Challenges for SMEs in seeking finance
Challenges for SMEs in seeking finance
The key challenges that SMEs face when seeking finance, including venture capital, have been widely researched and reported in the academic literature and professional press for many countries, including the UK. Such challenges include: not knowing which types of finance to access and the pros and cons of each (friends and family, bank finance, business angel finance, crowdfunding, VC, corporate VC, leasing, invoice discounting, AIM etc), the availability of such finance, how to access the finance and who are the providers of such finance. SMEs may also suffer from a lack of positive trading history, lack of cash flow to service debt, no security for debt nor willingness to offer personal guarantees for debt, lack of evidence for market growth projections and unfamiliarity with how to prepare realistic business plans for the purpose of raising equity finance.
Scale-up and VC
According to the BVA BDRC SME Finance Monitor Q4 2022, published in March 2023, 36% of SMEs used external finance in 2022, with 1 in 3 of them borrowing more than £25,000. 15% of all SMEs were using more external finance in that period than they were pre-pandemic, and this typically increased concerns about repayment. The proportion of SMEs that felt that it could be difficult for them to raise external finance has reduced from around 4 in 10 in previous years to 3 in 10 in 2022. The SME Finance Monitor reports that smaller and younger SMEs, and, perhaps counterintuitively, those in certain sectors such as Health and those already using external finance were more likely to feel that they would struggle to get finance.
According to the “Scale-Up Index 2022” (by Beauhurst and the Scale-Up Institute) there was £43.5bn total value of equity investment into visible scale-ups (those capable of identification as scale-ups) in the 10 year period 2012-2021. At the end of 2020, according to ONS data, there were 33,955 scale-ups in place, contributing £1.2 trillion to the UK economy. This represents over 50% of the value of the UK SME community despite these companies making up less than 0.6% of the SME population. They are the UK growth champions, employing over 3 million people.
So money is going into scale-ups, but is this enough and is it coming from sources of finance in the UK or overseas?
The British Business Bank had publicly backed 79 equity investors as of September 2022, 62 of which have invested in one or more visible scale-ups since 2011. The Business Growth Fund had participated in 128 equity deals into visible scale-ups, Crowdcube 76, Seedrs 60 and VCs: Balderton 58, Octopus 54, Index Ventures 52, Accel 41, Notion 40, Molten 38 (Beauhurst / Scale-Up Institute).
In my PhD research (Arundale, 2018) I noted that the US VC funds in my sample were considerably larger than UK and continental European funds. The larger size of US funds is consistent with previous studies (Lerner et al. 2011) and better permit US VCs to fund entrepreneurial businesses through scale-up to exit and provide the human capital for optimal investment practices. European VCs often do not have the finance available in the proportionately smaller funds in Europe compared to US to be able to follow-on with the initial investments: “In the US, if you start a company, you have an odds on chance of raising more money. In Europe, the single biggest risk of starting a new company is only one in five get further money, no matter how good you are.” (UK VC).
There is more finance available to fund innovative ventures in the US with Europe consistently suffering from a shortfall of venture finance (Aeronoudt, 1999 and 2017). My interviewees commented that Europe “suffers” due to its smaller funds as this results in difficulties in supporting follow-on rounds and in scaling (Coutu, 2014). Lack of funding was seen to be more of an issue at the later stage investment rounds, ie for scale-up, than at seed and early stages.
A number of my VC interviewees commented on the difficulty of scaling in Europe as one of the key differences between the European and US VC environments: “There is no single national market in Europe that is either an earlier adopter market for technology or has sufficient scale to be able to support a good sized business. Whereas, in the US you have both an early adopter market and one at scale.” (UK VC). A continental European VC commented that it is harder to scale companies in Europe as three key ingredients are missing viz: “One, a very big country where you can scale a business much faster and much more easily. Second, there can be tons of money invested in companies to scale them; and third you can find managers with outstanding scalability capabilities”. BVCA Committee members believed that the lack of ability to scale in UK / Europe is the most important issue in the difference between the UK and US environments. The smaller and fragmented markets in Europe and a shortage of expansion finance do not permit effective scaling.
At the BVCA High Growth Conference in June 2023 there were many VC firms speaking that have been formed in recent years, including Love Ventures, Stride, January Ventures, True Ventures, Kindred Capital Edge Investments as well longer established VC firms such as Molten Ventures (formerly Draper Esprit), MMC, Balderton, Notion and Beringea. It is encouraging that the number of VC firms in the UK has increased considerably over the past 10 years or so. So there should be more finance available for both start-ups and scale-ups. According to Beauhurst there are 327 VC funds in the UK; 263 of these (80%) are in London. Comments from the VC speakers at the BVCA conference on the current climate for VC included that it is taking longer to raise funds. VC fund sizes are smaller due to concerns in deploying those funds. Investments are back to 2019 levels (Beauhurst); the climate feels like 2001/2 ie the crash post dot com era. Beringea commented that companies typically go to USA for Series B, ie to scale-up, echoing comments by Hermann Hauser, co-founder of Amadeus Capital that “Europe doesn’t have a start-up problem; we produce more start-ups than the US. Europe has a scale-up problem and a deep tech finance problem”.
It is encouraging that the Mansion House Compact was signed just prior to the Chancellor’s Speech at Mansion House on 10 July whereby defined contribution pension funds are committed to allocating at least 5% of their funds to unlisted equities by 2030. In the USA Calpers, with it $442bn public pension scheme, is planning a multibillion dollar push into international VC in the hunt for higher returns from riskier asset classes. Calpers is planning on increasing the current 1% allocation to VC of its private equity portfolio to a low double digit percentage (Financial Times, 9 June 2023).
Should the Government do more?
First we should distinguish between those SMEs that are the potential high-growth companies of the future that will be in need of scale-up finance and those that are small, lifestyle businesses with no ambition for significant growth. It is the former that need Government support.
UK Government could:
1) Extend and enhance the British Patient Capital £2.5m Fund to allow more funding for UK VC funds to enable larger fund sizes for scale-up.
2) Enhance access to funding by SMEs as entrepreneurs may not be aware of sources of funds. The British Business Bank’s Finance Hub is a good start here in pointing companies seeking finance towards Local Enterprise Partnerships, Growth Hubs, Chambers of Commerce, investment networks and advisers in their regions.
Dr Keith Arundale
22 July 2023
