How government can unlock funding for UK entrepreneurs
The funding picture for SMEs is mixed: while access to traditional bank loans has been limited since the global financial crisis, we’ve seen a dramatic increase in equity investment – up from £1.6bn in 2011 to £12bn in 2019.
SMEs have benefitted from the rise of alternative finance. Over £2bn is lent through P2P lenders and close to 400 equity crowdfunding deals take place in the UK each year.
However, many entrepreneurs fail to access the finance they need. The best available data suggests almost one in ten (9.1%) of SMEs are discouraged from seeking external finance.
This causes an estimated £1.5bn in lost investment by SMEs (£11,773 per discouraged business). As a result, fewer jobs are created and businesses can fail unnecessarily.
Unlocking Growth, a new report from The Entrepreneurs Network and The Enterprise Trust, highlights a range of policies to ensure more entrepreneurs can access the finance they need. These include:
Reforms to make it easier for pension funds to invest in venture capital to enable more of the UK to benefit from equity investment.
Better mentoring for Start Up Loans to address why too few seek external finance again once their loan has been repaid.
Streamlining the process to access tax-relief on investments in early-stage firms to avoid unnecessary cashflow crunches.
Although the financing options and tax incentives open to UK SMEs are improving year-on-year, almost one in ten small businesses are still not seeking the external capital that would allow them to grow, a new report reveals.
Unlocking Growth: How to Expand Access to Capital, a joint report from The Entrepreneurs Network and The Enterprise Trust, evaluates the funding options open to SMEs – from Start-Up Loans and grants to equity crowdfunding and peer-to-peer lending. The report identifies policy changes that will ensure businesses can access the finance they need to grow.
While traditional lending is down, according to the British Business Bank, the bank is still the first port-of-call for SMEs seeking finance. It’s only once entrepreneurs have been turned down by the bank that they investigate other types of lending, including equity investment. These alternative forms of finance are effectively filling the gap.
According to Beauhurst, the demand for equity investment via venture capitalists has exploded. In 2011 the figure stood at £1.6bn; last year it reached £12bn.
Despite this, figures suggest 9.1 per cent of all SMEs fall into the category of so-called ‘discouraged borrowers’, businesses with a real need for finance, who fail to apply due to fear of rejection, a belief that raising capital would be too expensive, or concerns the process would be too difficult or time-consuming.
This leads to an estimated £1.5bn SME investment shortfall, or £11,773 for each discouraged firm.
It also leads to fewer jobs and weaker economic growth through a lack of investment in workforce skills, investment in new technology, and investment in international expansion.
Joy Foster, founder of TechPixies, a digital training firm for returning women, raised £150,000 through EIS and SEIS, but admits she almost didn’t and considered walking away because she was daunted by the amount she needed to raise with ‘no guarantee’ she could pay it back..
Similarly Francis Toye, founder of justice software firm Unilink describes not knowing how to grasp opportunity until he joined the Goldman Sachs 10,000 Small Businesses programme and raised £1m through Funding Circle and then another £7m through defined payment terms.
This report makes the case for key policy changes that would unlock new funding opportunities for entrepreneurs including increasing VC capital flow by reforming the way defined contribution pension funds invest or fast-tracking EIS and SEIS applications.
Increasing mentoring to Start Up Loan recipients, who tend to be among those described as ‘discouraged borrowers,’ could also help deliver growth.
Richard Harpin, founder of the UK’s leading home repairs and improvements business HomeServe and new ‘think and do tank’ The Enterprise Trust, said:
“All evidence points to the fact that businesses that take on investment at key moments in their growth trajectory do dramatically better than those that don’t.
“These founders go on to create jobs, generate taxes and contribute to UK economic growth.
“Yet, navigating the funding sphere has often become so difficult that it has left nearly 10% of founders discouraged from raising the finance they need to survive and thrive.
“It’s clear that finance is out there, with a dramatic uptake in Start Up Loans, equity finance and crowdfunding. However, it is also clear that this capital is not always getting to where it needs to be. We need to change that.”
Sam Dumitriu, Research Director of The Entrepreneurs Network and author of Unlocking Growth: How to Expand Access to Capital
“By helping small businesses manage cashflow, invest in better equipment, and expand into new markets, access to the right type of finance can be transformational.
“The meteoric rise of alternative finance and VC should be celebrated, but still too many businesses fail to access the finance they need to grow.
“Reforms to reduce wait-times for early-stage investment tax reliefs and allow pension funds to invest more in venture capital will allow more businesses across the UK realise their growth ambitions.”
Policy recommendations:
Experiment with lottery-style funding to channel more grant-funding to start-ups. New Zealand’s Health Research Council uses this approach to allocate funding to proposals that are “transformative, innovative, exploratory or unconventional, and have potential for major impact” and it works well.
