Challenging myths

about the funding of

small businesses...
Andrew Freeman
FINANCE FOR GROWTH
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FINANCE FOR GROWTH
Andrew Freeman
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Acknowledgements 3

Foreword 5
Executive summary 9
1 Introduction 15
2 Mapping the SME population 23
3 Where do banks come in? 33
4 A brief history of SME funding in the UK 39
5 Why do governments love SMEs? 47
6 Some numbers on funding of SMEs 53
they might surprise you
7 The front line of SME lending 65
8 SMEs and growth 71
9 Debtequity: the lenders dilemma 77
10 Conclusions and policy implications 83
Appendix A 93
Data and research methodology issues
for SMEs and entrepreneurship
Appendix B 97
A case study on Canadas SME statistics
Notes 101
References 115
Contents
3
Acknowledgements
Demos Finance would like to thank Barclays Bank for its
support of this independent report. Te author would like
to thank the numerous people who gave generously of their
time and knowledge. Professor Alan Hughes of Cambridge
University and Dr Richard Roberts of Barclays deserve
special thanks for their particular help and advice and for
pre-publication checking. Shiona Davies, Editor of the SME
Finance Monitor, kindly agreed to act as an additional expert
reader of the report in drah form.
Special eort has been made to ensure accuracy of the
many numbers quoted in the report. Any errors that remain
are the responsibility of the author.
Andrew Freeman
September sog
5
Foreword
With this report Demos Finance is properly born. Helping
to create a mainstream nancial services think-tank that
inuences both the expert and the public debate and is
respected by the industry and its many critics has been an
ambition of mine for many years.
When, more than ten years ago, as editor of Prospect
magazine I created the annual think-tank of the year awards
it struck me as odd that so little think-tank attention was
expended on nance, the single most important feature of
Britains economy. Te gap where a neutral, authoritative,
ideas space should have been operating between the
abstractions of academia and the instantness of journalism
became even more glaring aher the soo;/8 crash.
Of course nance has never been short of analysis and
there are many people in the industry and its regulatory
bodies, in universities and business schools, in newspapers
and, indeed, in some of the general think tanks (and the
CSFI) who produce excellent work.
But none of them bring the attributes of a good
think-tank to the subject by combining under one roof the
publishing of original, independent research; organising
topical events that bring together the dierent tribes in
the sector; responding swihly to events with briengs and
media comment and, nally, providing a public education
function by translating for general audiences some of the
specialist language of the nancial experts (and making it
all freely available).
Demos Finance, operating as a unit within the cross-
party think-tank Demos (where I am director), is less than
a year old but under the leadership of Andrew Freeman and
Jodie Ginsberg it is beginning to make its mark. We have
7 Foreword
already produced several brieng papers, most notably on
the LIBOR crisis and John Kays short termism review, and
hosted some memorable events, including one with the
Parliamentary Banking Commission and another with
Anat Admati, co-author of the remarkable book Te Bankers
New Clothes, about how to make banks safe with much higher
levels of equity.
But the publication of our rst major piece of research
Finance For Growth takes us to a new level. And Andrew
Freemans report sets a template for the kind of research we
want to do in the future. It is on one of the perpetually topical
nancial subjects: bank lending (or lack of it) to business. It
challenges a widely held assumption about lending to small
and medium sized businesses and asks whether we have been
looking in the right place for sustainable economic growth.
It is based on a sharp-eyed overview of the existing literature
plus some original research and insights. It provides practical
suggestions for retuning policy in this area. It is also clearly
written for a general reader audience and is pleasingly brief.
Finance is of course an enormous eld that touches all our
lives every day, from the money in our wallets to the national
and global economy. Demos Finances scope is similarly broad:
other current research projects include consumer nance,
bank technology, Islamic nance, accounting rules, payments
infrastructure, alternative lenders, and online currencies.
Te nancial sector will remain at the heart of all
modern economies. Understanding it better, including how
parts of it failed in recent years and can best be mended, is
a national priority both for politicians and for all of us as
individual citizens and consumers. Tat is easier said than
done; it is an unavoidably complex world marked by powerful
vested interests. But if Demos Finance can help in a small way
to increase that understanding, especially in the political and
media class, it will have served its purpose.
David Goodhart
September sog
9
Executive summary
Tere is an ongoing and heated debate in the UK about the
importance of small and medium-sized enterprises (SMEs)
for economic recovery, and the willingness or otherwise
of traditional banks to lend to these businesses. Despite
repeated eorts to stimulate lending by the Government
and the Bank of England, net lending to SMEs has been
steadily falling.
Clearly, something is not working. Te SME sector is
widely misunderstood and misrepresented; most signicantly
it is far from obvious that SMEs as a group are in fact major
contributors to economic growth, despite the crucial role they
play as existing employers, customers and suppliers.
Tis is because the majority of SMEs are focused on
remaining in business, and have no intention of aiming to
be the next Google. Teir challenges are cashow and
day-to-day nancial management, not growth nance. By
contrast, companies with realistic ambitions of growth are
found in all sizes.
Te starting position of public policy has been to focus
on size, with interventions aimed at smallness, rather than at
enabling growth and nancing risk. In addition, our research
shows that most SMEs do not wish to borrow from a bank and
of those that do, go per cent have no problems getting the
nancing they want.
1
Further, not enough attention is given to
the appropriateness of bank loans for the very few businesses
that require risk capital and struggle to secure it. A better
source of funds in these cases would be equity or an
alternative source.
Tis report therefore argues for two fundamentally
changed assumptions. First, rather than thinking small, we should
think growth. If most SMEs have no immediate ambitions to
11 Executive summary
interventions that meet the actual challenges they face,
for instance by providing more eective cash ow support,
a growth-positive tax and regulatory environment and
commercial skills support. A further report on the real
challenges faced by the small business community would
be very welcome.
Tis report makes a number of recommendations, which
ow from the two changed assumptions outlined above. Tey
have at their heart a belief that the UKs best chance to deliver
sustainable long-term business growth, rather than short-term
growth subsidised by the taxpayer, is to create an environment
that meets the needs of growth companies, regardless of size.
Summary of recommendations
Develop a genuine pre-capital market investment house
Te British Investment Bank is a welcome intervention, but the
UK lacks a genuine pre-capital market equity investment
house. Returning to a model of the Industrial and Commercial
Finance Corporation, the precursor to gi, could strongly benet
the UK economy.
Learn from Canada to develop a reliable SME registry
Te UK lacks adequate and reliable data on the SME sector
we do not even have up-to-date numbers on how many
SMEs there are. Te UK Government should instruct either
the Bank of England or the Oce for National Statistics to
emulate the Canadian model and address this gap.
Create SME impact assessments
Te World Bank has published an impact assessment
framework specically on SME funding and this could be
used as a blueprint for UK assessments.
2
Indeed, the UK
could volunteer to work with the Gso and the World Bank
as a pioneer of cost-eective SME impact assessments, creating
the additional benet of insights that can be exploited in the
developing world.
grow, we should focus our eorts on those businesses with the
will and potential to deliver signicant growth in the future
regardless of size. Even if most growth businesses are SMEs
(which is far from certain), it certainly does not mean most
SMEs are growth businesses.
Second, we need to look outside traditional bank lending to
address this challenge. If we want to target the parts of the
economy where growth is achievable, we need to devise a
funding environment able to support the risks associated with
innovation and start-ups. As this report shows, that is not the
job of bank lending, but at the moment the UK has precious
few non-bank nance alternatives.
To the extent that there is an SME funding problem,
and we would argue that where there is a problem it has been
grossly overstated, the solution lies not with traditional
banking activity, but rather with the UKs broader business
culture and funding environment.
Growth policy should be directed away from subsidising
the SME sector as a whole towards targeted interventions
aimed at those whose ambition is for growth and innovation
rather than ongoing stability.
Tese interventions should aim to improve business
education and mentoring of existing businesses that have
a propensity to grow, as well as develop alternative nance
markets suited to funding growth risk. It is clear that much
more attention and eort is needed to re-build an equity culture
in the UK.
Tis is not to let banks o the hook. Tey have a
continuing responsibility to support the market for bank
lending, and should also think deeply about whether they can
help to address the non-bank nance gap, and help to close
the clear business skills gap among UK SMEs. Te banking
sector has an unmatched ability to reach businesses of all sizes
and should put its distribution mechanisms to work in
delivering solutions.
It is apparent that SMEs have been poorly served
by policy that conates their needs with those of growth
companies. Tere is a need for a renewed focus on policy
13 Executive summary
Infrastructure and UK business culture pose much greater
challenges than access to bank loans our national debate
should reect this
Te most useful policy discussions should have almost
nothing to do with bank funding and much more to do with
the broader infrastructure and culture in which UK businesses
operate. Tat is where the debate should be conducted.
Dont let the banks of the hook
Banks have a huge distribution system through their branch
networks and an unmatched contact book of businesses and
investors. Tey should be encouraged or even mandated
to innovate to nd ways of distributing alternative nance
and addressing knowledge and skills gaps in businesses.
A further report is needed into the specic needs of SMEs
SMEs are poorly served by a policy approach that assumes
they are focused on growth. A further report should consider
the specic challenges faced by these companies and identify
policy interventions that would materially enhance these
businesses survival rates and economic output.
Focus on increasing the growth potential of our SMEs rather
than simply increasing the number of SMEs we have
Policy emphasis should be on encouraging growth potential
so that businesses are more able to survive and more likely to
do so in a way that makes a positive contribution to the
economy and society. Unfortunately, this requires the kind of
long-term policy that is notoriously dicult to synchronise
with electoral cycles. It would involve thinking through not
just how to direct more help to the existing stock of
businesses in the form of mentoring, education and so on, but
also how to build relevant literacy in the generations of future
business founders and owners.
Establish a business academy network able to support
businesses as they develop
Many businesses struggle because of a lack of professional
management capability across a range of issues including
marketing, access to nance and business administration.
Business academies backed by the Government could address
these skills gaps and signicantly increase the success rates
of UK SMEs.
Create a central database of lender information to allow banks
and new entrants to make more informed lending decisions
Te technology platforms required for this could be considered
a public good and a utility created to provide lenders with
information about would-be borrowers and monitoring services
for existing borrowers. Te Government and the Bank of
England should encourage exploration of this and related ideas,
not least as a mechanism by which new entrants could accelerate
their SME activities and enhance competition.
Address the lack of an equity culture in the UK
A working group led by the Treasury and the Department for
Business, Innovation and Skills (BIS) could examine the full tax
and economic impact implications of a radical change to the
UKs equity culture and make recommendations.
15
1 Introduction
Tere is a broad assumption that small and medium-sized
enterprises (SMEs) matter a great deal to the UK economy.
As a consequence, there is an extraordinarily diverse
literature on a topic that might, at rst glance, appear to be
straightforward how the sector is funded.
In recent decades, these rms have been attributed great
signicance in national economies, as drivers of economic
growth, employment, innovation, research and overall
societal wellbeing.
In the foreword to Financing SMEs and Entrepreneurs soI,
Angel Gurria, Secretary General of the OECD said:
Small and medium-sized enterprises (SMEs) and entrepreneurs
must continue to be key players in national strategies for growth,
job creation and social cohesion. SMEs and entrepreneurs are
crucial for tracing new paths to more sustainable and inclusive
growth, thanks to their role in developing and diusing innovation.
However, they can only fulll this potential if they obtain the
nance necessary to start and grow their businesses.
3
(Ironically, the only truly substantiated nding that
small businesses contribute to wellbeing is that their owners
are happier than the average citizen, but we will come back
to this later.)
4
Tanks to this attribution, SMEs have ohen received
substantial subsidies in the form of grants and tax breaks
from central and regional governments and they remain the
focus of great political attention. Tat SMEs are heavily
subsidised is never mentioned in the debate about their role.
In fact, the subsidy is huge more than the annual budget
for the police force.
17 Introduction
Equally, many MPs will have heard from business owners
who have been unable to access funding, which drives political
concern that banking is not doing its job. A highly specic
issue can appear to politicians to be a far wider, more general
concern. We need to consider the sample size before we come
to conclusions.
We have been in a similar situation before. In the early
ggos, there was a
breakdown of both communication and condence between many
SMEs and their main nance providers, notably the commercial
banks. SMEs complained that reductions in (interest) base rates were
not being fully passed on and that banks prematurely cut back on
loans and so pushed viable businesses into receivership. Meanwhile,
the banking sector suered bad debts among loans to the small
business sector.6
In response at the time, the Bank of England initiated a
major ongoing review of the relationship between banks and
SMEs, aiming to bring facts into debates typied by anecdote,
assertion and assumption.
7

