SMEF0064

Written evidence submitted by Enterprise Research Centre

Introduction 

 

The Enterprise Research Centre (ERC) is delighted to have the opportunity to respond to the Treasury Select Committee’s inquiry into SME access to finance and welcomes the Committee’s focus on this vital part of the UK economy. The aim of this submission is to highlight the key research findings from our core research theme on SME Finance as well as to draw attention to a number of short policy briefings we have published from a range of academics in the last 12 months.

 

We seek to provide evidence on the following sections set out in the Call for Evidence:

 

 

 

About the Enterprise Research Centre (ERC)

Funded by the Economic and Social Research Council (ESRC), the ERC has been delivering independent research to inform policy and practice on small and medium enterprises (SMEs) since 2013. The ERC is now the leading centre of excellence in the UK for research into the growth, innovation and productivity of SMEs and has become the ‘go-to’ reference point for anyone looking for robust, trusted data and insights on SME performance see: www.enterpriseresearch.ac.uk

Our research covers a range of themes with the core research team being based at Warwick and Aston University Business Schools, however we work with a network of researchers based in a range of institutions. Find out more about the team and associates here.

In addition to core funding from the ESRC, the Centre also receives support from the Department for Business and Trade (DBT), Innovate UK (IUK), the British Business Bank (BBB)and the Intellectual Property Office (IPO). The ERC also undertakes commissioned work for a range of other organisations.

As well as furthering academic knowledge, the ERC’s work equips policymakers and practitioners with a better understanding of SME growth and provides insights into many topics critical to economic competitiveness. We communicate our research widely to maximise its policy impact.

 


Headlines

 

 

 

 

 

 

 

 

 

 


ERC Research on SME Finance

 

The following SME Finance topics have been recently addressed by ERC researchers:

 

  1. Cost of doing business for SMEs – driving the demand for external finance?
  2. P2P lending at a time of economic uncertainty
  3. Access to finance for women-led businesses
  4. Ethnic-Minority Businesses (EMBs) and access to finance
  5. Entrepreneurial Framework Conditions in the UK

 

  1. Cost of doing Business for SMEs – driving the demand for external finance?

There has been much media attention on the trends in inflation in the last 2 years, but little is discussed about the rising costs of doing business for the small business population in the UK.  Small businesses with less than 50 employees employ 12.9m people (48 per cent of total private sector employment) and account for 36 per cent of private sector turnover.

The Small Business Price Index (SBPI) provides an indication of the cost of doing business among this critical group of firms. The SBPI dropped back sharply in 2022q3 from its peak levels of the previous two quarters. Largely driven by fuel price falls, small business costs increased by around 0.8 per cent overall during 2022q3. This continued increase in costs ‘locked in’ the extreme cost rises of earlier periods during 2022 and reflected cost rises in wages (+2.0 per cent this quarter), vehicle insurance (+9.4 per cent) and the cost of services (+2.3 per cent).  Read the paper here

Around 40% of all SMEs have been negatively impacted by increased costs with the majority planning to pass on these rising costs to their customers rather than absorb them (SME Finance Monitor March 2023).  There has also been a rise in SMEs using more external finance than pre-pandemic and previously non-borrowers were also more likely to be seeking external finance – clearly as a response to rising costs and a need to obtain working capital.

Despite these trends around half of all SMEs can be classified as permanent non-borrowers and although we know that external finance is positively associated with faster growth earlier ERC research points to a very complex interplay between attitudes, awareness and appropriate forms of private and public debt and equity finance products.

  1. P2P lending to SMEs

Over the last decade, the landscape of SME finance has changed dramatically. In the aftermath of the financial crisis, while traditional bank lending experienced a sluggish recovery, a new model of online marketplace (P2P) business lending emerged. Until the beginning of the pandemic, platforms performed quite well. ERC research found that pre-screening by platforms was efficient, as risk grades were a good predictor of default on loans.

Higher return on investment attracted individual lenders/investors who were driven mainly by pecuniary motivations. Small businesses feeling that traditional banks were disinterested in them turned to P2P platforms attracted by the speed and ease of the loan application process.  The Covid-19 pandemic brought an unexpected change. It’s not surprising that P2P platforms faced serious liquidity problems yet at the same time there was an increase in demand from SMEs who were looking for solutions for their cash flow problems.

What does this mean in the context of the current economic uncertainty?  If we are convinced that P2P business lending platforms emerged and grew after the previous financial crisis for good reason and that they provide much needed services, it follows that they may become also crucial facilitators of these specific financial flows. Put simply, we adopt a similar reasoning to the well-known arguments concerning “too big to fail” banks (bearing in mind important differences between financial intermediaries such as banks and P2P platforms). But would intervention be desirable in this particular market, and if so, what form should this take? We suggest this could be structured around three, more or less decisive, types of intervention: Read the paper here

  1. Supporting P2P business lending platforms by recognising the crucial role they are playing by channelling funds to SMEs and the self-employed. This would aim to preserve the infrastructure and business knowledge/networks of the P2P business lending platforms, as to enable them to be quickly operational as and when necessary. The accreditation of Funding Circle under the Coronavirus Business Interruption Scheme (CBILS) indicates an important step was taken during the pandemic.
  2. Institutional investors could become more active players on (a range of) these platforms. This intervention does not need to be sufficient to cover all credit needs, but it should be enough to provide a signal that some liquidity is available; more importantly it should act as a signal to investors, boosting their confidence (and allowing the P2P platforms to have enough liquidity to pay back, even with a short delay, some of the investors who want to pull out, thus preventing the “bank run” type reaction).
  3. Supporting and encouraging P2P business lending platforms to apply a grace period and to develop deferred payment plans for businesses experiencing financial difficulties due to the current economic uncertainty.