Simplify and modernise Research & Development Tax Credits by providing better feedback for applications and expanding the score of activities that qualify as R&D. It could be improved on three fronts: feedback, speed, and scope. Solving these problems would enable more start-ups to benefit from the relief and reduce the risk of theirs turning to specialist tax credit advisers who can take up to 25% of the relief claimed.
Make data sharing obligatory for incubators and accelerators receiving public funding. This will allow us to identify the most successful programmes, and better understand why they work. It will also allow us to identify the schemes best at expanding access to entrepreneurship among disadvantaged or under-represented groups.
Improve the mentoring offer for Start Up Loans by providing additional advice when businesses finish paying their loans. The programme’s evaluation found high numbers of discouraged borrowers among participants.
Streamline the advanced assurance process for EIS and SEIS to unlock more investment in high-growth start-ups so businesses using the pre-approved documentation could be fast-tracked and delivery more efficient.
Unlock additional investment into venture capital from defined-contribution pensions by reforming the fee cap and clarifying rules on the valuation of illiquid assets. In the US, VCs invested more than 10 times as much as UK VCs in 2017. This is partly explained by the impact of pension fund investment in venture capital. In the US, VCs are overwhelmingly (98%) funded by institutions such as pension funds, insurance companies, and endowments. Pension funds play a much larger role in the US. They contribute 65% of the capital in the US VC market and 18% in Europe, but just 12% in the UK.
Provide more long-term patient capital through the British Business Bank. The government should encourage the British Business Bank to investigate if funds can be better directed towards solving market-failures. For instance, there may be a case for prioritising investments in regions under-served by venture capital or tying funding from the BPC to support for start-up community building, such as training for emerging fund managers.
Case studies
Francis Toye, founder Unilink
Unilink is a medium-sized software company with 150 staff and is set to become the leading European and possibly world supplier of justice offender management software havingwon a contract with the Norwegian Justice Ministry in June 2019.
“Fundamentally I felt that we had plenty of opportunities, but that we did not know how to grasp them and had reached a point where the business was stagnating and not growing fast enough,” Toye says. “I was quite frustrated trying to find a way to grow the business. Although I made a reasonable salary each year, the business could be described as a ‘lifestyle business’ making a nice living for the owners rather than one that would change the world. Looked at as an outsider, I had taken a massive risk in starting a business, but I had much to learn needed to get out of the rut we were in.”
Toye used his savings and borrowed from his family to start the business. He joined the Goldman Sachs 10,000 Small Businesses programme and borrowed £1m from Funding Circle, 75% of which he has repaid, and borrowed £7m from the sellers of a business that it purchased: defined payment terms over a period of time. “Today we owe about £3.5m which will be repaid over the next two years but we are considering more finance to increase our R&D spending to develop new riskier ventures.” he says.
Joy Foster, founder Tech Pixies
Joy Foster secured just under £150,000 through seven investors in 2018 so she could grow her Oxford-based firm TechPixies – the majority through SEIS, and the rest through EIS.
But it almost didn’t happen. Had she not stumbled upon Adelpha, the angel investment advisory service run by Addie Pinkster, she might have walked away from the fledgling business altogether. “I was quite daunted by the amount of money I would have to borrow and repay with no guarantee of knowing whether I would ever be able to get where I wanted to be,” she says. “I happened to meet Addie at an event and decided to ask Adelpha’s advice.
“It was then that Addie said to me ‘You are investable, your business is investable, you are fantastic, you can do this.’ I realised I’d been going for so long on my own that I’d lost sight of why TechPixies was important and what potential it had.”
To find out more detailed recommendations
For more details contact
Liz Slee
The Enterprise Trust
T 07540060112
liz.slee@enterprise-trust.co.uk.
Philip Salter
The Entrepreneurs Network
T 07919 355290
philip@tenentrepreneurs.org
About the Enterprise Trust
The Enterprise Trust was launched in 2011 by Richard Harpin, the entrepreneur behind the UK’s leading home repairs and improvements business HomeServe, now a FTSE 250 company valued at more than £4bn. The charity is run by Helen Booth and aims to create an impact and leave a legacy by helping individuals from all backgrounds to realise their potential as independent wealth generators. In 2020 the charity launched a research arm to extend its reach and provide important insight, new thinking and evidence-based problem-solving around the key issues affecting the UK’s small business community. www.enterprise-trust.co.uk
About The Entrepreneurs Network
The Entrepreneurs Network is a think tank for Britain’s most ambitious entrepreneurs. It supports entrepreneurs by: Producing cutting-edge research into the best policies to support entrepreneurship; Campaigning for policy changes that will help entrepreneurship flourish; Hosting regular events to bridge the gap between entrepreneurs and policymakers; Updating entrepreneurs on how policy changes will impact their business; Making the case in the media for entrepreneurs’ contributions to society. It is also the Secretariat of the APPG for Entrepreneurship, which was set up to encourage, support and promote entrepreneurship and to engage with entrepreneurs; and to ensure that Parliament is kept up to date on what is needed to create and sustain the most favourable conditions for entrepreneurship.