More than two decades later it is as if we are back where
this began. A close examination of the academic, regulatory
and commercial literature shows that much of the rhetoric
and available analysis of SMEs and their role in the economy
remains riddled with poor thinking and muddled conclusions,
problems compounded by a plethora of issues relating to the
availability and quality of relevant data.
Tis Demos Finance report aims to unpack the debate
around SME funding in the UK. Te time is ripe for some
myth busting, and in some cases relearning earlier ndings
that have apparently been forgotten or ignored. And we can
start by repeating a conclusion from the Bank of Englands
Finance for Small Firms: Access to nance is not a barrier for
most SMEs.
8
So much so that the Bank concluded, Tere is
no longer a need for the Bank to be involved in these issues.
It passed the matter o to a specialist body that would focus
in future on this non-issue.
But are we asking more of our small and medium-sized
businesses than is fair or reasonable?
Many SMEs do not currently expect to grow, and they
would largely dene success as continued trading, and perhaps
greater protability. Te owners of a family restaurant, for
example, may be far more focused on keeping open from year
to year than on opening a second premises, let alone a third
or fourth.
Simply by keeping going, the restaurateur provides
employment and economic activity, but it would be
unreasonable to expect signicant growth from this activity.
Consequently, it is far from clear that unfocused
support for SMEs as a category, rather than the high-growth
companies which form a relatively small sub-set of them, is
either particularly eective or oers good value for money
in pursuit of economic growth.
In the UK, there is a widespread and cross-party
perception that a lack of SME funding remains a serious
problem, potentially thwarting short-term economic recovery
and limiting long-term economic robustness and
competitiveness.
High-street banks in particular have faced signicant
criticism for their unwillingness to lend to SMEs. Tere is a
broad consensus that since the onset of crisis in soo;, the
banks have contributed to exceptionally slow general recovery
of the economy by reining in their lending ocers. It is
assumed that by stopping the ow of credit to the economy
via small business lending, banks have eectively stopped
recovery itself.
5
Te criticism of some banks struggles under
the Funding for Lending scheme illustrates how potent this
assumption seems to be.
Tis deeply awed argument has taken hold in the
media. Stories on the no-growth state of the economy are
illustrated by reference to a disgruntled small business
owner denied a loan by an uncaring bank, but frequently
fail to ask deeper questions about whether this is a
representative experience or why the business was unable
to access nance.
19 Introduction
Structure and a note on sources
Tis report is structured as follows:
Chapter s lays out the SME landscape in the UK.
Chapter g explains how banks measure and report the extent
of SME lending.
Chapter q gives a brief history of SME funding in order to
support the case that historical comparisons need to go back
long before the soo; credit crisis and its ahermath.
Chapter explains that SMEs receive large government
subsidies with very little evidence that they deserve them.
Chapter 6 lays out some surprising truths about how SMEs
actually fund themselves and the actual role played by banks.
Chapter ; looks at the SME lending front line how decisions
get made by the big banks.
Chapter 8 explores the relationship between SMEs and
economic growth.
Chapter g examines the tricky boundary between equity
and debt.
A nal chapter examines the policy implications and suggests
ways the SME funding debate might be recongured to be
of greater relevance and impact.
Tere is a plethora of reports on SME and business
funding more generally, and this report is not an attempt to
summarise or synthesise them. Numerous taskforces and policy
groups have addressed the issue, including sensible work on
how the UK might seek to improve non-bank funding alterna-
tives.
9
Arguments about SME and business funding are closely
linked to parallel debates on growth and entrepreneurship and
some of the relevant literature is reviewed here. Similarly, there
is much available research on how business funding is organised
in other countries, with a noticeable focus on Germany and
the US.
10
Again, this report makes no eort to repeat this work,
but refers to it where appropriate.
Tis report was largely written before the Parliamentary
Commission on Banking Standards published its June sog
nal report.
11
Tis does not focus specically on SME lending,
although some of its oral and written testimony discussed the
An immediate objection might be that sooq is a silly
place to begin a report on SME funding in sog. Aher all,
in sooq the credit crisis was not far o and there was no
suggestion in the report referred to here or in any other report
at that time that there was something brewing that might
turn out to be exceedingly damaging. In other words, the lack
of a perceived problem was highly correlated with the fact that
at that time credit could be obtained by businesses of all sorts
looking to borrow. Credit was certainly freely available in sooq
and became more so in subsequent years before catastrophe
struck. Among the biggest borrowers were the banks
themselves, several of which leveraged up their balance sheets
until they were greater than the entire gross domestic product
(GDP) of the UK.
Surely these conditions were dierent and banks are
now behaving dierently? Tey were and they are. But banks
are not the real issue. A closer look at the small and medium-
sized business sector in the UK shows clearly that the boom
years aher the early sooos until the bust of soo;o8 were
anomalous from a funding perspective. And insofar as we have
returned to a more typical environment, we can be much
clearer about how and why some, but a tiny minority of, SMEs
ever want to borrow money.
And this is the really odd thing about the issue: most
SMEs never borrow from a bank, they borrow from the people
who set them up or from friends and family, and they do their
utmost not to get into debt, instead ploughing earnings back
into the company or business so that they can remain debt-free.
Which raises a question rarely asked and even more
rarely answered. Why are we specically concerned with
SMEs and whether banks are lending to them? Why would
we want to encourage UK businesses to borrow more when
we have right in front of our eyes the strongest possible evidence
that too much debt, or the wrong kind of debt, can be
extremely dangerous?
Why, in fact, do we assume that SMEs as a group
want to grow, and that bank lending is the right way to
fund that ambition?
21 Introduction
issue. However, the nal report addresses some of the cultural
failings in the lending and sales cultures of banks, for instance
in selling interest-rate swaps to SMEs. Tis is not looked at
below because there is very little to add to the Commissions
ndings, which stand on their own merits.
Rather, this report seeks to give accurate numbers for
SME activity in the UK in order to address a notable gap in our
understanding of the national economy.
It draws on a wide range of sources, from interviews and
eld research to detailed use of statistics. Particular emphasis
has been placed on the new ndings from the SME Finance
Monitor, as these represent the most comprehensive available
view of actual current SME practice. Other statistical sources
include the Bank of England, the British Bankers Association,
the Organisation for Economic Co-operation and Development
(OECD), the International Finance Corporation (IFC) and
the Oce for National Statistics (ONS).
Te Bank of Englands report Finance for Small Firms
referred to above was published in sooq. As there are subsequent
gaps in data collection, followed by changes in statistical
methods, there is no reliable data series for very long-term
comparisons. And there are almost always questions about
the reliability of data. For example, even in government reports,
we nd disclaimers such as, Te time series is not consistent
throughout due to changes in the methodology. Te series has
therefore been adjusted to take account of these dierences.
Figures are indicative and should be interpreted with caution.
12

We acknowledge the awkward fact that we cannot be totally
precise at many points where it would be most helpful. However,
where something is indicative, it is ohen strongly so and this
should not be grounds for undermining or rejecting the analysis
or conclusions that follow.
23
2 Mapping the SME
population what are
we talking about?
Let us begin with a description of some of the main challenges
facing anyone wanting to paint a clear picture of the SME
population and its needs. What is an SME? How many of them
are there?
Although there are some agreed denitions of SME
characteristics, these are not universally adopted, so any
eort to assess SMEs and their nancing needs invariably
runs into intractable problems of irreconcilable or simply
missing information. A subject of great importance to many
experts and policymakers is, in reality, poorly understood
and ohen misrepresented.
13
Figure shows the European Commissions denition
of the dierent categories of SMEs. Te important thing to
note for the UK debate is that the EU suggests a
combination of at least two factors is appropriate, but gives
the option of looking at balance sheet or asset size instead
of turnover. Tis element is almost never mentioned but
arguably should be part of the discussion about SME
funding. Depending on their sector, businesses will have quite
dierent nancial proles.
Te main factors determining whether a company is an
SME are:
number of employees and
either turnover or balance sheet total
Any discussion about SMEs needs to start with some
simple numbers. What is the actual stock of UK small
businesses? How many are there? Here we see the semantic
and data-related issues faced by participants in this debate.
25 Mapping the SME population
Figure 2
The UK business population, by rm size
It is important to note that these gures do not, as is
ohen claimed, include the grey economy. Each entity has
some form of ocial registration, so cannot be considered as
being part of the shadow economy.
Te numbers immediately tell us that most of the
businesses in the UK are very small, with insucient turnover
to be VAT-registered. In fact, BIS estimates that three-quarters
of these businesses are sole traders with no employees, while
there are nearly million micro rms employing between
one and nine people.
17

According to Professor Alan Hughes of the Centre for
Business Research at the University of Cambridge, the vast
majority of these rms employ fewer than ve people.
By way of comparison, there are .s million businesses
employing between and qgg workers, but a mere s,goo
rms employ more than oo people and these businesses
For example:
Tere are at least ve ways of dening small businesses. Tere are
roughly million people registered with HM Revenue & Customs
(HMRC) as self-employed.
Tere are just over million registered companies, although many
of these are holding vehicles for property management, so are not
typical small companies.
Approximately .g million entities are registered for VAT, while
there are more than s million people using the pay as you earn
(PAYE) system.
15
If everybody concerned with the SME debate used the same
measures consistently, then policy discussions would be a lot easier.
But politicians, academics and other lobby groups ohen oat
between denitions, sometimes in support of a particular case.
Ohen they simply ignore the best potential source, the
Governments Inter-Departmental Business Register, which
aggregates information across various government departments.
16

It is published with a time lag, but oers the most comprehensive
view of UK business activity. It suggests that in sog there are
q.8 million businesses in the UK a much higher number than
the .g million VAT-registered entities, and an increase of almost
oo,ooo from the equivalent gure in soo8.
Figure 1
The European Commissions denition of diferent types of SMEs
Source: Enterprise and Industry, What is an SME?
14
27 Mapping the SME population
that there is no information on why a particular company
ceases trading, but we do know that there can be good reasons
as well as bad ones for this decision.
Table 1
Use of business nance across diferent sized rms

Turnover Broad
character-
istics
Use of regular
nance
Use of
specialist
nance
Typical providers
Smallest
micro
busin-
esses
Below
50k
Cash-based
rms, often
part-time
businesses;
few tangible
assets; local
operations
Limited mainly
to overdraft,
loans and
credit cards
or personal
nance
products
Limited. Some
asset-backed
lending (ABL)
mainly vendor
nance
Banks, credit
card providers
and point of
sale (vendor
assistance)
Micro
busin-
esses
50k
to 1m
Increasingly
full-time rms
with staf,
premises
and assets;
local activity
normally
limited to a
single region;
occasional
exporting
Overdraft,
loans and
credit cards
Increased use
of structured
ABL.
Occasional
use of trade
nance
products
Banks, credit
card providers,
specialised
providers for
ABL and trade
products
SMEs 1m
to 25m
Full-time,
larger multi-
regional and
national rms;
increasing
export/import
activity
Overdraft,
loans
Still some
use of ABL,
factoring
and invoice
discounting,
export nance,
some equity
nance
Banks, credit
card providers,
specialised
providers,
business angels,
private equity

