Written evidence submitted by the Federation of Small Businesses

 

FSB is a non-profit making, grassroots and non-party political business organisation that represents 160,000 members in every community across the UK.  Set up in 1974, we are the authoritative voice on policy issues affecting the UK’s 5.5 million small businesses, micro businesses and the self-employed.

 

Small businesses rely heavily on access to external finance, be that traditional loans, equity, asset, or trade. Many small businesses do not have the capital in-house to be able to organically grow their business and hence rely on external finance for this development.

We found in FSB’s Q1 2022 Small Business Index (SBI) that 50.3 percent of all small businesses have the aspiration to grow over the next twelve months and importantly, of these firms, 23.5 percent aspire to grow in excess of 20 percent. This is slightly down on the previous quarter, likely due to the economic headwinds small businesses are facing, but the sentiment remains that the majority want to grow and expand their businesses.[1]

To achieve this growth and generally manage their operations, small businesses tend to rely on external finance. However, small businesses frequently rely on traditional debt-related finance than alternative forms such as equity. The figure below illustrates the types of finance small businesses have, on average, applied for since 2015. As can be seen, small businesses have a tendency to rely on debt-based finance – overdrafts (37.5%), bank loans (37.3%) and asset finance (21.6%). Alternative forms of finance feature far less in the types applied for, with equity finance (venture, seed and angel) on average only accounting for 7 percent of applications each quarter. 

Figure 1: Types of finance applied for by small businesses that have applied for any finance, average from SBI Q3 2015 to Q1 2022

Source: FSB Small Business Index Q3 2015 – Q1 2022

 

Part of the reason for this trend is that small businesses often rely on their main lender as their primary source of finance, which naturally lends itself to more debt-related financial products. Many small business owners are not financial experts and are likely unaware of the range of available financial products available to their business and what may be more appropriate than debt.

Indeed, anecdotally, we have heard that many small businesses that do wish to go down the equity and investment route are unsure of how to do so. These are businesses that are unsure how to present their business case to show that they are investment ready. Although these may be the minority of small businesses that do want to move towards equity finance, a system that helps them take those steps to become investment ready would be highly beneficial.

Small businesses find applying for equity finance more difficult than other, more traditional, forms of finance. We found in our Insurance and Finance survey, conducted in January 2022, that over the past five years of small businesses applying for equity finance, only 47 percent were successful in their endeavours. This compares to a 68 percent success rate for traditional bank loans, 85 percent rate for overdrafts and 95 percent for credit cards. Of those that applied for any form of equity, 71 percent overall disagreed that the application itself was an easy process – this is again significantly greater than the other forms asked: 43 percent said traditional bank loans were difficult and only 20 percent said applying for asset finance was difficult.

An expansion to the current Help to Grow framework could bridge the gap of investment desire and investment readiness. Modules on what equity finance is and how to model your business to become investment ready would aid significantly in small businesses that want to expand their businesses but are uncertain in how to do so. To really create impact however, the Help to Grow scheme should be expanded to include all small businesses including sole traders and micro-businesses with fewer than five employees.  

However, venture capital and equity finance is not always appropriate for small businesses. Many small businesses, especially micro-sized entities, do not always want to part ways with shares in their businesses and, even if they might have high-growth potential, would rather either grow organically or do so through debt finance. There is also a subset of small businesses that do not aspire to grow – which is a perfectly valid business position.

One of the stark issues facing small businesses wishing to embark on equity financing is the regional access to equity funds. As highlighted in Figure 2 below, London accounts for 19.0 percent of all SMEs, but in 2020 accounted for 47.2 percent of all equity deals, equivalent to 66.4 percent of the total equity value provided.[2] London hence accounts for 3.49 times the proportion of equity value relative to its SME population. Not a single other region or nation in the UK has an equity value representative of its SME population; the East of England comes in at second with a SME to equity value ratio of 0.68. At the far end of the spectrum, Northern Ireland’s ratio is just 0.08. Excluding London, the average SME proportion to SME equity value ratio is just 0.37 – this highlights the extent to which non-London SMEs will struggle to acquire equity funding.

 

 

 

 

 

 

 

 

 

 

 

Figure 2: SME equity deals and value by region and nation, 2020

Source: British Business Bank, FSB analysis

FSB would be supportive of a scheme which aids the ‘levelling up of the equity market beyond London. There are many small businesses where equity finance would be suitable for their growth objectives but are limited simply by where they are located. This levelling up could perhaps be done through tax credits to investors who invest in SMEs outside of London, providing a financial incentive to do so.

FSB also views the Seed Enterprise Investment Scheme (SEIS) as particularly useful for small businesses albeit underused. We found in our report A Duty to Reform[3], that small businesses were typically under aware and by extension under used a range of tax reliefs available to them. FSB strongly believes small businesses should make greater use of the available reliefs to bolster their business position. In this case, small businesses need to be made aware of the availability of the SEIS through awareness campaigns. Likewise, FSB is encouraging the Government to reconsider the Sunset Clause on the SEIS of 2026 and make the scheme permanent – small businesses require consistency and long-term planning to undertake investment plans, scrapping the relief will impact investment. Similarly, the SEIS also needs updating in line with multi-year inflation. The £100,000 investment limit is no longer suitable and is being eroded by such high inflation that is set to persist – the effective real limit is now notionally much smaller than when the £100,000 nominal limit was first introduced.

We trust that you will find our comments helpful and that they will be taken into consideration.

June 2022

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[1] FSB, FSB Voice of Small Business Index, Quarter 1, 2022, May 2022, https://www.fsb.org.uk/resource-report/sbi-q1-2022.html

[2] British Business Bank, Regions and Nations Tracker: Small Business Finance Markets 2021, https://www.british-business-bank.co.uk/wp-content/uploads/2021/10/J0018_Regional_Tracker_Report_AW.pdf

[3] FSB, A Duty to Reform, October 2021, https://www.fsb.org.uk/resource-report/a-duty-to-reform.html