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What’s holding back SME business investment?

Author: ICAEW Insights

Published: 25 Apr 2023

SMEs face plenty of barriers, both recent and historic, when it comes to funding their growth. So what can they do about it?

Of the 5.5m businesses based in the UK, 4m are sole traders and 1.2m have fewer than 10 employees. These have an average turnover just shy of £500m. They are competing for funding with the 8,000 companies with more than 250 employees, which have an average turnover of £265m. 

“When SMEs engage with investors and lenders in the show-and-tell exercise aimed at enticing them to finance their company, they must first leverage personal charisma to obtain access to an initial conversation, ahead of carrying on extolling the promising features of their idea, product, business model and unique selling points,” says Professor Marco Mongiello, PhD, ACA, Pro Vice-Chancellor, Business and Science, The University of Law.

Investors have traditionally been the safer option for SMEs when it comes to raising capital, but in recent years, attitudes have changed. According to research by the Financial Times, investors are putting greater emphasis on profit earlier in the cycle – “two years runway” is the investor’s jargon of the day.

“This change in tack is a consequence of the current uncertainty that pervades all sectors in the UK,” says Mongiello. “While the effects of COVID-19 are fading as sectors get back on track, companies are confronted with price shocks – a consequence of Putin’s invasion of Ukraine; an increase in interest rates due to the Bank of England’s attempt to contain inflation; financial instability due to international financial turmoil; and mounting inefficiency of international trade, shrinking markets, cumbersome access to resources and a fluid labour market – thanks to the still unravelling effects of Brexit.” 

Successive UK governments have devised various schemes to support SME growth – for example, last year’s UK Innovation Strategy – Leading the Future by Creating it. These have drawn criticism, but they have had some positive impacts, says Mongiello. “For example, in 2022, £65bn was lent to SMEs – 13% more than in 2021. More than half of that came from the UK Government’s British Business Bank.”

Hatty Fawcett has spent her career raising equity investment for early-stage start-ups. She believes start-up investment should be available to everyone and the process shouldn’t be overcomplicated or unnecessarily time consuming. She agrees that investors have become more reluctant to part with their money.

“In economic downturns, even angel investors (who are traditionally high-net-worth individuals) will face pressure on their finances like everyone else. They will think twice about the amount of money they invest in start-ups/SMEs – a traditionally risky asset class that is not very liquid.”

Not all of the issues and barriers that SMEs face are due to the current economic climate. Some are longer-running problems that hold back or limit the scope for investment. There has been very little change to equity investment since the MacMillan report in 1931. Equity investors are largely male and aged 55 and over, and less than 14% of angel investors are women.

“This lack of diversity impacts on the businesses attracting funding, making it harder for certain SMEs to do so,” says Fawcett. “Data from British Business Bank shows that for every £1 of venture capital (VC) investment in the UK, all-female founder teams get less than 1p, while all-male founder teams get 89p, and mixed-gender teams 10p.”

The situation is further compounded if a business is based outside of London, Fawcett explains. Equity investment is a world driven by personal networks steeped in jargon, she says. “As a business owner or start-up founder, if you don't have a well-connected network you will find it harder to raise investment. The amount of jargon used and ill-defined processes for accessing equity investment also creates barriers.”

Fawcett believes the government has a mixed track record. The closure of Tech Nation, which helped connect SMEs and start-ups with investors, has made it harder for SMEs to access equity investment, she says. 

“The recent extension of the criteria for Seed Enterprise Investment Scheme (SEIS) has helped extend opportunities, but more needs to be done to change the profile of angel and VC investors to make them more representative of business owners seeking funding.”

What SMEs can do

Fawcett believes more practical training and coaching is needed to support SMEs preparing for equity investment. “SMEs need clear processes, proven systems and expert, tailored guidance on what is required to attract equity investment.”

Mongiello highlights three routes for investment that SMEs can take. The first is to take advantage of fiscal incentives such as R&D tax credits. There are also incentives for investors that put money into SMEs, such as the Enterprise Investment Scheme. “All that’s left for the SME to do is to point the investors in the direction of these schemes upon offering them shares in exchange for investment funds.” 

SMEs should also reach out to lenders that signed up to The SME Finance Charter, says Mongiello; they pledged to support SMEs through various lending facilities such as loans and overdrafts, asset finance including hire purchase and leasing, stock lending, and invoice finance. SMEs also miss out on other types of incentives available in the form of funding competitions. These are focused on supporting specific areas of innovation in SMEs, such as AI and manufacturing innovation. 

“A lot more can be done to support SMEs in the UK, but it’s not just down to the government to play its part,” says Mongiello. “Given that their success is beneficial to all parts of our economy, no stakeholder should be dismissive of entrepreneurs. Professional bodies, education institutions, local governments and individual consumers alike need to keep investing, supporting, encouraging and believing in our SMEs – it’s in all our own interests.”

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