argumentthat the cyclical impact of recession on credit availabilityhas retreated does not mean that structural problems

in the market have been resolved. Additionally, issuesaround the diversity of supply of nance are long-standing (see chapter 4 for discussion).

It has long been accepted that structural issues inaccessing nance markets exist, meaning that thereis a proportion of viable smaller businesses that areunderserved. Where a lack of information impedes a creditdecision, rms with limited track record or insucientsecurity are more likely to be denied bank loans oroverdrafts, because they are less able to demonstrate theviability of their business to banks. A restricted supply ofnance to viable businesses, caused by this information

failure, is likely to lead to lower levels of investment, andtherefore growth, by those businesses. In aggregate,this may lead to lower levels of economic output andemployment in the short and long-term.

• The availability of bank lending for smallerbusinesses is improving

• Gross lending to SMEs has exceededrepayments resulting in four quarters ofpositive net lending

• Use of overdrafts has stabilised, but SMEscontinue to strengthen balance sheets byincreasing deposits

• Latest research nds that the market for loansto smaller businesses remains concentrated


25/88


GROSS LENDING TO SMES HAS EXCEEDED REPAYMENTS

RESULTING IN FOUR QUARTERS OF POSITIVE NETLENDING

According to the Bank of England (BoE) bank lending data,the gross ow of loans (exc. overdrafts) to SMEs reached£53bn by the end of November, continuing the upwardtrend of recent years.28 Repayments have followed

a similar trend. However, gross loans have exceededrepayments in each of the last four quarters for which fulldata is available resulting in an increase in net lending.

LENDING TO MEDIUMSIZED BUSINESSES IS DRIVING THEIMPROVEMENT IN SME NET LENDING

Evidence from the BBA allows an analysis of ows ofbank lending within the wider SME, or smaller business,population. The data suggests that improvements inoverall lending to smaller businesses is much morepronounced among medium rms compared to thesmallest rms, where the value of quarterly gross termloans is yet to pick up and net lending remains negative.29

According to the BBA, the commercial real estate sector(CRE) accounts for around 29% of the stock of loans inSeptember 2015 for overall smaller business lending.Since at least late 2011, negative net lending in the formof term loans to CRE has dragged on overall net lendinggures for SME loans, as banks typically looked to reducetheir exposure to this sector. In general, this trend hasbeen less prominent in 2015 when net CRE lending hasbeen positive.

USE OF OVERDRAFTS HAS STABILISED IN 2015, BUT

SMES CONTINUE TO STRENGTHEN BALANCE SHEETS BY

INCREASING DEPOSITS

The value of outstanding overdrafts has been decreasingover time, as SMEs reduce their levels of debt. The declinein the stock of overdrafts seems to have slowed in 2015.According to SME Finance Monitor, in H1 2015 16% ofSMEs had an overdraft, compared with 26% in 2011, andapplications as well as renewals of overdraft facilities bySMEs have declined since 2011.30

Deposits however have continued to grow in 2015 as SMEscontinue to strengthen their balance sheets, supported

by positive trading conditions. In Q3 2015 80% of smallerbusinesses reported a prot in their latest trading periodand 23% of all smaller businesses held a credit balanceover £10,000 in 2015, up from 17% in 2011.31

QUARTERLY GROSS AND NET FLOWSOF BANK LOANS TO SMES

FIG 1.11

Source: Bank of England Bankstats table A8.1

6

4

2

10

8

14

16

12

2 0 1 1 Q 2

2 0 1 1 Q 3

2 0 1 1 Q 4

2 0 1 2 Q 1

2 0 1 2 Q 2

2 0 1 2 Q 3

2 0 1 2 Q 4

2 0 1 3 Q 1

2 0 1 3 Q 2

2 0 1 3 Q 3

2 0 1 3 Q 4

2 0 1 4 Q 1

2 0 1 4 Q 3

2 0 1 4 Q 4

2 0 1 5 Q 1

2 0 1 5 Q 2

2 0 1 5 Q 3

2 0 1 4 Q 2

Gross LendingRepayments

Quarterly lending to SMEs (excluding overdrafts)

Net Lending

-2,000

-1,200

-400

400

1,200

2,000

£ B

i l l i o n

£ Mi l l i on

NET LENDING TO MEDIUM AND SMALL SMES

FIG 1.12

Source: BBA SME Statistics: https://www.bba.org.uk/news/statistics/sme-statistics/

Q 3 2 0

1 1

Q 4 2 0

1 1

Q 1 2 0

1 2

Q 2 2 0

1 2

Q 3

2 0

1 2

Q 4 2 0

1 2

Q 1 2 0

1 3

Q 2 2 0

1 3

Q 3 2 0

1 3

Q 4 2 0

1 3

Q 1 2 0

1 4

Q 2 2 0

1 4

Q 3 2 0

1 4

Q 4 2 0

1 4

Q 1 2 0

1 5

Q 2 2 0

1 5

Q 3 2 0

1 5

-800

-600

-1000

-1200

-400

-200

200

400

0

600

800

1000

1200£millions

-800

-600

-1000

-1200

-400

-200

200

0

400

600

800

1000

1200

Net lending med - other sectors

Net lending med - CRE

Net lending small - other sectors

Net lending small - CRE Net lending all SMEs

Notes:

