Anthony Hilton: How to bridge the small-firm funding gap

Walmart, the US supermarket group that owns Asda in this country, employs 2.2 million people worldwide and is valued at $185 billion (£122 billion). Amazon, the most successful of the online retailers, is worth $293 billion — almost half as much again — but employs only 154,000 people. Facebook, an even bigger phenomenon than Amazon, employs only 9000. While technology may be where the growth is in today’s economy, it is not where the jobs are.

The big industrial business with hundreds of thousands of employees is a thing of the past. The story of the last 50 years has been one of decline, cost-cutting and plant closure — the current pain in the steel industry is just the latest episode. It underlines how companies have to be nimble and flexible to survive in a fast-changing world. Big organisations controlled from the centre don’t have it. Small and medium-sized firms can move before giant ones even realise there is an opportunity.

More than ever, jobs and employment growth depend on thriving small and medium-sized enterprises (SMEs). Britain potentially has several million of these but the bulk exist primarily to provide the owner with a living and employ just one or two people, and are unlikely to go much further. But tens of thousands of others do have potential. However, they rarely have the money to exploit that potential as employers or exporters. Following the departure from office of Business Secretary Vince Cable, the dearth of loans to SMEs is not such a hot topic in government but it remains a huge problem.

Bank of England figures suggest that small-business overdrafts have fallen from about £21 billion in April 2011 to less than £13 billion today, a drop of about 30% despite the rapid growth of challenger banks such as Aldermore and Shawbrook and the steady progress in the UK of Sweden’s Handelsbanken.

Banks are still interested in the market but they only want straightforward quality business that lends itself to computerisation. However, they are also more willing than before to co-operate with other lenders to find finance for those they do not want to help directly themselves — witness Santander linking up with peer-to-peer lender Funding Circle and HSBC providing £50 million of wholesale finance to Amicus, a platform focusing on property bridging loans. Government legislation will also soon require banks that turn down a business customer to refer it to intermediaries who may be able to help. This, and the greater willingness of SMEs to go beyond their bank for finance, signals boom times for Funding Options, an internet-based advisory start-up, and the more traditionally structured National Association of Commercial Finance Brokers.

The new willingness of investing institutions to see loans and credit as a way to secure higher returns is also significant. Some, like fund manager M&G, have developed the in-house skills to become lenders themselves. But the bigger change is the proliferation of small independent teams of specialists such as Hayfin, which make loans to businesses with capital subscribed by pension funds, hedge funds, insurance companies and family offices. This willingness to use specialists to originate business is also opening up very small firms to private equity. Connection Capital, a leader in this section of the market, thinks that total investment in venture capital, growth capital and very small buyouts is up at least 20% this year, partly because SMEs are coming to appreciate the advantages of equity over debt, partly because it is so much easier to mobilise institutional money.

Then there is peer-to-peer lending, which continues to evolve. Some, such as Funding Circle, are going for scale; others, like MarketInvoice, hope to exploit a niche in invoice discounting. Others — ArchOver, for example — think the key to growth lies in the security and comfort it gives to lenders.

Unfortunately, although it is all very exciting and fast-growing, it still does not add up to much — particularly when set against the need. Banks used to lend £80 billion to the sector. All the peer-to-peer platforms combined currently provide between £1 billion and £2 billion. It is estimated that they, the challenger banks and the loan capital funds supplied by institutions could one day get to about £20 billion — or about a quarter of what the banks used to do.

Small-business finance needs an act of boldness and imagination from Chancellor George Osborne. Maurice, now Lord, Saatchi wrote a short book a couple of years ago called The Road From Serfdom, which contained a brilliant idea behind its unhelpful title.

Saatchi pointed out that the vast majority of small businesses finance themselves out of their profits and never borrow from anyone. Therefore, the amount they grow is directly linked to the amount of cash they generate. Allow them to keep more of their cash and they will grow faster, he said.