Note: Denitions have been developed for the purpose of the
Taskforce and may not reconcile with other denitions of SMEs.
Source: Supporting UK business: the report of the
Business Finance Taskforce, October 2010, p.14
20
account for qq per cent of all UK employment and q per
cent of all turnover.
18
Figure s shows the UK business population represented
in simplied and rounded terms.
It is already clear that this is a diverse population, and
we should be suspicious of any eort to treat it as homogenous.
As we will see below, there is no such thing as a typical SME,
and in fact smallness is a a poor indicator of the importance
of a business to the momentum of the national economy.
In addition, there are some g.g million business current
accounts held with UK-based banks, demonstrating that
there is a large number of businesses operating in ways not
easily captured by statistics. Tese might be people trading on
auction sites such as eBay, or simply taking advantage of free
personal banking and mingling their personal nances with
those of the business. Tey might be running what amounts
to a fairly substantial small business, but in a way that
requires no external nance and is almost entirely unnoticed
by ocial statistics.
It is extremely dicult to know whether this business
stock how many businesses there are currently trading is
changing, for better or worse. But we can make one observation.
While the headline number of business entities is relatively
stable, indeed is a lot higher than it was a few decades ago, there
is considerable annual churn as existing businesses die and
new ones are created. Tracking this ow is not easy, however.
Te guiding principle of policy in this area is the
belief that an ecient, well-organised SME sector is an
important economic asset. Yet while there are rich data on
how people as individuals enter and exit the labour market,
there are no equivalent data for businesses and most estimates
are unreliable.
19
We know very little about why a new business is launched
and even less about why it might subsequently exit (does it fail,
become insolvent, or leave for personal reasons including
exploiting capital gains tax rules?), so in eect we have very
little understanding of how and why the stock of SMEs is
changing. Filing requirements for Companies House are such
29 Mapping the SME population
Interestingly, banks are in the privileged position of
having access to the management accounts of some companies
that are or wish to be borrowers. In these cases, they can see
whether an entity is protable and they can assess from its
transactions whether, for example, it is exporting goods and
services. However, these data are also highly selective. Tey
cover only the universe of companies that has dealings with
each bank, and they are not aggregated in a way that might
allow a national picture to emerge. Moreover, only a minority
of companies are sophisticated enough to warrant management
information at this level of detail.
Nevertheless, there is a source of information about
bank and other lending to SMEs that is gradually building a
more reliable picture and is worth describing in a little detail.
In July soo the Business Finance Taskforce was set
up to review the role of UK banks in lending to the UK
economy and to make recommendations and commitments.
Te Taskforce was a response by the six main UK banks
and the British Bankers Association in light of sustained
criticism of banks in the wake of the credit crisis and
subsequent recession. Te widespread perception, fuelled by
a constant ow of political interventions, was that banks
were deliberately withholding funds and making it dicult
or impossible for rms to borrow or to renance on
favourable terms. Te British Bankers Associations report
in October soo included in its recommendations the funding
of an independent survey to create an agreed and
authoritative set of data on business nance demand and
lending supply.
23
Te result is the SME Finance Monitor, a quarterly
publication based on a rolling survey of ,ooo businesses
since the rst quarter of so as of Q sog some qo,ooo
interviews have been conducted.
24
Tis oers the most
detailed view of SME attitudes and practices with regards
to funding. It is important for this report, then, to explain
its ndings in some detail.
Te SME Finance Monitor is suciently well established
that we can begin to see something of the shape of the SME
In other words, we have limited insight into the SME
business population and its evolution over time. Tis problem
is exacerbated by the diering methodologies of business
lobby groups, many of which conduct and publicise their own
small-sample surveys on business activities and attitudes. It is
a matter of logic that any company that is a member of a lobby
group or trade association is, by denition, not a typical SME.
21

Indeed, it might help the debate if we abandon the very notion
that there is such an entity.
Table shows one eort to classify business size and
the related nancial requirements and providers of nance.
Its own footnote is illustrative of the issues discussed above.
Te diculty of estimating the UK business stock in
aggregate is mirrored by the equivalent problem at the level
of individual businesses and companies. Even the simple
rounded numbers used earlier in this report show that the vast
majority of UK businesses are unincorporated and employ
one person or no one (but mostly one person, the founder or
owner, who has no current intention of employing anyone
else therefore they create no employment, as we will explore
below). Tey are not required by law to le information on
their activities, although some of this is captured in HMRC
data, particularly via individual tax returns.
Where a business is incorporated, a long-standing drive
against red tape has resulted in a progressive reduction in
ling requirements, particularly for the smallest entities, which
are not asked to le a prot and loss statement (P&L) and are
oered lengthy time lags before they must le their accounts.
By the time their balance sheets can be accessed the information
is so old as to be eectively useless as a basis for assessing the
market, its protability and its performance.
22

For their own reasons, some companies volunteer
information about themselves to credit agencies such as
Experian and Dun & Bradstreet, both of which gather
extensive data in order to compile credit les on individual
entities. However, this creates an obviously biased sample
and leaves by far the biggest group of entities opaque to
meaningful external analysis.
31 Mapping the SME population
some international comparisons, but also oers a picture of
the UK market, albeit with a time lag. Te latest scorecard
for the UK is shown in gures q. and q.s.
What do we learn from the scorecard? By this measure,
SME lending actually increased aher soo;, and even in so
was only a little below its soo; level. As a proportion of total
business lending, it looks remarkably stable at around so per
cent. Tis time series and the comparisons it allows will become
much more valuable over time.
Figure 4.2
Government loans guaranteed to SMEs (ofered)
Source: Centre for Entrepreneurship, SMEs and Local Development,
Financing SMEs and Entrepreneurs 2013.
Figure 4.1
Trends in SME and entrepreneurship nance in the UK, 200711
population. For example, Figure g conrms the prevalence
of single-owner businesses in sectors such as construction,
transport and health and community services in the rst
quarter of sog.
In addition to the SME Finance Monitor, which looks
only at the UK market, important new analysis of SMEs
internationally has been developed in recent years by the
OECD.
25
Aware that there are signicant challenges connected
to data quality, the recently updated SME scorecard allows
Figure 3
Proportion of SMEs and single-owner businesses
in a number of sectors, UK, Q1 2013
33
3 Where do banks
come in?
A measure of the diculty facing anyone aiming to take an
evidence-based approach to SMEs and the importance of
funding in supporting their role in the UK economy is that
the Bank of England tracks one set of numbers and the
British Bankers Association another. Te OECD summary
statistics shown in chapter s reect this confusion. Hence a
caveat the numbers in this chapter are highly likely to be
somewhat rounded because it is impossible to generate
completely reliable data, but this should not reduce their
credibility, as they have been extensively tested among
market participants.
According to the Bank of Englands numbers, the total
SME market is some ;q billion of bank loans,
26
but the
British Bankers Association estimates the market is only
og billion a gap of more than ;o billion. Te reason? Te
Banks data capture all lending to SMEs by so-called Mq
lenders, and this includes foreign banks, leasing companies
and so on. By contrast, the British Bankers Association
reporting banks are the so-called high-street banks plus a few
others such as the Co-operative Bank (although it withdrew
from new business lending in May sog).
Whereas the Bank of England requires reporting based
on the simple metric of company or entity size, the British
Bankers Association allows some discretion. Tanks to its
relationships with its customers, a reporting bank has an
understanding of their actual status and intent. For instance,
some businesses choose to operate as a series of small aliates
that link together, have nancial and organisational motives
for remaining separate, but actually operate as one overall
entity. Do you reect this in what you record or do you record
each entity as a standalone SME?
35 Where do banks come in?
Figure 5
The change in total stock of credit outstanding in each UK
lending market, 200509

PNFC = private non-nancial corporations; OFC = other nancial corporations
The boom period is 2005 Q1 to 2007 Q3 and the bust is 2007 Q3 to 2009 Q3.
Data are not adjusted for securitisations. Excludes intragroup lending and assets
held at the Bank of England.
Source: Bank of England.
Evidence for this comes from the Bank of England in
the form of a chart clearly showing the extent to which
non-UK banks ramped up the stock of lending in the boom
years before exiting with haste aher the bust (gure ).
28
On the ip side, banks insistence that UK SMEs
actually dont want to borrow very much at present tends
to be ignored or dismissed as special pleading. Tere is
good evidence, reviewed below, that they are correct in
their assertion.
Let us take the case of Barclays as an example of this
tricky point. Its Bank of England ling suggests it lends s8
billion to SMEs as of the end of Q sog, but its British Bankers
Association number is somewhere between ss billion and
sq billion, reecting the Associations discretionary knowledge
of its customers. Te dierence of between q billion and
6 billion is accounted for by just a few hundred customers,
which Barclays judges are not SMEs, but in reality bigger,
connected businesses. It believes this gives it a truer picture of
the actual SME market. Anecdotal evidence from the other big
UK banks suggests that they view the world in similar fashion.
It is important that these numbers are understood. Take
the insight that ;o billion of SME lending is not provided by
the high-street banks. Teir lending amounts to roughly
og billion, so is not a huge amount more. Yet the presence in
the UK market of foreign banks, leasing companies and so on
is almost never mentioned in the political debate about SME
lending. Nor is an important consequence of this observation.
Foreign banks entered the UK market aggressively in the
period from soos until the blow up in soo;o8 of the entire
nancial system. During that time, they competed hard,
typically using mortgages on commercial property as collateral
for lending. A feature of the market since the credit crisis has
been the wholesale withdrawal of foreign banks providing net
new lending they cannot aord to lend on an unsecured basis
in the UK and they certainly cannot trust UK commercial
property as the basis for secured lending. If anything, they
want to call in loans.
Tis helps to explain why SME lending has become such
a canard. At the very time UK banks are under pressure to lend
more to SMEs, following the withdrawal of foreign banks and
others, the overall gures on lending show a remorseless decline,
although UK banks might be trying their best to lend more.
27

Te banks feel under strong political pressure since the exposure
of some business practices and attitudes that leave a lot to be
desired, but in fact are much more willing to lend, and have
been making much more eort to lend, than they are credited
with in almost every inuential channel in UK public life.
37 Where do banks come in?
Tere is an additional irony here. On the one hand, banks
face criticism for lending too little to SMEs. On the other
hand, there is growing awareness that if they lend too much
they risk sustaining a generation of zombie companies that
continue to live by recycling debt, but which in ordinary times
would have gone bust (assuming they would have been able to
borrow money in the rst place). Tese zombies are marginal,
likely to be ex-growth or even shrinking, but they are also
potentially damaging competitors who can distort markets.
Te trouble is no one knows how many such companies exist,
making it tricky to argue for specic behaviours or policies.
Tis is by any standards a shame and the SME debate
in the UK is further impoverished. What could be a genuine
argument about how best to stimulate company performance,
which in theory should lead naturally to employment growth
and an escape from economic stagnation, remains stuck in
sterile rhetoric based on lazy use of statistics and economic
populism, combined with simple ignorance.
39
1
2
3
3A
4
4 A brief history of SME
funding in the UK
In the g8os UK businesses had a range of options for how
they funded themselves externally. Tis has been described as
a funding escalator, as shown in gure 6.
Figure 6
The UK funding gap (funding escalator)