Loans exclude overdrafts. Commercial real estate sector refers to SIC code10a in BBA statistics: Buy ing, selling & renting own or leased real estate


26/88


This chapter so far has reviewed the latest evidence from2015 in small business nance markets. Overall ows ofnance have increased, with a rise in net bank lendingto smaller businesses and stronger growth in ows ofnance in areas such as asset nance and other debt

products.

The analysis of rejected loans applications suggeststhat a proportion of rejected businesses may potentiallybe viable lending opportunities, but that a lack of trackrecord or lack of collateral may have prevented them fromobtaining nance.

Economic growth is expected to continue with asignicant number of smaller businesses expecting togrow. Survey evidence suggests that, whilst awarenessof nance products in rising, eective demand wouldincrease if smaller businesses had more information and

understanding of how to obtain nance.This provides evidence for the Business Bank to continueto pursue its objectives. Existing programmes are alreadyhelping to reduce the extent to which potentially viablesmaller businesses have problems in accessing nance.However, the Business Bank will continue to developand rene its programmes to help address the gap inthe provision of debt nance. For example, in helping tosupport bank lending, the Enterprise Finance Guaranteecan continue to facilitate successful applications fornew lending and Help to Grow will enable expandingbusinesses to obtain nance where their proposition may

be considered higher risk for a commercial provider.

Furthermore, the continuation of the Start-Up Loansprogramme will help to ensure that funding is availablefor new businesses, where the lending proposition isinherently subject to greater risk, and sometimes beyondthe reasonable appetite of commercial lenders, but wherethe benets to the economy of these new starts aremeasurable.

STOCK OF OVERDRAFTS AND VALUEOF DEPOSITS, ALL SMES

FIG 1.13

Source: BBA SME Statistics

40

20

80

60

120

140

160

180

£ B

i l l i o n

£ B i l l i on

100

J ul -1 1

J ul -1 5

O c t -1 1

J a n-1 2

A pr -1 2

J ul -1 2

O c t -1 2

J a n-1 2

A pr -1 3

J ul -1 3

O c t -1 3

J a n-1 4

A pr -1 4

J ul -1 4

O c t -1 4

J a n-1 5

A pr -1 5

10

5

20

15

Stock of overdraftsDeposits

D e p o s i t s

S t o c k of ov er d r a f t s


27/88


1.6

SUPPLY SIDE - EQUITY FINANCE

Equity nance32 is used by a small proportion(around 1% in the previous three years33) of smallerbusinesses, but it is particularly important forstart-up businesses and business with high growthpotential. These businesses may be too risky or lacksecurity and track record for debt nance. Trendsin the dierent equity stages (start-up, ventureand growth) are explored in specic sections lateron in the report, but this section provides a brief

overview of how equity markets have changedoverall over the last year.

This section uses data from Beauhurst34 on the numberand value of published equity investments which coversa wider range of equity investors than just VC funds.35 It is important to acknowledge that a number of otherdata sources also cover equity investments including theBritish Venture Capital Association (BVCA) and InvestEurope. These predominantly measure the investmentactivities of their members, which are mainly comprisedof private equity and venture capital funds.

Therefore, the data sources have dierent coverage ofinvestors and are not always consistent with one another.There are likely to be dierences in observed trends andscale of investments. For instance:

• BVCA shows a decline in the value of funding

between 2011 and 2014, but funding is increasing

in the Beauhurst data, which is due to the presence

of other equity investors like crowd funders and

business angels. Beauhurst data shows a decline in

the number of investments made by Private Equity/

Venture Capital funds bet ween 2011 and 2014, which

is consistent with the wider trends seen in the BVCA

data.

• In fact the proportion of deals involving private equity

funds declined from 56% of the total equity market

in 2011 to 30% in Q1-Q3 2015 showing the increasing

importance of other providers in the equity market.

The other consideration for explaining some of the

trends in the BVCA data is that BVCA membership has

declined between 2007 and 2014, so that fewer deals

are picked up in the gures.

• It is important to acknowledge that Invest Europe

investment volumes are originally derived in Euros and

are converted back to Sterling at current exchangerates. This may obscure underlying trends due to

exchange rate movements. However the Invest

Europe data does tell a similar story to the Beauhurst

data, with activity in the later stage VC relatively weak,

but early and growth stages are increasing.