Additional quotes
Francis Toye, Founder, Unilink on the Goldman Sachs 10,000 Small Businesses programme “The best thing of all is meeting other like-minded entrepreneurs. They are inspirational! Learning that you have the same problems and that you have a group with whom you can share them is brilliant. When asked what was the biggest thing he learnt: “Sounds basic but if you want to grow a business you have to work really hard. When I saw how much harder other people were working I tried to match them.”
Paul Adrian founder, MOJO Hair on invoice financing
“We gained listings in 300 Sainsbury’s stores and I needed to pay my suppliers and buy more stock asap, so the opportunity to get hold of my own cash in 48 hours and not wait 60 days was a no brainer! In addition, the process was easy to understand and incorporate into the business. Many of the big retailers now see invoice financing as a natural process of doing business with them and there is nothing better than having cash in the bank as opposed to waiting 45-60 days for it,”
Tammy Kolowski, Co-Founder, NAF! STUFF on securing the Scottish Edge grant
“I’d urge anyone out there looking for funding to look into your options and shop around. I used to use instant loans as a quick and easy option, and I was always scared of “answering to someone” or getting feedback about my business plans. Those loans worked for me at the time but the interest was high and I didn’t quite understand the value of taking the time to assess how the funding (and possible repayments) would impact my business in the future.”
“Funding takes time because you need to sit down and form a plan, think ahead, challenge your ideas and be challenged – the process of competing in Scottish Edge forced me to step back and take the time to analyse how my business was running, form a plan, and evolve. It isn’t always just about the money and a lot of the time you realise you need more or even less than you initially thought. I thought I needed £25,000 at first, but after figuring out the direction I wanted to go in and getting final costings back from our manufacturer we actually needed to go for the full £100,000.”
Randa Bennett, Co-Founder, Veeloop on raising equity finance from angel investors
“We got a six-figure angel investment from one high-net-worth angel investor. We were personally introduced to him by someone he trusted, who’s a serial entrepreneur himself and had built a very strong network over the years. We had one meeting with this investor that lasted an hour and a half and he transferred the money within a week of meeting us.”
“We realised that there is this circle of high-net-worth angels that we’ve just started to tap into after three years of trying. Both myself and my co-founder are immigrants to the UK so we had to build every contact we have and gain trust over the years. We are only now starting to get the right introductions.”
Joy Foster, Founder, Techpixies on raising through angel investors
“I’d been very ill with a serious chest infection earlier that year, partly because the business was not moving in the direction it needed to. In fact, it was on its knees. I was not my usual, optimistic self and, as a consequence, I felt I had no choice but to let people go. It was crushing. During those awful meetings, every single member of staff totally understood – but they all told me I had to save the business, one way or another.
“[The angels] helped me develop a rock solid financial model. Once I had that in my hand and my pitch was rehearsed to the last detail, I knew I was ready.”
All her investors were female investors or female/male partnerships. Along with the investment comes an all-female board of advisers who are there to provide support and guidance every step of the way. “TechPixies is no longer considered a social enterprise in its purest sense, it is a commercially viable business with a good purpose, and that is just fine with me.”
Richard Mabey Co-Founder, Juro on raising venture capital
“Given our product ambition, we knew we would need a heavy R&D spend to ensure we really executed in the right way on the product before commercialising it. Now that the market we are in is seeing significant growth, the funding also allows us to grow headcount far faster than we could if we were bootstrapping from revenue.
Mabey says Juro’s VCs have been great, and help them in 3 main ways:
Strategy: “Ensuring we keep a laser focus on execution and challenging us as founders of our strategic thinking, both in and out of board meetings.”
Customer intros: “We have closed significant revenue from introductions made to prospects and fellow portfolio companies.”
Exec hiring: “Getting their hands dirty in interview processes and helping us to focus on who to hire and when.”
When asked about the concern of losing control of losing control of the business, Mabey says there are trade-offs. “Giving up governance rights and board seats is often one. I’d come back to the point of finding the right partner. If they are not the right partner, you should be very concerned about giving up control; if they are the right partner, it’s less of a concern. Stepping into their shoes, VCs deploy large amounts of capital at eye-watering valuations and so it’s ok to accept governance protections, provided they are reasonable.”
Jacob Thundil, Founder, Cocofina on raising peer-to-peer finance
Thundil hasn’t raised money through a bank. “It seems like a huge ask even for an established business such as ourselves. When we recently asked for a small bank guarantee to provide to HMRC our relationship manager discouraged us by saying that they needed to run credit checks etc. when they have the whole history of trading over the last 15 years right in front of them.”
Cocofina raised £100k through a peer-to-peer lender. “There was a more open conversation and feedback compared to a mainstream bank, which might not want to have a transparent dialogue on the qualification criteria.”