Source: Dr. Richard Roberts
Another way of looking at this is to compile a menu
of funding options for businesses of all sizes:
Working capital
s year cap ex/asset purchases
Development capital
Pure start-up capital
Equity
41 A brief history of SME funding in the UK
Te rst problem is that there is a potential lack of
development and equity capital, thanks partly to the absence
of competition from foreign banks and partly to the weak
equity culture.
Box 1
Dont sugar the pill
Sir Alan Sugar gave a typically pithy speech in the House
of Lords on sq March so:
To reect on the past I years or so, it has been customary for a
person dressed in a nice pair of designer jeans and a nice blue
blazer with a white open-collared shirt, a bottle of Evian in one
hand and a wonderful Microsof spreadsheet in the other, to
walk into a bank, mention the word dotcom and walk out with
million. Tose days, I am afraid, are over. We all know what
went wrong there; and we also know what a mess the banks got
into recently; but the penny has not dropped with some people.
We still have in some cases an expectancy culture, where people
still think that there should be money freely available to nance
lost causes, poorly run companies or a whim of an idea
True, the banks were irresponsible, and they have been told in
no uncertain terms to get their act together. However, having
told the banks to get their house in order, the current
Government are constantly bleating that the banks are not
being helpful in lending money to small businesses, whereas the
message to the small business community should be one of
realism in understanding that no one is going to lend money
to a lost cause. Te banks are now looking at the traditional
criteria of showing some assets or having some historic record
of prots before parting with their money. Tey are denitely
open for business. Tat, I remind your Lordships, is how they
make some of their money. In my recent seminars, I have
received comments from some people along the lines of, Te
bank has been outrageous. It has actually asked me to put up
some collateral my house, for example. Well, I am very
sorry, but why not? Why should it take a risk on you if you are
not prepared to take a risk on yourself?
29
Each step of the escalator had dierent participants.
Te banks role was largely conned to and s with the
expectation of three- to ve-year payback periods on what was
eectively secured or partially secured lending in the case of
s. g and q were the territory of gi, venture capital specialists
and some specialist banking units. gA was typically provided
from personal wealth or by friends and family, and more rarely
by so-called angel investors.
Te recent history of UK business funding and our two
current problems is shown in gure ;.
Figure 7
UK business funding from before 1990 to 2007

HNW High Net Worth; MEW Mortgage Equity Withdrawal.
43 A brief history of SME funding in the UK
fund themselves thanks to a willingness among banks to
compete during a time of abundant credit.
But that all changed. As noted above, foreign banks,
which had been aggressive competitors in the UK market,
withdrew. Tere was no more equity to be released. Borrowers
who had received credit in the boom years no longer seemed
like plausible candidates, but needed to nd ways to deleverage
or renance their existing debts. And the banks questioned
whether their participation in medium- to long-term business
lending made economic sense given capital requirements and
the costs associated with understanding individual business
borrowers. In particular, they essentially withdrew from lending
with maturities from o to years on the grounds that this
type of long-term funding is better suited to equity.
Put simply, SME debt nance is dicult to lend protably
at scale, and this problem is by no means conned to the UK.
We will explore this further below.
Te important point is that banks role in SME funding
changed signicantly prior to soo; and is in the process of
changing again. As part of that process, the banks themselves
are assessing how they participate, how they make a prot
over the cycle, and how they recongure customer relationships
and customer attitudes so that there is a better meeting of
expectations and reality. It goes without saying that successful
borrowers pre-soo; will naturally nd it strange that their bank
might no longer be willing to oer funding either on the same terms
or at all. But the change reects the fact that the period from
roughly sooo to soo; was anomalous.
Some aspects of the change are particularly vexing for
some borrowers, but seem more reasonable when viewed from
the perspective of the lender. Aher soo;, banks increasingly
asked for personal guarantees on new SME loans, to the
consternation of many existing customers seeking either new
or rollover funding. Tey also reviewed and ohen revised their
overdrah facilities and assessed the covenants on outstanding
loans to see whether these could be called in.
In simple terms, for the lender a loan is a commitment,
Te second problem is that life is trickier for start-ups,
particularly because there is rarely the option to fund a start-up
using the mortgage equity withdrawal that was a feature of the
go-go years. Moreover, funding from friends and family is
harder to come by. Although at the very top of the wealth
spectrum there has been little hardship, many potential equity
funders of start-ups lower down the cohort have been
distracted by concerns about pensions, care bills, university
fees and so on. An unintended consequence of the withdrawal
by the state from areas such as these has been that the
propensity for personal investing in risky start-ups has dropped.
Tis element of the funding menu is clearly broken.
Before the early ggos, banks business lending balance
sheet consisted of 8o per cent overdrahs and working capital
and so per cent secured loans. From todays perspective, this
might look like a funding nirvana, but it was actually
dangerous for SMEs. Unlike a loan, an overdrah is repayable
on demand, so if a bank thinks a business is in trouble or merely
shihs its risk appetite, an overdrah can be cut or cancelled.
A loan, by contrast, cannot be called in unless the borrower
has failed to make a due payment. Overdrahs, by denition
then, are inherently short term and contingent they can be
reduced or withdrawn, and the borrower has no right of appeal.
Tis type of SME funding was not nearly as appropriate as it
appeared to be.
In the recession of the early ggos banks made
signicant losses on their SME loan portfolios.
30
As a
consequence they changed the way they lent, increasingly
moving to a fully secured basis and relying heavily on
commercial mortgages as collateral. Tey quickly reversed
their balance sheets, in eect changing their role in the
day-to-day funding needs of their business clients. When new
capital rules were introduced banks mostly closed down their
development capital operations.
Before the crisis of soo; rising property values suggested
that this was a successful strategy. Some start-ups were able
to fund themselves using mortgage equity release rather than
traditional channels. Some marginal businesses were able to
45 A brief history of SME funding in the UK
would be oered more favourable terms and encouraged to
borrow more in order to consolidate growth. But it appears not
to be the case. Banks are slow to reduce interest rates on loans,
for example, even if a successful company is clearly less risky
and should therefore benet from some form of risk-based
price reduction.
At the portfolio level, banks use price inexibility to keep
a small portion of the upside being generated by the successful
clients, with the eect that debt nance is more expensive than
clients might have expected. Tis could partially explain why
rms generally seek equity nance only when they have
reached a certain size.
32
while for the borrower it represents an option on future success.
Te outcome for the bank is clear it gets repaid on time in full
(or partially) or it does not and loses everything. Te borrower
or business owner has a dierent riskreward trade o. If the
loan helps the business to add value, then all of the benet goes
to the borrower or owner. If not, the option is, in eect, put
back to the lender and is either worthless or worth less.
Depending on the duration of the loan, a bank is constantly
vulnerable to this mismatch in outcomes.
Moreover, lenders are acutely aware that there can be a
lemons problem in the SME market.
31
Businesses and their
owners will always know more about their actual health and
situation than the lender, despite its best eorts to gather
and monitor information. Tere is a tendency for businesses
to turn to bank funding precisely when they know something
is going wrong and that external nance might help to avert
a nancial problem. As one banker puts it, Among the most
dangerous words a banker can hear are back me!
Te tension goes both ways. Bankers describe the
Friday ahernoon syndrome whereby a business owner phones
to ask for an emergency short-term increase in their overdrah,
typically to pay sta wages that would otherwise go unpaid.
If the bank manager declines, then it is easy to see why the
business owner will think that this decline is the true reason
for the failure of the business, when the truth is very dierent
and much more deep-seated.
Te problems associated with the information
asymmetries between lenders and borrowers have been the
subject of much academic research. One nding of interest
is that successful SMEs, the tiny minority that grow in a
sustained way, can actually end up paying more for bank loans
than their less successful peers because banks are aware of the
dicult underlying economics of lending. With SME lending
there is a portfolio eect whereby the population of good
borrowers is eectively subsidising the uneconomic borrowers
by paying a higher rate of interest than would apply if they
were treated individually.
Indeed, you might think that a visibly successful client
47
5 Why do governments
love SMEs?
Tis background partly explains why the Government and
other groups are so focused on banks role in the SME
economy. But to understand the issue we need to look harder
at why SMEs are the subject of so much political attention. Te
funding debate seems ohen to assume that SMEs face a form
of nancial discrimination. In fact, they are heavily subsidised
by taxpayers, despite a lack of robust evidence that as an
aggregate group they full many of the claims made on their
behalf for incremental growth rather than (welcome) stability.
Professor David Storey conservatively estimated in
soo6 that the annual total nancial support for small business
is equivalent to a public expenditure of ;.g billion, more than
the then annual budget for the nations police force.
33
Are they
worth it?
Tat might seem like a heretical question, but it is justied
by the evidence or lack thereof. In recent years a major
European Commission research project has been exploring the
role of nance in growth, employment and competitiveness.
34

Some of the most striking ndings cast doubt on whether the
SME sector deserves the support it receives from governments
all over Europe.
In their paper Muppets and gazelles, published in
September so, Paul Nightingale and Alex Coad, of the
University of Sussex, claimed convincingly that there is no solid
proof that SMEs and entrepreneurs are especially benecial to
the economy.
35
Teir arguments are worth close attention as
they go to the heart of the SME problem.
Academic work over recent decades has established that
developed economies, including the UK, are disproportionately
inuenced by a few very successful companies, which drive
innovation, create wealth and generate new jobs. Te ipside
49 Why do governments love SMEs?
more innovating small enterprises than there are larger
innovating enterprises, and this skewed reality has shaped
the policy agenda.
38
Tere is an argument in the academic literature that a
combination of cultural and ideological biases in favour of
entrepreneurs has crowded out a proper examination of the
issue, a dilemma exacerbated by the problems of data quality
already discussed above:
39

Rather than entrepreneurship being a universally good thing, the
evidence for positive impact is at best weak and highly skewed towards
the impact of atypical rms small rm jobs are more volatile, less
productive and less well-paid, have fewer benets, and have higher
rates of accidents. Entrepreneurial rms are less innovative, less
productive, and are not associated with GDP growth.
40
In fact, some argue that there may be excessive
entrepreneurship in an economy if public policy encourages
too much market entry.
A more productive policy route may be to focus attention
on the growth potential of new businesses rather than the
quantity. Interestingly, this is a feature of some current UK
eorts to improve new business success rates. For example, the
o,ooo small businesses project funded by the Goldman Sachs
Foundation and run by Aston Business School oers selected
businesses close mentoring and support in several UK regions.
Its self-description does not challenge conventional thinking,
however the programme aims to support the vital role
played by small businesses in creating jobs and driving
economic growth.
Nightingale and Coad note that the typical entrepreneur
is not Bill Gates, but rather
someone who starts from an underprivileged position (s% of
start-ups in the UK come from unemployment, for example), uses
their savings to start a low-productivity rm such as a sh and chip
shop, in a town with two sh and chips shops, but a market that can
only support one if they are still around in two years, which is
is that most companies, in fact the vast majority of them, have
little positive impact, are not innovative, and generate no or
few new jobs. Tey are in eect post-growth, regardless of the
size of the rm.
Most companies are SMEs, including start-ups, so these
will make up most of the group that makes little impact. We can
run the same observation for growth (of which more below)
only a few companies are capable of sustained growth and,
given the size of the SME sector as a fraction of the economy,
it follows that the majority of companies that do not sustain
growth are SMEs.
Small company survival rates support these analyses.
An accepted broad nding is that roughly half of new rms in
the UK fail to survive for more than two years. Even if this is
overly pessimistic, it is directionally correct. In Canada, for
example, which has some of the best statistics on SMEs thanks
to a long-running data-collection eort, 8 per cent of SMEs
(with up to so employees) survive a full year aher starting up,
;o per cent survive through a second year, but only per cent
survive for ve years.
36
Nightingale and Coad ask why the relatively poor
performance of so many companies receives so little attention
when the question is crucial for industrial and economic policy.
Te underlying point is that this is an intensely political issue.
Broadly speaking, since the g;os support for SMEs has been
seen as a convenient proxy for supporting growth in the
economy. Furthermore, small business owners are part of a large
and vocal constituency they are good at getting attention
and they have a lot of votes.
Rather than asking why so many SMEs dont want to
grow, all the attention is given to the few successful enterprises,
which motivates a range of responses from untargeted public
subsidy to criticism of banks for their unwillingness to lend.
A good analogy made by Professor Storey is that of a lottery
we hear plenty about the incredibly rare winners, but nothing
about the millions of routine losers.
37
Professor Hughes notes
that this also holds true for product and process innovations
large rms dominate these activities, but there are many
51 Why do governments love SMEs?
very unlikely, it is only because they have displaced a similar
marginal rm. Such rms create a lot of jobs, but also destroy a lot of
jobs, and while they make their owners happier, they have a fairly
marginal impact on the rest of the economy and only make up a
small proportion of employment.
41

