Written evidence submitted by the British Business Bank (RDE0070)

 

Executive summary

 

  1. SMEs play a vital role in driving growth across less productive regions of the UK. For new businesses to grow, they need awareness of and access to a variety of financing options.

 

  1. The Bank’s research shows there are significant regional imbalances across the UK in access to finance for smaller business, particularly for equity deals. London dominates, accounting for a disproportionate volume of supply (by value and number of deals) compared to the number of high growth firms who are the main ‘consumers’ of this type of finance. Regional variations in demand (awareness of finance type and finance provider) are also apparent, reinforcing London’s dominance.

 

  1. In the Bank’s view, such imbalances can hamper the ability of businesses to fulfil their growth ambitions and as a result is one factor that contributes to and reinforces disparities in productivity and growth between UK regions.

 

  1. The British Business Bank has recently started to focus on building local finance ecosystems and existing clusters of activity outside of London and the South East so that, over the long-term, private sector activity in these areas becomes self-sustaining without public intervention. To date, in many areas outside London and the South East a significant proportion of equity investments include some public involvement given thinner private markets for this form of finance.

 

  1. To meet its mission of making finance markets work better for SMEs, the Bank’s activities cover the whole of the UK. Recognising however there are specific issues in some areas of the market, the Bank is undertaking a range of either partially or entirely regionally focussed activities both in terms of supply of finance and in addressing the demand for finance amongst SMEs. They are outlined below.

 

  1. Supply:

 

  1. Demand:

 

About the Bank

  1. The British Business Bank (the Bank) is a government-owned economic development bank. We aim to make finance markets for smaller businesses work more effectively, allowing those businesses to prosper, grow and build UK economic activity. The Bank has a single shareholder, the Secretary of State for Business, Energy and Industrial Strategy (BEIS). On her behalf we manage the UK Government’s access to finance programmes for smaller businesses, within a single commercially-minded institution, supporting Government initiatives such as the Industrial Strategy. The Bank received State aid clearance to start operating in November 2014.

 

  1. The British Business Bank is not a bank in a conventional sense. We work on a wholesale basis through the market to provide funds and guarantees to private sector partners, enabling them to finance a greater number of smaller businesses (either through debt or equity). The Bank uses economic evidence to design programmes that address market failures and gaps affecting smaller businesses across the economy, crowding in and not crowding out private sector activity, with the aim of allowing us to exit these markets once failures have been addressed. We also work to improve smaller businesses’ awareness of the finance options available to them.

 

  1. From the start of the financial year 2018/19, the British Business Bank has six strategic objectives against which it measures its success:

 

Objective

Delivery to date

1. Increase the supply of finance available to smaller businesses in areas where markets do not work effectively.

As at the end of 2018/19, the Bank had

£6.6bn of stock of finance supported, an increase of 27% from £5.2bn the previous year. We are currently supporting over 89,000 businesses.

2. Help create a more diverse market for smaller business finance with greater choice of options and providers.

92% of British Business Bank-supported finance is currently being delivered via non- major (‘big-5’) banks (as at December 2018).

3. Encourage and enable SMEs to seek the finance best suited to their needs

69% of SME survey respondents found the information they were looking for on finance options through the Bank. 74% found the information useful and 77% would recommend the Bank’s site to other people.

4. Manage taxpayer resources efficiently and within a robust risk management framework.

The British Business Bank achieved a 3.6% adjusted return on capital employed in 2018/19.


5. Be the centre of expertise on smaller business finance in the UK, providing advice and support to Government

New for 2018/19, to be reported in future briefing.

6. Identify and help to reduce imbalances in access to finance for smaller businesses across the UK

New for 2018/19, to be reported in future briefing.

 

Q: What are the most significant regional imbalances in the UK i.e. is it the imbalance between London/southeast and other regions; between towns and cities; or between urban and rural areas? How have these imbalances changed in the past decade (and potentially longer) and how are they likely to change in the future?

  1. Bank research has consistently identified the principal divide within UK finance as being one between London and the rest of the UK. More so than a general urban/rural or town/city imbalance, this gap between London and the regions stands out across all Bank data. It is clearest in equity finance where London received 59% of equity investment in 2018, a much higher share than the 20% of high-growth businesses that are in the capital (Table 1).