 

  1. Access to Venture Capital Amongst Female-led Firms

While the participation of women in entrepreneurship has increased in recent years, women’s access to venture capital (VC) has not moved at the same pace. The gender gap in VC funding persists, as is also the case in other equity financing markets. Recent studies using socio-psychological perspectives indicate that the gap is associated with gender biases, which affect whether and how women entrepreneurs seek funding and how decision-makers evaluate business opportunities.

From the demand side, this relates to some women’s tolerance for risk and their perceptions about external equity capital, which can lead to lower aspirations to seek business growth and to apply for VC funds.

From the supply perspective, gendered beliefs about what makes a successful business founder, and lack of female role models may impact negatively on the evaluation of businesses led by women. These barriers may require interventions that go beyond a focus on just improving women’s financial or technical skills. Read the full report here

  1. Ethnic-Minority Businesses (EMBs) and access to finance

The Centre for Research in Ethnic Minority Entrepreneurship (CREME) has partnered with NatWest for the Time to Change report which sets out ten evidence-based recommendations to promote greater success and inclusion of Ethnic Minority businesses (EMBs) in finance and business support in the UK.  A large part of the evidence was provided by the ERC's Global Entrepreneurship Monitor (GEM) UK project

 

Experts say the implementation of the recommendations could help tackle the multiple barriers faced by EMBs, particularly in accessing finance, markets and quality business support, and could increase their GVA contribution from the current £25 billion a year to £100 billion, highlighting the significant potential of EMBs to the UK economy.

Tackling the perception of finance barriers and high levels of discouragement could significantly increase EMBs’ uptake of bank finance and help them grow. The challenge for the finance sector, particularly banks, is to improve marketing and targeting of EMBs with innovative engagement initiatives such as local community hubs.  Core recommendations include:

 

  1. Entrepreneurial Framework Conditions in the UK (GEM)

The context, or entrepreneurial environment, which encompasses a wide range of economic, political, institutional, financial and social conditions may influence individual decision to start a business. That context may be supportive - and encourage the decision to become an entrepreneur and facilitate the progression from a start-up towards established business – or, on the contrary, may be discouraging and burdensome. The context for entrepreneurship also evolves over time and may be dramatically impacted by national and global events and societal challenges, it can also reflect government priorities and spending.

GEM Global created a specific tool to assess an economy’s entrepreneurial ecosystem against nine Entrepreneurship Framework Conditions (EFCs). These are based on more than twenty years of research and experience.  Each condition is multidimensional and is not directly observed, i.e., a latent variable.  In order to provide an overall view of how favourable an environment is for entrepreneurial activity across countries, GEM introduced the National Entrepreneurship Context Index (NECI) in 2018. It is a composite index which represents the arithmetic average of EFCs – see: GEM UK Report - Chapter 5 for a more detailed discussion

 


Recent Publications by ERC Research Associates

The ERC commissions research projects on behalf of the Department for Business and Trade (DBT) using he Longitudinal Small Business Survey (LSBS) datasets.  Here is a list of reports and their summary findings published post-pandemic.

Gender, Ethnicity and Access to Finance - evidence for social enterprises

This paper investigates the access and use of various forms of finance for social enterprises, including those that are women and minority ethnic group (MEG) led. Using data from the UK Longitudinal Small Business Survey, we find that relative to commercial small and medium enterprises (SMEs), social enterprises are less likely to apply for bank overdrafts, but more likely to apply for government grants. However, upon application, social enterprises are more likely to receive credit card and loan funding from mainstream financial intermediaries. By gender lead, our results suggest that women-led social enterprises are more likely to apply for loans from a bank, but less likely to receive funding compared to male-led counterparts. Our results also show that MEG-led social enterprises are less likely to apply for credit cards and government grants, and less likely to get a bank overdraft facility or a loan from a bank.

The Uneven Spatial Nature of Access to External Finance in UK SMEs - determinants, impacts and the 'levelling up' agenda

In this report, the authors provide new evidence on some of these problems SMEs confront obtaining finance in different parts of the UK.  In particular, it examines the effects of self-exclusion from the credit market in the UK.  The focus of this study is on bank finance as this is the dominant form of funding used by SMEs, accounting for 85% of all outstanding debt owed by UK SMEs.

Research found that around quarter of a million smaller firms have dropped out of the UK capital market and that in many localities this has reduced job creation and sales income growth. Overall, we find that in a general sense self-exclusion from the market for external finance when finance is still required is a sub-optimal for future growth outcomes.  The general trend in terms of small firms seeking external finance from capital markets is downwards over the period examined, although there is considerable year-on-year variation. What is apparent is that this demonstrates a distinct shift in the willingness of small firms to seek external capital in the UK since the Global Financial Crisis (GFC).

The report suggests introducing spatially calibrated policy instruments could be one solution to help alleviate barriers to finance in certain parts of the country. In particular, loan guarantee instruments for SMEs could play a major role as a spatial policy by using the four key parameters (the guarantee coverage ratio, the interest rate premium, the term structure, and the maximum loan size), to create unique configurations of these four scheme parameters to target specific types of firms located in particular spatial areas with high prevalence rate of full rationing and also self-exclusion from capital markets.

Exploring External Finance links to Build Back Better a Green UK SME economy

This paper outlines key findings and policy implications from research exploring the link between external finance and SMEs becoming ‘green’ i.e., having a ‘green mission’ and adopting energy efficiency practices.

 

September 2023