Nightingale and Coad suggest that the majority of
start-ups should be classied as marginal undersized poor
performance enterprises (hence the muppets of their title).
More usefully, the authors argue that market entry generates
three kinds of rms. In addition to the muppets, there are
businesses with potential that fail to realise it thanks to bad
luck or poor judgement, along with the few rms that achieve
their potential. By far the largest share comes from the rst
of these, they conclude.
Few sources better illustrate the divide between academic
research, for all of its drawbacks and diculties, and policy
makers. Tis is surely an area where evidence-based research
in the public sphere deserves more attention.
53
6 Some numbers on
funding of SMEs they
might surprise you
We noted above that SMEs in the UK rely overwhelmingly
on banks for their funding. But this type of generalisation
risks precisely the misdirection pointed out by Nightingale
and Coad. We need to unpack the numbers before we can
understand whether or not there is a problem.
An HM Treasury and BIS report on SME nancing
noted in its overview of nancing options that SMEs, in
particular, suer from long-standing challenges in accessing
bank and equity nance, and have therefore been historically
the main target of government action.
42

Tis creates an initial potential confusion by conating
bank and external equity nancing. In fact, equity nance is
extremely unusual in the SME sector and represents
arguably one of the biggest opportunities for future reform
of overall business funding. How many SMEs seek equity
funding in any given year? Only s per cent so in every
,ooo. Te number is a signal that these seekers might be
of policy interest, if only because they are so unusual. Any
solution here might involve banks, but is certainly not their
primary responsibility.
Te report goes on to note, Around a third of SMEs
do not use formal sources of external nance at all, relying
instead on retained earnings or personal nance to fund
investment and growth. Tis is highly signicant, but also
contains a serious misdirection. It is signicant because it
points to an easily overlooked fact about SMEs they
dont borrow very much and most simply dont borrow at
all, at least from a bank.
43
And the misdirection is that
investment and growth are two very dierent things, again
conated. We will come back to the question of SME
growth below.
55 Some numbers on funding of SMEs
We also know from the SME Finance Monitor that
roughly qo per cent of SMEs meet the denition of permanent
non-borrowers they have not borrowed in the past ve years
and indicate no intention of borrowing in the foreseeable future
this tallies exactly with the Treasurys number. Tis group is
over-represented among smaller SMEs, which makes sense
because that very large population includes many businesses
that have no need for external nance at all and they are
unlikely to turn to a bank in the event that they were to do so.
Tis category of permanent non-borrowers is mildly
problematic, not least because it is a supplement to the earlier
designations of happy non-seekers and would-be seekers, but
it represents an important analytical insight. Indeed, it allows
us to put some other aspects of SME funding into perspective.
It demonstrates that any assertion about the demand for and supply
of external funding for SMEs can apply at best to less than two-thirds
of the population. In other words, one could say, Of the 6o% of
SMEs that have any interest in seeking external nance, xx%
etc etc or only qo per cent of SMEs are currently using
external funding, and only a proportion of that, albeit a large
one, comes from banks.
Critics have argued that no one can be sure that they
will not borrow in future and that the assumption of
permanence is therefore questionable. However, whatever
the semantics, it seems that there is validity in identifying
those SMEs that are highly likely to remain nancially
independent. Te SME Finance Monitor sets a tough hurdle
before an SME is considered to belong in the group of SMEs
that seem rmly disinclined to borrow, because they meet all
of the following conditions:
are not currently using external nance
have not used external nance in the past years
have had no borrowing events in the past s months
have not applied for any other forms of nance in the last
s months, said that they had had no desire to borrow in the past
s months and reported no inclination to borrow in the next
g months
Figure 8
Use of external nance by UK SMEs, 2011 to Q1 2013



By date of interview
Source: SME Finance Monitor, Q1 2013, p 41
We run into some dispute about the precise numbers
here. Te Treasury and BIS report gure looks low compared
with other research that suggests only so per cent of SMEs use
bank nance, until we realise that there is an important
dierence between external nance and bank nance, the
latter being a sub-category of the former.
44
Anecdotally, banks
believe that the so per cent number feels about right given their
knowledge of local business populations. Te annual report of
SME Finance Monitor in sos reported that somewhat over
half (q per cent) of SMEs have not used external nance at all
over the last ve years.
45
Figure 8 gives the breakdown for
these gures between so and the rst quarter of sog; we can
see the proportion of SMEs that have not used external nance
is increasing.
57 Some numbers on funding of SMEs
One completely overlooked aspect of the relationship
between SMEs and banks is that over time SMEs have been a
remarkably stable source of net funding for banks. Deposits
from small businesses routinely were larger than their
borrowings for at least three decades prior to the mid-g8os.
Te Bolton Inquiry into small rms, which reported in g;,
made precisely this point.
47
Only from the late g8os to the
mid-ggos did a higher percentage of SMEs borrow from the
banks to the extent that the group as a whole became net
borrowers. Interestingly, this reversed in the late ggos, with a
brief dip into net indebtedness in soo.
48
SMEs in general
entered the current turmoil with relatively good net liquidity
and the rate of business failures since soo; has been
correspondingly low, in contrast to the earlier recession when
banks were hit hard by losses from their SME portfolios.
49
Tis raises another important but subtle point about the
role of SMEs in the economy and their symbiosis with the
nancial system. As a group they generally lend money to banks
rather than borrow it. Banks then seek productive uses for those
funds, lending them on and seeking value-creating
opportunities. Among the borrowers is a sub-set of the SME
sector, those companies that are growing and need external
funding short of being ready to raise equity. So the general
population of SMEs helps the atypical tiny minority, albeit
obliquely and unwittingly.
We can go further. If we look at the amounts borrowed,
the biggest borrowers come overwhelmingly from the biggest
SMEs those companies on the cusp of escaping the
classication that are not yet able, or are unwilling, to tap
funding sources other than banks. Simply by their own
borrowing, they greatly reduce the net deposits of the SME
sector, so the typical picture we see understates the sectors
actual contribution to banks funding. It is like looking down
a telescope the wrong way.
Tis has important implications for such matters as
overall nancial stability. While most SMEs are fairly
conservative in their nances, they contribute to overall
stability, even if failure rates within the sector remain high.
Tus during the research process there are sequential
opportunities for an individual respondent to drop out of
the category.
Most SMEs have always funded their activities entirely
from internal sources, namely accumulated capital and
retained earnings. Te SME Finance Monitor is showing that
there is growing reliance on these sources of funds, perhaps
because of debt aversion post the credit crisis or because
business owners know that in the current climate they are
unlikely to look like an attractive proposition to a potential
lender. More than half of SMEs have a personal element in
their business nances, whether a personal bank account, a
funding facility in a personal name, an application for such a
facility or an injection of personal funds into the business. Te
latter is by far the most common some qo per cent of SMEs
say that in the last year they injected funds either because they
wanted to or had to. Most of the capital injections were pretty
small though 6o per cent were for ,ooo or less. Again, this
makes sense. Hundreds of thousands of small business owners
routinely tap in and out of their companies partly because
they are optimising their personal taxes, for example using
director loans that must be repaid and taking dividends in
lieu of salary.
We can make a useful international comparison here.
Recent research by Oliver Wyman, a consulting rm, found
that while many US SMEs (or small businesses dened as in
business for at least one year and with fewer than oo
employees) used credit cards, car loans or rst mortgages to
fund their business, only % report having an operating
loan or an equipment loan or lease. Tus small businesses
dont actually have many small business loans.
46
Te
researchers noted something equally striking: ;o8o per cent
of small business owners report that access to credit is high
up the list of things they look for when choosing a bank. While
they dont want a traditional line of credit or a term loan, they
overwhelmingly want something that can act as a reserve or
buer against an occasional cashow gap, typically to cover an
amount equivalent to between half and one months revenues.
59 Some numbers on funding of SMEs
Figure 10
Use of external funding by UK SMEs, 2011 to Q1 2013
Percentages shown represent highest and lowest values per category
Source: SME Finance Monitor, Q1 2013
We can see clearly that overdrahs overwhelmingly act as a
liquidity mechanism put another way, an overdrah can be
seen as protection against cashow volatility as per the
Oliver Wyman US research cited above. Tis ts with our
knowledge that many overdrahs are actually not fully used.
In fact, there is a very large pool of unused credit in the
UK SME sector according to the Business Finance
Taskforce, facilities across the board are utilised by only ;
per cent, with rates of utilisation ranging from o per cent
in manufacturing to 8 per cent in real estate. One bank says
that its overdrah facilities are only qo per cent drawn and

Figure 9
Use of bank overdraft as nance by UK SMEs, 2011 to Q1 2013
Source: SME Finance Monitor, Q1 2013
Where they do use external nance, overdrahs from a
bank are the most common source of funding. But only just,
as Figure g shows, and the number of overdrahs has fallen
sharply in the last few years. Tis is in part because capital
requirements have made it much more expensive for banks
to advance overdrahs, so they have responded by introducing
annual fees even if the overdrah is not used.
One interesting nding concerns those SMEs using a
credit card for their business. Tree-quarters of them report
that they usually pay o their balance in full each month,
which suggests that the cards are more a source of short-term
liquidity and a payment mechanism than they are actual
loan nance as such. In addition, small business owners
are shrewd and know that bank charges on card balances
can be substantial and should be avoided if possible by
regular clearing.
Only 8 per cent of SMEs has a bank loan or a commercial
mortgage. But as Figure Io shows, in soII the figure was only
Is per cent the difference is hardly dramatic. This again
raises the question of why SME funding should require so
much attention.
Figure lists the reasons why businesses apply for
overdrahs or bank loans. Te SME Finance Monitor looks at
the motivation of SMEs that actively sought to have a new
overdrah or to renew an existing overdrah in the last s
months a surprisingly small number of just gs6,ooo rms
as of the rst quarter of sog, or ; per cent of all SMEs.
50

61 Some numbers on funding of SMEs
that the trend is falling: Across the industry, undrawn
committed facilities from banks exceed 8 billion. Tere is a
further ;o billion of committed, undrawn facilities available
from other lenders.
51

To put that into context the stock of undrawn credit is greater
than the stock of all SME loans.
Te equivalent gures for loans made to SMEs in the last
two years is also revealing (gure s). Only q per cent of all
SMEs, or some 6g,ooo businesses,
52
applied for a loan during
this period.
Further, we can see that those SMEs that do want to
borrow dont want to borrow very much (gure g). As you
would expect, only the larger rms want to borrow signicant
amounts and it is likely that it is in this sub-group that we will
nd the true pressure point between would-be borrowers
and bank lenders.
53
Many of the smaller SMEs want a loan to
purchase a car or van, or to purchase xed assets such as oce
equipment, while larger rms want to fund expansion within
the UK or to purchase oce premises.
54

