UK IT Association (UKITA)

• SMEs are a vital part of the UK economy and contribute significantly to economic growth. Access to finance in particular is important for funding investment, ensuring businesses reach their full growth potential, and for facilitating new business start-ups.
• Whilst around half of businesses use external finance, a smaller proportion (around 20%) is actually seeking finance at any one time. Of those who have used external finance in the last year, bank finance is still the primary source of finance. In the last year, 28% of all SMEs have used an overdraft and 11% have used a bank loan.
• Whilst the majority of firms seeking finance do get it (74% of SME employers), there are a number of structural market failures restricting some viable SMEs from accessing finance. This is due to imperfect or asymmetric information between finance providers and small businesses. This manifests itself in a debt funding gap affecting businesses that lack collateral or track record; and in the equity gap affecting SMEs seeking between £250,000 to £5m of equity finance. There are also cyclical issues relating to the supply and demand of finance.

• Prior to 2008, the banking market was more crowded with banks competing for market share, but the market has now become more cautious about assessing risk. As a result, the stock of bank lending to SMEs peaked in 2009 and has been declining ever since. For instance, the stock of bank lending in November 2011 was 6.1% lower compared to a year ago.
• This decline in the stock of lending is affected by both demand and supply side factors. There is evidence indicating that SMEs are reducing demand by repaying existing bank debt (deleveraging), and more generally putting off investment plans in light of economic uncertainty. The value of applications by SMEs for new term loan and overdraft facilities in the six months to February 2011 was 19% lower than in the same period a year earlier. Around 3% of all SMEs have put off borrowing due to the current economic climate.
• Although most businesses can obtain the finance they need (74% of those SME employers seeking finance over the previous 12 months managed to obtain some finance), it is now harder to obtain than in 2007/08 when 90% of those seeking finance obtained it. This is equivalent to 21% of SME employers that sought finance in 2010 being unable to obtain any finance from any source, a significant increase from the 8% seen in 2007/08. This is because banks are now also more risk averse, due to the credit crunch and because they are required to hold more capital/liquidity by new financial services regulations. In addition, there has been deterioration in the credit quality of businesses due to lower sales.
• Despite widespread perceptions that businesses are now paying more for finance than previously, most SMEs are now paying less for finance overall. Average interest rates on variable rate lending were 5.39% in November 2008 compared to 3.5% in November 2011. This is due to the decline in the Bank of England Interest rate, although margins are higher than pre-recession levels.

• Although only around 1-2% of SMEs looking for external finance seek equity finance (also known as “risk capital”), it is especially important for those early stage businesses with the highest potential for growth. However, the venture capital market has been heavily affected by economic conditions with a 31% decrease in the value of investment in 2010 compared to the previous year.
• Over the last decade business angels have become a more important source of funding for early stage businesses and now supply a similar amount of equity finance to SMEs as venture capitalists (just over £300m per year).
• There has been an increase in the use of other types of SME finance including asset based finance. In addition, there have been some recent improvements in liquidity on SME public equity markets, e.g. AIM.

• The Government has a range of policies for increasing the supply of finance to SMEs and addressing the market failures preventing some viable SMEs from raising finance. These include:
  • Enterprise Finance Guarantee. EFG is a loan guarantee scheme that addresses the market failure of lack of collateral or track record by providing a Government guarantee of up to 75% of the individual loan amount in the event of a default.
  • Enterprise Capital Funds. These are commercially managed venture capital funds operating in the equity gap that provide equity finance to high growth potential SMEs initially seeking up to £2m of finance. The Government provides around two thirds of the capital, with the remainder being raised from private sector sources.
• Although it is too early to evaluate the schemes, emerging evidence suggests these schemes appear to be working at providing additional finance. There have also been evaluations of older schemes, like the Small Firm Loan Guarantee Scheme and Regional Venture Capital Funds, which have helped informed the design of these newer schemes.

• There are a number of other Government interventions designed to increase the supply of bank lending to businesses including the Project Merlin lending agreements and the recently announced National Loan Guarantee Scheme.

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