COMPARISON OF TRENDS IN DIFFERENT EQUITY DATA SOURCES

FIG 1.14

Source: BVCA, Invest Europe and Beauhurst

£1,000

£1,500

£2,000

£500

Investment per year (£m)

£2,500

BVCA

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

Invest Europe Beauhurst

Growth capital

Later stage VC

Early stage VC

• The volume of equity investmentis increasing in 2015 with increasesseen in all stages of funding, butis particular driven by increasedventure stage nancing

• The UK performs relatively well interms of VC activity compared to rest

of Europe, signicantly lags behindthe US


28/88


• BVCA also shows a decline in growth capital between

2011 and 2014, which is not seen in the Invest Europeand Beauhurst data. Growth capital investments are

very volatile due to the small number of very large

deals. It is possible that dierences in the way deals

are classied may explain some of this divergent trend

with some of the BVCA later stage VC deals falling

under Beauhurst’s denition of growth stage.36

The British Business Bank has used data from Beauhurstto explore detailed trends in equity markets in the UK.This is because Beauhurst has a wider coverage ofinvestors beyond VC/ PE funds and also because the datais available at the micro investment level, allowing more

detailed analysis. BVCA and Invest Europe data is onlyavailable at an aggregated level.

However, the Beauhurst data presented includes onlypublished deals, but many deals are not formally madepublic by their investors.37 This therefore means thatthe Beauhurst data (alongside other data sets) does nothave complete coverage of the total equity market. Forinstance, the UK Business Angel Association estimates

that private investors account for between £800 millionand £1 billion of early stage investment each year in theUK – the single largest source of early stage capital in thiscountry.38

THE VOLUME OF EQUITY INVESTMENT IS INCREASING IN2015 WITH INCREASES SEEN IN ALL STAGES OF FUNDING,

BUT IS PARTICULAR DRIVEN BY INCREASED VENTURE

STAGE FINA NCING

Overall, UK equity markets have performed well over 2014with increased number and value of investments and haveperformed even more strongly over the rst three quar tersof 2015. Beauhurst data shows 870 equity deals in Q1-Q32015 compared to 779 in the same quarters in 2014, a 12%increase by number. In value terms for known investmentamounts, the increase seen in the rst three quarters of2015 is even greater at 43% compared to the same timeperiod in 2014. The total investment volume for the rstthree quarters of 2015 (£2.4bn) already exceeds the totalfor 2014 with one quarter gures still to go.

Whilst the increases in venture stage funding have beenrelatively low between 2011 and 2014, venture stagenancing has also seen a large increase in 2015. Venturestage nancing increased by 118% compared to therst three quarters of 2014. The rst three quartersdata (£882m) exceeds 2014 whole year gures (£595m),suggesting 2015 will be a very strong year for venture

category overall. This is explored further in the venturesection but caution is needed as it is being distortedby a small number of pharmaceutical companies withdeal sizes signicantly exceeding £10m. In fact onepharmaceutical company received funding of £205m in

NUMBER OF EQUITY DEALS AND VALUE OF INVESTMENT OVER TIME

EQUITY DEALS INVOLVING VENTURE CAPITAL/PRIVATEEQUITY

FIG 1.15

FIG 1.16

Source: Beauhurst

Source: Beauhurst

100

50

200

150

300

350

250

2 0 1 1 Q 1

2 0 1 1 Q 2

2 0 1 1 Q 3

2 0 1 1 Q 4

2 0 1 2

Q 1

2 0 1 2

Q 2

2 0 1 2

Q 3

2 0 1 2

Q 4

2 0 1 3

Q 1

2 0 1 3

Q 2

2 0 1 3

Q 3

2 0 1 3

Q 4

2 0 1 4 Q 1

2 0 1 4 Q 3

2 0 1 4 Q 4

2 0 1 5

Q 1

2 0 1 5

Q 2

2 0 1 5

Q 3

2 0 1 4 Q 2

Deals all equity providersDeals involving PE/VC

N u m b e r o f e q u i t y d e a l s p e r q u a r t e r

100

50

100

200

300

400

500

600

700

800

900

1,000

200

150

300

350

250

2 0 1 1 Q 1

2 0 1 1 Q 2

2 0 1 1 Q 3

2 0 1 1 Q 4

2 0 1 2 Q 1

2 0 1 2 Q 2

2 0 1 2 Q 3

2 0 1 2 Q 4

2 0 1 3 Q 1

2 0 1 3 Q 2

2 0 1 3 Q 3

2 0 1 3 Q 4

2 0 1 4 Q 1

2 0 1 4 Q 3

2 0 1 4 Q 4

2 0 1 5 Q 1

2 0 1 5 Q 2

2 0 1 5 Q 3

2 0 1 4 Q 2

InvestmentDeals

N u m b e r o f e q u i t y d e a l s p e r q u a r t e r

V a l u e of e q ui

British Business Bank Small Business Finance Markets Report 2015 16

Documents

Transcript of British Business Bank Small Business Finance Markets Report 2015 16