Figure 13
Amount UK SMEs initially applied to borrow, where stated, Q1 2013
Figure 12
Types of loans UK SMEs applied for, Q1 2013
Figure 11
Purpose of overdrafts sought by UK SMEs, June 2010
63 Some numbers on funding of SMEs
Preliminary analysis suggests that roughly ;o per cent
of the applications for loans and overdrahs were successful,
sq per cent were unsuccessful and per cent ended with the
borrower taking some other form of funding. Tus roughly
gg,ooo businesses wanted to borrow from a bank in the form
of a loan or an overdrah, but were unable to do so. Why?
From the lenders perspective, the biggest single reason
for declining an application for a loan or overdrah from an
SME is that they judge the potential borrower as being
unlikely to be able to service the debt. Even with collateral
or a government guarantee, if a loan has only a small chance
of being repaid lets say less than o per cent it would be
irresponsible to advance the money.
Many of those refused credit were recently-started small
businesses looking to borrow for the rst time. Others were
established businesses seeking to renew an existing loan or
take on additional debt, and we can put that gure into some
context. One high-street bank has a business banking arm
that lends only to SMEs up to a turnover limit of million.
It processes roughly oo,ooo credit applications annually and
says that go per cent of applicants are successful.
55
Let us assume it has a s per cent market share and
that the other big banks have roughly the same number of
applications reasonable, but not oo per cent accurate
assumptions. Tat would suggest there are something in the
region of qoo,ooo applications annually. Te gg,ooo
businesses that fail to get funding reect proportionally
almost exactly the o per cent of applicants refused by the
one bank (gure q). We can say with some condence, then,
that the SME funding problem boils down to this a fraction
of the SME population wishes to borrow and Io per cent of that
fraction fails because the bank or lender deems them unacceptably
risky or simply inappropriate.
56
It hardly seems the stu of
frantic national debate.
Figure 14
Business credit applications by UK SMEs, 2013
65
7 The front line
of SME lending
It was mentioned above that it is dicult to lend to small
businesses at scale while making a prot. Tis is an
important issue with a distinct lack of hard data, but
there is some persuasive evidence. In the report cited
above, Oliver Wyman explains that in the US market,
which is much bigger than that in the UK, small
business loan portfolios typically show positive
accounting prots but negative economic prots
through the cycle.
57
Why? Te researchers identied
the main factors that determine SME lending
protability as:
unit cost
cost of funds
loan losses
economic capital
loan pricing
Unit cost the cost associated with booking an
individual loan is by far the biggest factor, followed by
capital and inadequate loan pricing.
58
It made apparent
sense to try to cut unit costs by introducing techniques
borrowed from consumer lending, in particular semi-
automated methods relying on credit scoring of a
business or its owner, or both. But banks in the US used
these new techniques only on the easy cases those
applicants that were obviously good or bad, so relatively
few loans ended up being decided only via the
automated path, which in turn ensured that unit costs
remained stubbornly high.
67 The front line of SME lending
dierent levels, but the maximum loan before a request moves
to a dierent area of the bank is g million. Tese are coveted
and senior jobs: each sanctioner in the banks national team
has an average of s years experience; they usually began
working in a branch and then worked up through consumer to
business credit.
Te lending requests for overdrahs or actual loans begin
overwhelmingly in the banks branches, of which it has
roughly s,ooo. In each branch there might be between oo and
soo business customers, and new potential borrowers
invariably go to the nearest branch of the bank to which they
are applying.
61
So, in fact, it is the branch business manager, who
supposedly no longer exists (but who may not be the same person as
the actual branch manager), who makes the initial call on whether or
not to advance a request. Te no decision ofen happens exactly
where no one suspects right in the branch.
But here is where automation comes in. Te branch
managers request or recommendation to advance credit is sent
to the banks internal systems. A credit-scoring technique then
determines not whether or not the loan should be approved or
denied but instead suggests where decision rights over the
approval should lie. In one-quarter of cases, it gives the choice
right back to the branch. In the remaining three-quarters of
cases the sanctioners decide, but even then the branch-based
colleague can appeal a decision on behalf of the applicant.
Any decline is subject to a second opinion. Appeals can
work.
62
Roughly qo per cent of no decisions are over-turned
internally, mainly because during the process new information
emerges that gives the lender more comfort remember the
discussion above of the lemons problem in SME lending. Te
point is that people, not machines, make the lending decision.
Tere is a twist in the story at this point, and one that
helps to explain why banks get so much ak for apparently
being tough on SMEs. Te one-quarter of applications that get
sent back to the branch have a higher failure rate than those
processed centrally by the experienced sanctioners. So it is
actually in the high street that businesses feel rejection most
directly. Why?
The truth about automation
Tis is useful background to something almost never mentioned
in the SME funding debate. It is something of a clich that UK
banks collective aversion to SME lending has its roots in our
own version of automation. Across the relevant literature is a
never-challenged narrative: in the olden, golden days, local
bank branch managers knew their business customers and knew
exactly how much to lend them. Put aside the fact that they
could be highly prejudiced, not just in business lending but, for
example, in their decisions about whether they viewed someone
as t to be granted a mortgage so they could buy a house. In
the harsh, modern environment, greedy banks took away the
branch manager role, replacing him (not many women here)
with automated decision-making systems based on credit
scoring.
59
Nowadays, cold calculation replaces the nuance and
judgement of the past. Banks have forgotten how to lend, hence
the deciencies of their SME oerings.
We can see that, based on everything above, this is already
looking like another myth to be questioned. Te US evidence is
that SME lending is tricky precisely because there are so many
exceptions to automation it only works well for the obvious
duds or must-haves, so exceptions crowd out the cost-saving
potential of the data-based analysis.
How does a loan get decided?
What informs whether a request for credit is approved or turned
down? What happens on the front line of SME lending?
To answer these questions, let us look in some detail at the
role played by a sanctioner in the SME lending unit of one of
the high-street banks.
60
Te unit has sta whose job is to
approve, query or decline requests for loans by businesses with a
turnover of up to million. Te term sanctioner sounds
forbidding, but suggests that these sta are pre-disposed to
approve loan requests. Teir job is to act as independent judges
of whether loans should be granted o the back of customer
credit les put together by colleagues on the ground who
interact directly with the would-be borrowers. Depending on
their experience, they are authorised to sanction loans at
69 The front line of SME lending
month-end, and that treatment is highly dependent on the
nature and extent of the request. Some are nodded through
because the business case is so well set out by the business
manager at branch level. Others lead to almost forensic
inquiry. If the applicant has their personal bank accounts with
the bank, then the sanctioner can look closely at the
connection between the two, but clearly this is impossible if
the customer banks elsewhere. Google Earth might be used to
assess the shape and state of a piece of land. Detailed credit
les are accessed where they exist. Companies House records
are checked to make sure what the bank has been told is
correct. And so on.
When one sits alongside a sanctioner it is clear that the
bank wants to lend aher all, that is its business purpose,
despite it reporting at demand. But what is impossible to
appreciate from outside is the care with which the decisions are
made. In one case the sanctioner approved a renancing for an
existing customer, investigating to allow them to look beyond
several indicators that there were underlying risks that were
deteriorating or at least suggested a need for further
investigation. But the sanctioner only did so aher making
careful checks about the development status of a piece of land
that had been key to the original lending decision a few years
earlier. Te sanctioner also checked on the personal nances of
the borrower to assess whether trouble in the business was
mirrored there. Reassured on both counts, the loan extension
was approved. Te sanctioner explained that the rationale was
that this increased the chance of eventual repayment, a better
outcome than forcing the customer into default. In another
case, a large new loan for an existing borrower was also
approved, but only aher the sanctioner had spoken directly to
the business manager to check some facts that were unclear in
the application. Tis was as about as far from machine lending
as one can imagine. Tme-consuming and costly. And certainly
not impersonal.
Te answer is that a dierent process kicks in at branch
level, which is dened by the economics of small business
lending. Most of the requests are for fairly small, unsecured
loans. Tese would be prohibitively expensive for the bank
to process using central underwriting. Te customer would
not see the costs as reasonable if they were passed on, but if
the bank absorbed them then SME lending would be
instantly unprotable.
Tus many of these requests are sent back to the branch
and are treated less as idiosyncratic one-os and more like a
retail product where the yesno decision is based on a set of
absolute rules rather than the managers discretion. Tat
dierence between decision and discretion is vital. If the rules
say no, then that must be the branch managers response,
hence the higher proportion of refusals in the branches.
Does that still seem dierent in a bad way from go or qo
years ago? Banks accept that these days there is less deep
business expertise, and certainly less discretion, in their
branches. Branch sta have less experience and training than
might be needed to make lending decisions for large amounts.
But, once again, economics is key. Tirty years ago there were
roughly one-quarter of todays number of business entities, so
the many fewer requests could be handled at branch level by
experienced business lenders and the economics worked. Today,
the business has such high volumes that central processing is
the only possible economic route for the majority of loan
requests. But, as we will see, central processing is not the
terrible thing it is ohen made out to be.
Interestingly, the centralised loan sanctioners make the
yesno decision, but they do not set the price of the loan. Prices
are set centrally, so this aspect of the automation myth has
some truth. Tat said, even pricing can be appealed at the
branch level. Te bank maintains a specialist pricing desk to
allow for exceptions to the norm.
Tere might therefore also be a disconnect between
centre and satellites as to the true costs of what is, in eect,
idiosyncratic decision making. A senior sanctioner explains that
on average there are numerous daily requests with spikes at
71
8 SMEs and growth
Following the logic of the numbers set out above, we can also
bring some light to the debate about whether and how SMEs
are crucial to overall economic growth. Anyone who runs or
owns a small business will be familiar with a question that is
routinely asked by nancial advisers and accountants is the
business something you are intending to grow? If not, then it is
a reasonable assumption that the company in question will
aspire to a given level of turnover and no more. Equally likely,
it will have no intention of creating jobs because the turnover
is intended to meet the owners lifestyle needs and little else.
Such a company is likely to be protable and, depending on
the sector, might trade with very high margins. But it is not a
growth company.
Tis is not to denigrate the contribution of these
businesses to the economy, a great many jobs, and a good
deal of multiplier benets via the supply chain rely on them.
But it is important to note that while small, these businesses
are post-growth.
Further, although it is not directly the topic of this
report, company growth is a vexed subject in its own right.
Academic studies suer from many of the same issues that
aict the SME debate. For example, what is the correct
denition of growth? Some look at employment, others at
turnover. Some start-ups demonstrate exponential growth rates
because the starting point is zero, but the survival rates
mentioned above are a reminder that very few companies go on
and grow consistently for a sustained number of years. As
businesses get larger it becomes ever more challenging to
maintain high growth rates, while the tendency towards
mergers and acquisitions can complicate our ability to tease
out underlying growth rates. Some top-line growth can be at
73 SMEs and growth
on size. Tis leads us to a changed assumption: rather than
thinking small, policymakers should think growth if most SMEs
have no immediate ambitions to grow, we should focus our eorts on
those businesses with the will and potential to deliver signicant
growth in the future. Even if most growth businesses are SMEs, it
certainly does not mean most SMEs are growth businesses.
Loans are not always the best nance
All of this is consistent with the idea outlined above that SMEs
are not a single category and that there will always be a high
proportion of them that must be excluded from any attempt to
generalise. Intelligent analysis of them and their nancing
needs requires a lot of specication, but this is typically
missing from the debate. We can look a little closer at the
growth challenge to develop this point. An important, but
largely overlooked, question relates to the dierent needs for
nance that companies in dierent industries might have at
various points in their life cycles.
We have established that a majority of SMEs, regardless
of industry sector, have no or only little need for external
nance beyond plain-vanilla, transaction banking services.
Te minority of businesses that do require external nance,
indeed depend on it for their development, typically have
needs that are determined by the industry in which they are
competing. A growing manufacturing rm, for example, will
require term loans in order to make capital purchases
machine tools, production facilities and so on. From the
lenders perspective this is ne because there are some
recoverable assets in the event that the business fails and the
term of the loan can be linked to the lifetime of the assets.
An agricultural business will have seasonal needs from
sowing to harvest, but might also need capital investment for
machinery, so requires a combination of term loans and
overdrahs. Here, as with the manufacturer, the lender can
assess asset values and the history of the shorter-term direct
nancing of the business is this a business that regularly
pays on time or manages its overdrahs well, thereby avoiding
the expense of sustainability of growth, so how should we
measure good growth as opposed to absolute growth in the
short term? Some growth among larger SMEs that are heading
towards raising equity might occur because a management
team has set that goal and is deliberately managing towards it,
but it might be cutting into corporate fat in order to get there.
Te methodological problems are myriad.
Nevertheless, it is clear that the few companies capable of
growth contribute a disproportionate amount to the overall
performance of the economy. Pioneering research by Nesta
published in soog studied a cohort of roughly so,ooo rms
that were new in gg8. It concluded,
High-growth companies represent only 6 per cent of all UK rms
employing ten or more people, but accounted for more than half the
growth in jobs. More specically, II,o high-growth rms were
responsible for I. million out of the increase in s.q million new jobs
in established businesses employing ten or more people between soo
and soo8 (q per cent).
63