 

  1. London also accounts for the majority (53%) of the value of investment through the Enterprise Investment Scheme often used by Angel investors. Conversely, despite being home to 8% of UK high growth businesses, the West Midlands only saw 3% of the value of the UK equity deals. Similarly, the South West only saw 5% of the value of UK equity deals, despite being home to 8% of UK high growth businesses.

 

Table 1 Equity investments and Business Population shares1

 

Region

UK Deal Share (2018)

UK

Investment Share (2018)

UK              SME

Share (2018)

UK High Growth Businesses Share (2017)

Deals              per

100              HGB (2018)

Deals per 10,000 SMEs (2018)

London

46%

59%

19%

20%

28.1

6.8

South East

9%

8%

15%

15%

7.3

1.6

South West

4%

5%

10%

8%

6.2

1.2

East Midlands

1%

1%

6%

6%

2.7

0.6

West Midlands

3%

3%

8%

8%

4.1

0.9

East              of

England

7%

12%

10%

10%

9.6

2.1

Yorkshire and

Humberside             

4%

2%

7%

8%

6.0

1.5

North East

3%

4%

3%

3%

13.4

3.1

North West

6%

3%

10%

10%

7.2

1.8

Northern

Ireland             

1%

0%

2%

2%

6.6

1.4

Wales

4%

1%

4%

4%

14.3

3.6

Scotland

10%

3%

6%

6%

19.8

5.0

UK              Excluding

London             

54%

41%

81%

80%

8.2

1.9

UK Total

100%

100%

100%

100%

12.1

2.8

Source: ONS, BEIS, British Business Bank analysis of Beauhurst

 

 


1 Taken from BBB (2019) Small Business Equity Tracker: https://www.british-business-bank.co.uk/wp- content/uploads/2019/06/Small-Business-Equity-Tracker-2019.pdf


  1. Even within London there is considerable unevenness. For example, the City of London received 19% of London equity investment in 2018, more than triple the 5% share of investment received by the 20 Outer London boroughs combined. This is despite the combined Outer London boroughs having over ten times as many SMEs as the City of London.

 

  1. Imbalances can also seen in other regions, where there are equity hotspots in cities like Cambridge, Edinburgh and Manchester (Figure 1). These regional hubs of equity investment play important roles for UK firms but nevertheless a clear divide remains between London and elsewhere.

 

Figure 1 UK Equity Deals in 2018


 

 

 

Source: British Business Bank analysis of Beauhurst, Contains both Ordnance Survey and ONS Intellectual Property Rights © Crown copyright and database right 2019


  1. London is also home to a far greater array of venture capital (VC) investors than any other region or devolved nation within the UK. In 2019 there were around 370 unique equity investors in London whose primary strategy was VC. For comparison, the East of England, Scotland, the South East and North West all had 20 to 30 each while the other regions and devolved nations had fewer than 10 each.2

 

  1. Similar imbalances exist with regards to demand for finance. Particularly for equity and growth finance. 74% of SMEs in London were aware of venture capitalists, whilst areas such as the North or Midlands had awareness rates of 67% and 66% respectively.3 Similarly, 47% of SMEs in London are aware of business angels as a form of raising external finance, whilst only 39% of SMEs in the North and 35% of SMEs in the Midlands were aware.4 This shows clear gaps between SMEs based in London and the South East and elsewhere in the country.

 

  1. Through its role as the UK’s development bank, the British Business Bank has been working to tackle these well-documented disparities. The Bank has a specific objective to identify and help to reduce imbalances in access to finance for smaller businesses across the UK.

Q: How do imbalances present themselves in the UK, in terms of growth, wages, employment and other indicators?

 

  1. The British Business Bank is not best placed to respond to this question.

 

Q: What are the main drawbacks of having significant regional imbalances?

  1. Ensuring that businesses with growth potential and aspiration can access the finance they need is important for long-term UK competitiveness. Through providing competition and introducing innovations to markets, SMEs can play a vital role in driving growth across less productive regions of the UK. SMEs, high growth or not, are significant contributors to every sector and every region of the UK economy, and are central to generating new jobs and productivity gains.

 

  1. The evidence suggests that smaller businesses with growth aspirations are more likely to achieve those growth plans if they make use of external finance and where use of equity finance can be particularly important to fund such growth ambitions. Unfortunately, as set out earlier the SME finance picture is not consistent nationally with notable imbalances around equity finance. As illustrated earlier, understanding and use of both equity and debt finance varies from region to region, and often significantly within regions. London and the South East is dominant in a range of measures: it accounts for a disproportionately large share of SME finance supply and its SMEs’ have the highest levels of knowledge and understanding the financing opportunities available to them.

Q: To what extent can regional imbalances explain the UK’s poor productivity performance?

 

  1. The Bank’s view is that regional imbalances in access to finance can hamper the ability of businesses to fulfil their growth ambitions and as a result contributes to and reinforces disparities in productivity and growth between UK regions. The government’s Industrial Strategy makes a similar case in reference to its ‘Places’

 


2 Taken from BBB (2019) Small Business Equity Tracker, BBB analysis of Pitchbook, excluded government investors

3 The British Business Bank Finance Survey

4 The British Business Bank Finance Survey


foundation. A variety of factors drive these disparities and will require a range of policy levers and co-ordinated action to address the underlying issues.

 

  1. In addressing regional imbalances in access to finance, the Bank’s approach has not been simply to divert funding away from London and the South East. Instead, our focus has been on building local finance ecosystems and existing clusters of activity outside of London and the South East so that, over the long-term, private sector activity becomes self-sustaining without public intervention.

 

  1. One way that leading productivity researchers analyse aggregate productivity growth is by looking at the roles played by firm entry, firm exit, within-firm changes and across-firm changes.5 External finance can influence all of these productivity growth channels, so the existing disparities seen in finance conditions within the UK have a role in explaining productivity differentials between London and the rest of the UK.

 

  1. Clearly finance is not the only force behind regional productivity differences, but the Bank has a wealth of understanding of how finance can impact productivity growth that we use to help design our programs (Figure 2).

 

Figure 2 The role of finance in productivity growth channels6

 

  1. The Bank is committed to adding to our evidence base on how our programs help alleviate these problems and benefit the UK as a whole. A recently published early assessment has shown that Northern Powerhouse Investment Fund (NPIF) funding has

 

 


5 This is the Haltiwanger decomposition, see Harris and Moffat (2012) for an explanation: http://www.spatialeconomics.ac.uk/textonly/SERC/publications/download/sercdp0112.pdf

6 For more information on productivity impacts of BBB programmes, see BBB, SQW & BMG Research (2019) Evaluation of Start Up Loans: https://www.british-business-bank.co.uk/wp-content/uploads/2019/06/SUL-Evaluation-Year-3-Report-June- 2019.pdf, BBB (2019) Annual Report: https://annualreport2019.british-business-bank.co.uk/ , BBB London Economics and Ipsos MORI (2017) Economic Impact Evaluation of the Enterprise Finance Guarantee (EFG) scheme: https://www.british- business-bank.co.uk/wp-content/uploads/2017/11/Economic-impact-evaluation-of-the-Enterprise-Finance-Guarantee- scheme-November-2017-s.pdf, BBB and SQW (2019) Northern Powerhouse Investment Fund – Early Assessment Report https://www.british-business-bank.co.uk/wp-content/uploads/2019/07/NPIF-early-assessment-report-FINAL_24-July- 2019.pdf


been used by recipients to invest in productivity enhancing business improvements such as training, research and development and new processes. 7

 

  1. The research shows that NPIF finance has enabled a wide variety of firms to invest in activities that will directly improve their productivity through enhancing skills, increasing research and development and introducing new products and services.

 

  1. For SMEs that have received finance 70% report increased skill levels in their workforce and over 60% have introduced more efficient processes. Those receiving equity finance are highly likely to have increased investment in R&D (80%) and introduced new products or services (75%). A similar evaluation of the Midlands Engine Investment Fund (MEIF) is now underway.

 

Q: What is the interaction between regional and income inequality? Is there greater inequality within regions or between regions?