Tis nding goes a long way to explain the enduring
interest among politicians in identifying and facilitating
growth companies a tiny minority are engines that can
create jobs. But other headline ndings in the same report
have received much less attention. In fact, Nesta noted that
eorts to target a few rms with higher growth potential are
likely to be more ecient than general business support
policy for all SMEs, many of whom lack the ambition to
grow.
64
Tis is another way of saying, as Nesta itself also
did, that eorts to focus on quality and growth potential might do
better than those focused on quantity. Te Nesta report also
points out that ;o per cent of high-growth rms are at least
ve years old. Only one-third of the initial cohort from gg8
survived to soo8, and only around 8,ooo of the survivors
employed more than ten people.
It is clear that size is a poor proxy for growth potential,
and that it would appear more rational for policymakers to
focus their attention directly on growth as a characteristic than
75 SMEs and growth
fees? Note that the bank is concerned mainly with the security
of repayment, not other measures such as the protability of
the business.
A high-tech start-up with no prospect of prots for several
years, no positive cashow in its rst three years and few assets
against which to secure a loan obviously requires quite
dierent nancing. Te sort of venture funding that it needs is
very unlikely to come from a bank, although a bank will be
involved in the more prosaic funding needs and doubtless
watch overdrah and other limits with care.
Paradoxically, it might be the high-tech start-up that
generates jobs in the short term, with no guarantee that those
jobs will survive beyond the companys initial eorts. But this
also brings us up against one of the fundamental issues of
SME funding in general. As a lender, a bank is asked to extend
a loan that exceeds the visible lifetime of the asset securing
that loan. Should it make the loan? In recent history,
specically the anomalous period before soo;, it tended to,
because the loan could be secured additionally against
property and also because credit was cheap in an extremely
competitive environment. Cheap credit is no longer available
now, so the lending decision is more complicated. If there has
been a reversion to the mean, this is it.
But we can also see this is a way of explaining that there
is a boundary, somewhat uid and denitely somewhat cyclical
between what banks should nance and what should come
from other sources. Tis boundary is key and it leads to our
next section.
77
9 Debtequity:
the lenders dilemma
In the UK there is a cultural assumption that it is somehow
preferable for the owner of the business to take on a loan rather
than to raise capital by selling equity. We noted above the
option-like nature of a loan for the borrower. And surely debt
is cheaper than equity?
As always, real life is more complicated than neat theory.
By the time a borrower has nished negotiating a loan, the
costs can double from the initial quoted interest rate to
something not far o the cost of equity. Moreover, debt can
behave in funny ways, especially in bad times. We noted above
that many indebted SMEs found that their lenders attitudes
changed once the credit crunch began. Banks seeking to
deleverage scanned their loan agreements for covenants that
the borrower might have breached and if they found any they
called in the loan or altered its terms. One of the reasons this
was so upsetting was that debt was actually behaving like
equity the lender became the de facto owner of the business,
able to dictate terms and potentially even to put the business
into administration. Equity, on the other hand, only conveys
control if an owner sells a majority stake.
65
Tere is a fundamental issue related to the nancial
structure of equity and a traditional loan, which is at the heart
of the unsuitability of lending as a mechanism for absorbing
development, innovation or start-up risk.
A loan requires certainty of income to meet interest
payments, and in the case of secured lending a dened asset on
which to secure the loan. A classic example might be an
established manufacturer seeking nance to fund the purchase
of a new machine, the output of which is predictable, with the
loan addressed within the lifetime of the asset. As noted earlier
in this report, this nance remains available to the market.
79 Debtequity: the lenders dilemma
equity culture for business is that it receives less favourable
tax treatment than debt. A few tentative steps have been
taken to alter this. For example, in March the Government
abolished stamp duty on shares for medium-sized business
listed on the Alternative Investment Market (AIM). Tat
alone cut the cost of equity capital for SMEs by per cent,
according to the chief executive of the London Stock
Figure 15
External funding sources for UK SMEs, Q1 2013 Equity nance does not demand interest repayments,
and does not require assets on which to secure the nance.
It is structured to allow the investor exposure to potential
open-ended capital growth, but asks the investor to accept
losses in the event that the investment fails.
It is therefore the most appropriate structure to
nance risk. As an example, a pre-prot high-tech business
may well have no cash ow and no certainty over future
cash ow. It may also have no assets other than its
emergent intellectual property. It therefore represents
signicant investment risk, but might oer signicant
potential. Equity nance would be the most appropriate
solution for the business and for the investor or lender.
It is ohen remarked that UK business owners have a
cultural disposition against selling equity and that this
contrasts with the more open attitude among, for example,
US entrepreneurs. Figure shows how little equity is used
by SMEs and how relatively little dierence there is by
company size. But the SME Finance Monitor went further,
asking those SMEs that are incorporated whether they
used equity from third parties. Te response? Only per
cent reported using this form of external funding.
66
Tis seems like a more profound issue than whether or not
banks are lending to SMEs. Indeed, it could be argued that
the preponderance of bank lending is a problem not because
there is too little of it but because there is too much.
Tm Ward, Chief Executive of the Quoted
Companies Alliance, makes the neat analogy of an engine
designed to grow the economy. It requires both fuel and
lubrication. Te latter can be bank debt, exactly as it is
used for day-to-day purposes, but in recent times it also
became the fuel, replacing or displacing equity, which is a
much more natural form of growth capital.
67
He reiterates
the point made above that bank debt used for long-term
nance can put a company at risk in ways that are not evident
until it is too late.
One much-noted problem with Britains lack of an
81 Debtequity: the lenders dilemma
Exchange.
68
But much more could be done. As the veteran
nancial commentator Anthony Hilton pithily remarked, If
the Government is serious in its desire to support SMEs, it
needs to stop ogging the disabled horse of bank nance and
instead commit itself to making equity more attractive.
69

83
10 Conclusions and
policy implications
Tis report has uncovered a good deal of well-meaning,
and at times hugely expensive policy activity in support
of SMEs, which has proved unsuccessful both in
supporting these businesses and in delivering growth for
the wider economy.
We believe that this activity needs to be
fundamentally reframed, and a new approach developed,
underpinned by two changed assumptions about the
nature of the growth challenge:
Rather than thinking small, we should think growth If
most SMEs have no immediate ambitions to grow, we
should focus our eorts on those businesses with the will
and potential to deliver signicant growth in the future
regardless of size. Even if most growth businesses are
SMEs (which is far from certain), it is not the case that
most SMEs are growth businesses.
We need to look outside traditional bank lending to address this
challenge If we want to target the parts of the economy
where growth is achievable, we need to devise a funding
environment able to support the risks associated with
innovation and start-ups. Tat is not the job of bank
lending, but at the moment the UK has precious few
non-bank nance alternatives.
From this new position, we propose a series of
recommendations which we believe can together
materially improve matters.
85 Conclusions and policy implications
pressure to focus more on short-term cyclical issues. With the
right structure it could occupy a strategic place in the market.
Learn from Canada to develop a reliable SME Registry
Te UK lacks adequate and reliable data on the SME sector
we do not even have up-to-date numbers on how many SMEs
there are. Te UK Government should instruct either the Bank
of England or the Oce for National Statistics to emulate the
Canadian model and address this gap.
As this report has consistently noted, there are signicant
problems with the integrity of data about this topic. Given the
extent of public subsidy directed at SMEs, there is likely to be
a strong cost-benet case for (re-)investing in SME statistics.
Te SME Finance Monitor is an important addition. Although
the Monitor is industry-funded, it is produced independently
by BDRC Continental and the data are publicly available.
However, it remains the case that there is no central data
warehouse for SME information. Not only are SME data
fragmented, but many are simply lost, for example when an
individual bank closes its les on a business customer that
switches its business or simply shuts down. An unfortunate
consequence of data fragmentation is that SMEs themselves
lack the ability to measure how well they are performing, or
how well they should be performing given the economic and
sector conditions in which they are competing.
Te UK can learn valuable lessons from other
countries eorts to understand their SMEs and to provide
services to them based on more comprehensive data. In
Canada, for example, in addition to excellent base data the
Government provides a simple, but eective, benchmarking
service via a website. A business can test how it is
performing against other similar rms nationally or
regionally, looking for example at whether its margins are
in line with typical levels for its industry. Tis can give
managers and would-be lenders extremely useful insights.
Te UK Government should instruct either the Bank of
England or the Oce for National Statistics to design and
implement an SME registry that emulates the Canadian
Recommendations
Develop a genuine successor to the Industrial and Commercial
Finance Corporation
Te British Investment Bank is a welcome intervention, but the
UK lacks a genuine pre-capital market equity investment
house. Returning to a model of this gi precursor could strongly
benet the UK economy.
Eective policy options have been around for decades
but have been ignored or sidelined. One is the British
experience with the Industrial and Commercial Finance
Corporation (ICFC), set up in gq. Its history is neatly
summarised in a recent book by Professor Colin Mayer, and
some points are important here.
70
Te ICFC was owned by the
UK clearing banks, but these institutions were not especially
happy at having what they viewed as a competitor focused on
nancing small manufacturing companies, ohen via equity
stakes. Te ICFC actively monitored its borrowers via the
attention of loan ocers who had technical expertise and were
committed to long-term lending. Aher years of success the
ICFC became gi and by the late-g8os was the largest provider
of venture capital in the UK. But aher it was oated on the
stock exchange in ggq it changed its nature, becoming
mainly a buy-out rm. As Professor Mayer notes, By the
beginning of this century, Britain had once again returned to
being a country in which there was little serious long-term
funding of SMEs and limited venture capital to nance
seed-corn, start-ups, and early stage ventures.
71