 

  1. The British Business Bank is not best placed to respond to this question.

 

Q: What light does new regional economic data being produced shed on regional imbalances?

 

  1. The British Business Bank is not best placed to respond to this question.

 

Q: What lessons can be learnt from the success or otherwise of programs designed to promote regional economic growth so far? What are the future interventions that the UK should consider?

 

  1. The Bank has put in place a variety of funds and programmes to tackle the underlying drivers of regional imbalances in access to finance. Our actions are geared to supporting the supply of finance across the UK’s regions, developing sustainable finance ‘ecosystems’ led by private sector activity. Over 25% of venture capital investments between 2016 and 2018 in the North of England were public sector backed, compared to under 5% in London.8 Our goal is to close this gap over the long- term through catalysing and encouraging private sector venture capital activity, allowing government to step back from these markets.

 

  1. The Bank’s view is that demand activities are complementary and necessary to efforts to increase supply and reduce regional imbalances. We have therefore invested considerable efforts to bolster our work in these areas notably through creating a regional presence and developing a best-in-class online information resource.

 

  1. The following summarises the range of activities being undertaken by the Bank both in terms in of supply of finance and in addressing the demand for finance amongst SMEs.

 

A.     Supply of Finance Regional Funds

 


7 BBB and SQW (2019) Northern Powerhouse Investment Fund – Early Assessment Report

8 British Business Bank analysis of Beauhurst data


  1. The Bank has set up and is using its expertise to manage three regional investment funds dedicated to reversing the UK’s regional imbalances in smaller business finance. These are:

 

£50m milestone - the result of over 170 investments in firms located across the Midlands and includes £19m of private sector leverage.

 

  1. These regional funds provide both debt and equity to businesses across their respective regions to deal with supply side constraints that prevent businesses accessing the finance that they need. Between them they have around £700m of public funds at their disposal that when invested, leverages in further private sector funding. At the same time, these funds are helping to develop the business networks and the wider ‘ecosystem’ that can support these firms as they grow and nurture regional entrepreneurship for the long term.

 

  1. MEIF and NPIF are unique across England in that they are examples of multiple LEPs across wider regions opting to pool funds into a larger entity and therefore achieve the benefits of economies of scale. Through these existing Regional Funds, the Bank is gathering considerable experience in working with local partners to help reduce regional disparities.

 

  1. Alongside this growing local expertise, the Bank’s core capabilities lie in designing and operating financial instrument-based programmes (both state-aided and commercial) targeting SMEs. It is therefore an institution that HM Government may ask to develop and deliver an efficient and well targeted financial instrument element of the UK Shared Prosperity Fund (UKSPF). Through both our existing Regional Funds and longer- standing relationships with the range of partners delivering debt and equity at regional and sub-regional levels, we have gathered considerable experience in working with local partners to help reduce regional disparities. We hope this expertise can be put to further use.

 

  1. The Bank takes a close interest in the progress of The North East Fund which is contemporaneous with NPIF and shares a very similar overall funding structure and delivery model. It has a total value of £145m and is partially capitalised by the returns arising from a previous generation of publicly funded SME finance programmes in the region.

 

  1. In December 2018 the Bank also announced a £10.5m commitment to a fund aimed exclusively at supporting growing businesses in Northern Ireland. The £30m Growth Finance Fund includes a £7.5m commitment from Invest Northern Ireland and £12m from private investor Northern Ireland Local Government Pension Scheme. The fund will provide loans from £500,000 to £2m over the next four years and made its first investment in March 2019.

Enterprise Capital Funds

  1. The Enterprise Capital Fund Programme (ECFs) combines private and public money to make early stage venture capital equity investments up to £5m in high growth businesses and is designed to increase the supply of equity finance to growing companies across the UK.

 

  1. The ECF Programme is demand led and is managed by a number of experienced Fund Managers from a variety of backgrounds across the UK. Analysis of the current portfolio shows that over £200m of investment has been made by ECF Fund Managers outside of London and the South East.

Regional Angels Programme

  1. Announced in the Autumn Budget 2017, the Bank’s £100m Regional Angels Programme will help to develop clusters of business angels around the UK and outside London where angel activity is already well established. Business angels tend to be high net worth individuals (HNWI) who invest their own money in an area that they have previous expertise in. The HNWI population is much more regionally diverse, in comparison to equity fund managers, which means that there is a greater opportunity to increase funding outside of London.

 

  1. The programme, which formally launched in October 2018, aims to raise the profile and professionalism of angel investment activity in other parts of the UK and to attract further third-party capital alongside business angels while generating a market rate of return. Through this it aims to increase the availability, supply and awareness of angel and other early-stage equity investments across the country, particularly in areas where this type of finance is less readily available. It will work by committing funds for investment alongside business angels and other early stage equity investors, acting as a catalyst to bring longer-term capital to smaller businesses with growth ambitions. The Bank is currently assessing applications to the programme.

 

  1. This builds upon the achievements over the last eight years of the £100m Angel Co Investment Fund, managed by the British Business Bank. This programme makes equity investments alongside syndicates of business angels to support businesses with strong growth potential. To date it has invested over £43m and has leveraged over five times this of private sector investment, 43% of which has been into businesses outside London and the South East.

 

Start Up Loans

 

  1. The Bank’s Start Up Loans programme has a long track record of providing debt finance to less productive regions of the UK. This initiative offers loans (£500 to £25,000, at 6% p.a. interest) to individuals looking to start or grow a business in the UK. 38% of loan recipients from the programme to date reside in the 20% of the country’s most deprived areas. In addition to funding, successful applicants are offered free business support and access to a business mentor for up to 12 months after receiving funding, thereby enhancing their chances of success.

 

  1. Since its inception in 2012, the scheme has delivered loans to support over 64,000 businesses, providing over £510m of funding. Over the lifetime of the scheme the average loan size stands at c.£7,800 which has steadily increased over time. In 2019/20, the scheme plans to distribute 9,500 loans, drawing on £113m of finance at an average loan size of c.£12,000, up from an average of £10,545 in 2018/19.

 

B.     Demand for finance


  1. In October 2018 the Bank established a new Demand Development Unit (DDU). It has been specifically created to develop the Bank’s positioning and relationship with smaller businesses across the UK, i.e. the ’demand’ side of the Bank’s business and thereby help us in better supporting our delivery against two of our objectives:

 

 

  1. As set out below, the DDU will deliver through two means: first, by developing and maintaining an ‘information service’ that provides SMEs independent and impartial information about their finance choices; and second, managing a new UK Network team that covers all parts of the UK.

 

Information

  1. For markets to work effectively requires information so consumers or in the case of the Bank, SMEs, can make informed decisions. Evidence however suggests that many SMEs may have insufficient information on the types of finance available, possible providers and the benefits to using external finance. This lack of information or awareness may affect SMEs’ willingness to apply for finance that could otherwise enable them to grow. Information gaps can also lead to an inefficient allocation of capital, constraining business development and potentially resulting in forgone growth across the UK economy.

 

 

  1. The DDU has been established to address the underlying issues behind these behaviours. It does so by focusing on raising awareness of the different finance options available to UK SMEs, encouraging and enabling SMEs to seek the finance best suited to their needs. It has two online information sources targeted at two SME audiences to help in those efforts.

 

New ‘Finance Hub’

 

  1. In September 2018, the Bank launched a new website, the ‘Finance Hub’, that offers independent and impartial information on different finance options for scale-up, high growth and potential high growth businesses. It targeted this audience on the basis that our research showed these businesses were most amenable to taking on this information; and that if then acted on the information, they would make the greatest economic impact. Throughout, the design and development of the Finance Hub has

 


9 Small Business Finance Markets report 2019 10 Small Business Finance Markets report 2019 11 BVA BDRC, SME Finance Monitor, Q2 2018 12 Small Business Finance Markets report 2019


been based on direct feedback from SMEs themselves and was developed with a range of partners from the scale up world.

 

Finance Hub, Highlights 2018/19

 

The Business Finance Guide

 

  1. In contrast to the Finance Hub, the longer established Business Finance Guide sets out the different sources of finance available to businesses and is especially aimed at smaller and early-stage start-up businesses.

 

  1. The British Business Bank produces the guide in partnership with the ICAEW and a further 21 business and finance organisations, in order to raise awareness of the finance options available to smaller businesses. Better informed businesses are likely to make better choices about their finance and are therefore more likely to invest and grow.

 

British Finance Guide, Highlights 2018/19

 

UK Network

  1. In response to the Government’s Industrial Strategy White Paper, which outlined the need for a formal British Business Bank regional structure, the Bank established a UK Network (UKN) - a team of colleagues based in every region and country across the UK. That team has been operational since autumn 2018.

 

  1. UKN engages with business finance stakeholders in each of the English regions and devolved nations with three core objectives:

 

i.            To increase small businesses’ awareness and understanding of the finance options best suited to their needs, supporting work through our online information offer;

ii.            To develop a deep understanding of the business finance ecosystems in all parts of the UK, so that, ultimately, the British Business Bank can improve its support to SMEs across the entire UK; and

iii.            To add value to the business finance ecosystems across the UK, by enhancing collaboration and co-ordination within and across each English region and Devolved Nation.

 

  1. Since its establishment in autumn 2018 up to the end of March 2019, the UKN has held over 800 engagements with regional stakeholders. This level of engagement will continue during financial year 2019/20. Each UK region (sub-region) and devolved nation is unique, with its own business finance challenges and opportunities. By engaging with stakeholders within each area, the Bank will develop a deep understanding of the challenges and opportunities in each place, so that its future activity can be tailored to reflect those needs. By working closely with regional stakeholders, the Bank aims to build effective two-way stakeholder relationships, to help strengthen the business finance ecosystems across the UK, by enhancing collaboration and co-ordination within and across each English region and Devolved Nations, by spreading good practices and expertise.

  1. By doing so, the Bank provides better information on finance options to smaller businesses, identifies regional imbalances, and ensures deeper understanding of the different ecosystems in the UK as the Bank becomes a centre of expertise in regional access to finance.

Q: How effective have regional bodies, for example combined authorities, cities, Local Enterprise Partnerships, been in promoting strong growth across all areas of the UK?

 

  1. As has been outlined above, working in partnership with Local Enterprise Partnerships the Bank has set up and manages three regional investment funds. Governance is provided by a ‘Strategic Oversight Board’ on which the LEPs sit and through which they can provide views of the Funds’ performance. These funds are dedicated to reversing the UK’s regional imbalances in smaller business finance. These are:

 

 

  1. MEIF and NPIF are unique across England in that they are examples of multiple LEPs across wider regions opting to pool funds into a larger entity and therefore achieve the benefits of economies of scale. They attracted both new and existing funding from Central Government, the British Business Bank and European Investment Bank (EIB), in addition to the EDRF. The Cornwall and Isles of Scilly LEP also wanted to work with the Bank to create an investment fund that could provide debt and equity to growing businesses in Cornwall through a combination of ERDF and LEP resources. Similarly, the Bank maintains regular contact with the North East LEP in connection with the performance and governance of The North East Fund.

 

  1. As at July 2019 the funds have made over 618 loans or investments worth more than

£155m across the three regions, attracting over £126m of additional private investment. At the same time, these funds are helping to develop the business networks and the wider ‘ecosystem’ that can support these firms as they grow and nurture regional entrepreneurship for the long term.

Q: To what extent can devolution of funding to regional bodies promote growth and reduce regional disparities?

 

  1. Many business improvement policies are best delivered locally as part of an integrated package of investment, with local decision-making and management being essential to delivering appropriately tailored solutions. One complication with addressing market failures in SME access to finance, however, is that effective interventions need to operate at some scale in order to attract high quality fund management expertise, leverage in private capital, and consider a sufficiently wide portfolio of potential investments. This can require collaboration across geographies.

 

  1. The Bank has experience of working with local areas to address this challenge through our current Northern Powerhouse and Midlands Engine investment funds, which offer one model for individual LEPs being heavily involved in strategic decision-making alongside the Bank providing scale and expertise to deliver shared programmes across a larger geography. Building on this experience, the Bank stands ready to work with other local areas to explore how we can assist addressing their own SME access to finance needs.

 

August 2019