It seems like a winning move to attempt to recreate the gi
of old and it is possible that the state-funded British
Investment Bank could try to emulate some of its
characteristics. However, as currently envisaged this appears
not to be likely, as the bank is being set up mainly as a
provider of funds to other lenders rather than as a specialist
provider of risk capital directly to the SME sector. Tis is
something that could be reconsidered before the banks formal
launch in the second half of soq. Te Business Bank could be
given an explicit mandate to address the long-term structural
problem of UK business funding rather than facing political
87 Conclusions and policy implications
Establish a business academy network able to support
businesses as they develop
Building on this point, the UK Government needs to look at
whether taxpayers money is better spent in the form of very
large nancial subsidies (direct and indirect) to SMEs rather
than on specic funded eorts to improve the growth potential
of UK business. Tis report has argued that there is no
particular problem with SMEs having access to nance in the
UK, although there is less nance around at present and there
are issues about which forms of nance are appropriate for
particular types of borrowing. Nevertheless, the Government
is intent on handing hundreds of millions of pounds to SMEs
in the form of debt that is cheaper than it otherwise would be.
Tat money might be much better spent on creating a series of
regional or targeted business academies designed to support
rms and help them develop in a sustainable way. David
Sainsburys recent book Progressive Capitalism lists a series of
existing and past interventions that can be highly eective
without requiring the handing over of cheap debt.
75
His
concept of the enabling state is also relevant for the way
governments can help to create conditions in which businesses
can ourish, without that amounting to an industrial policy
that repeats mistakes made in the past. Tis is a role which
local enterprise partnerships, given renewed support from the
Government in the sog budget, can help ll.
Create a central database of lender information to allow banks
and new entrants to make more informed lending decisions
Blaming banks for not lending to SMEs in the current
environment is misleading. Not that the banks are blameless,
far from it, and they thoroughly deserve some of the criticism
they have been receiving. But the right policy for Britain is
to create a stable banking system with appropriate
exposures, rather than use it as a route to unsustainable or
inappropriate lending.
So might the banks be able to serve the SME sector
better in ways that do not involve lending per se? We referred
model and acts as a central gatherer and provider of reliable
SME data.
72
It should also form an expert group to report
on the relationship between size and growth, addressing
many of the issues raised on this report.
Work with the G20 and the World Bank to create SME
impact assessments
Better data in future will allow governments to make better
policy choices. And policies can be assessed for their impact
systematically so that only the most eective ones receive
valuable public support. Te World Bank has published an
impact assessment framework specically on SME funding
and this could be used as a blueprint for UK assessments.
73

Indeed, the UK could volunteer to work with the Gso and
the World Bank as a pioneer of cost-eective SME impact
assessments, creating the additional benet of insights that
can be exploited in the developing world.
Focus on increasing the growth potential of our SMEs rather
than simply increasing the number of SMEs we have
We commented above that a potential policy route is to
advocate that what the UK needs is not more but better
SMEs. Te emphasis should be on encouraging growth
potential so that businesses are more able to survive and
more likely to do so in a way that makes a clear positive
contribution to the economy and society. Tis requires the
kind of long-term policy that is anathema to successive
governments hooked on electoral cycles. It would involve
thinking through not just how to direct more help to the
existing stock of businesses in the form of mentoring,
education and so on, but also how to build relevant literacy
in the generations of future business founders and owners.
74

Tis challenge links directly to the vexed issue of general
nancial literacy, of which business literacy is a close cousin.
While there are some interesting programmes seeking to
engage secondary schools in business ventures and
innovation, these could be much more systematic.
89 Conclusions and policy implications
is rich material in the Breedon Report and those interested can
also refer to the report by Andy Davis mentioned above.
76
Te
recent report from the Commission on Banking Standards
strongly endorses the idea that bank alternatives are of
growing interest and importance for funding UK business.
77
Address the lack of an equity culture in the UK
A working group led by the Treasury and BIS could examine
the full tax and economic impact implications of a radical
change to the UKs equity culture and make recommendations.
More work is needed to rebuild an equity culture. Tis
challenge links directly to the broader long-term literacy
issue, but has some discrete elements, particularly related to
the tax treatment of dierent instruments. Stamp duty
exemptions could be extended and there is no shortage of
policy suggestions by SME trade lobbies, many of them
worthy. An ohen-suggested route by which SMEs can be
supported is via government procurement, and this could be
usefully linked to the creation of new equity markets or to the
repopulating of existing ones.
Infrastructure and UK business culture pose greater
challenges than access to bank loans, and our national
debate should reect this
Te intensity of the SME funding debate is remarkable given
that there is no problem. But as this nal chapter makes
clear, this is not quite the same as saying that there are no
problems among SMEs in the UK and that there is no need
for a loud policy debate. It is just that the most useful
discussions have almost nothing to do with bank funding
and much more to do with the broader infrastructure and
culture in which UK businesses operate. Tat is where the
debate should be conducted.
Dont let the banks of the hook
Banks should innovate to nd ways of distributing alternative
nance and addressing knowledge and skills gaps in
businesses. Tey have huge distribution networks and a deep
above to research carried out in the US by Oliver Wyman on
small business banking there. Te report made the parallel
observation for that market that small businesses
overwhelmingly want short-term liquidity, but currently they
obtain this using overdrahs and credit cards. It then makes an
intriguing suggestion that what it calls new-form lending has
the potential to transform how banks serve the SME sector.
Te underlying idea is that a businesss cashows can be a
strong real-time indicator of its creditworthiness. Banks can
have a window into cashows via merchant servicing accounts
(for businesses that take payment via credit cards) and via
primary current accounts. Te Oliver Wyman report contains
useful detail on how new-form lending works and how it has
the potential to improve banks traditional SME lending. Not
only will unit costs be lower, but the funding on oer should
be more relevant for the borrower and less risky for the lender.
Te UK Government would arguably have greater
positive impact by actively encouraging banks to consider this
type of service innovation than it has had by focusing on their
supposed unwillingness to lend to SMEs. But this raises
important issues linked to competition. SME lending in the
UK is an oligopoly and banks are therefore forbidden from
tying loans to other services such as credit cards or current
accounts. So new-form lending, for example, will only work if
the lender can actually see the relevant cashows. Te
technology platforms required for this could be considered a
public good and a utility created to provide lenders with
information about would-be borrowers and monitoring
services for existing borrowers. Te Government and the Bank
of England should encourage exploration of this and related
ideas, not least as a mechanism by which new entrants could
accelerate their SME activities and enhance competition.
Tis report has deliberately not focused on alternatives to
bank funding for SMEs, for two reasons. Te rst is that its
principal aim has been to blow away much of the fog around
the existing debate. Te second is that this ground has been
extensively covered elsewhere and there is little new to add
beyond calling attention to new-form lending as above. Tere
91 Conclusions and policy implications
understanding of the challenges faced by small businesses;
they also have an unmatched contact book of businesses and
investors. Tese are strengths that the banks should be
encouraged to leverage. Banks should innovate to nd ways of
distributing alternative nance and addressing knowledge and
skills gaps in businesses.
Growth SMEs need appropriate nancing, but just
because this is not a role for bank lending does not mean that
this is not a problem for the banks.
A further report is needed into the specic needs of SMEs
SMEs are poorly served by a policy approach which assumes
they are focused on growth. A further report should consider
the specic challenges faced by these companies and identify
policy interventions which would materially enhance these
businesses survival rates and economic output.
93
Appendix A
Data and research
methodology issues for
SMEs and entrepreneurship

Nightingale and Coad make the important point that as the
breadth and quality of research into SMEs and entrepreneur-
ship has grown, so has reasonable scepticism about some of the
earlier ndings, concluding that both the sector and the
phenomenon are good things. Indeed they suggest that more
nuanced conclusions are required in light of better evidence
and understanding.
78
Tey explore six ways in which research in these areas is
easily compromised:
Poor data quality: the desire to lih red tape was mentioned
above. Further, conventional datasets ohen miss whole areas of
SME activity. For instance, roughly half of new businesses fail
in their rst three years, so are eectively invisible. Data might
be non-existent or inaccurate. And the available data will over-
sample successful rms while under-representing SMEs that are
unsuccessful.
Tis generalises into a problem with unrepresentative samples
both for entrepreneurs and SMEs in general.
A general feature is the skewness of the statistics. Most start-ups
and entrepreneurial rms perform poorly, but a tiny minority
bring up the average performance of a cohort, so any discussion
of average is likely to highly misleading. As the authors note,
It is fallacious to ascribe the properties of one atypical subsample
to the entire population of rms.
As denitions of SMEs and entrepreneurs are so exible there is
no consensus on research objectives and ndings, which can leave
policymakers wildly confused. While most (but not all) new rms
are small, most small rms are old, the authors remind us.
Another common statistical fallacy relates to regression to the
95 Appendix A
mean and how initial classications can lead to misleading
subsequent analysis. A small rm that grows large will
typically be categorised as a high-growth small rm, but if
it later shrinks it will be seen as a fast-shrinking large rm,
leading to the fallacious conclusion that small rms grow while
large ones decline.
Te literature is riddled with conceptual slides, for example
between net and gross gures (in job creation, for example,
but also in bank lending to SMEs). It is vital to take starting
points into account when examining such things as growth
rates because ohen, small rms show very large rates from
very low bases.
79
97
Appendix B
A case study on Canadas
SME statistics
Summary of the 2011 results
Below are the key results from the so survey.
80
For further
descriptive statistics by business size, industry, region, census
metropolitan area, age of business, export status, innovation
activity and owner age, gender and education see the data
tables. Comparable statistics are also available for the years
sooo, soo, sooq, soo;, soog and soo.
Financing characteristics
In so, g6 per cent of SMEs requested some type of external
nancing, with s6 per cent requesting debt nancing, ; per cent
requesting leasing nancing, 8 per cent requesting trade credit,
q per cent requesting government nancing and s per cent
requesting equity nancing.
Chartered banks were the main suppliers of nancing to
SMEs in so, serving per cent of nancing requests,
followed by credit unions or caisses populaires (6 per cent),
government institutions (; per cent), leasing companies (q per
cent), family and friends (s per cent), venture capital funds or
angel investors ( per cent) and foreign banks (o.q per cent).
In so, go per cent of debt nancing requests were
approved. Both request and approval rates for debt nancing
increase with business size (see table s), suggesting that the
larger the business, the more likely they are to require debt
nancing and the more likely they are to obtain debt nancing.
SMEs paid an average interest rate of 6.; per cent for their
debt nancing in so. Two-thirds (6 per cent) of SMEs were
required to provide collateral to obtain their loan: q8 per cent
pledged business assets, s6 per cent pledged personal assets
and .g per cent pledged intellectual property.
Table 2
Debt request and approval rate by size of business, Canada, 2011
99 Appendix B

Employees Request rate Approval rate* Amount authorised/
Amount requested
ratio
All SMEs
1 499 25.5 89.9 94
Size of
business
1 4 19.9 88.4 90.4
5 19 29.9 88.5 88.6
20 99 36.9 97.1 97.2
100 499 47.6 97.7 99

*A request that was fully or partially approved was considered approved.
Tese are some of the SME owner characteristics:
In so, 6o per cent of SME owners were o years of age or
older, s8 per cent were between qo and qg, and s per cent were
younger than qo.
;; per cent of SME owners had over o years of management or
owner experience.
Most SME owners were male: 66 per cent of SMEs were majority
male-owned, 6 per cent were majority female-owned, and 8 per
cent were owned equally by men and women.
;8 per cent of SME owners were born in Canada while ss per
cent were born elsewhere.
Te majority of SME owners possessed some form of post-
secondary education with gs per cent having a college, CEGEP
or trade school education, ss per cent having received a
bachelors degree and g per cent a masters degree or above. For
sq per cent of SME owners, high school was the highest level of
education obtained and o per cent of owners had not completed
high school.
101
Notes
1 Tis gure is the internal metric used by a major high street
bank and represents applications for secured and unsecured
lending by SMEs. Given the diculty in dening what
constitutes an application (and for example how much
triaging takes place before an application is put forward) it
is unsurprising that these numbers are heavily contested.
Te SME Finance Monitor, for example, which is produced
for a group of organisations including business trade
groups, banks and the Department for Business, Innovation
and Skills (BIS), uses a dierent number. It nds that in the
year ending Q sog where applicants applied for new
money, but not for the rst time, ;; per cent of overdrah
applications and 6g per cent of loan applications resulted in
a facility. Among rst time applicants, g8 per cent of
overdrah applications and q per cent of loan applications
resulted in a facility.
2 See World Bank and Global Partnership for Financial
Inclusion, Impact Assessment Framework: SME nance, Oct
sos, www.gp.org/sites/default/les/documents/SME%so
Finance%soImpact%soAssessment%soFramework%so
GPFI.pdf (accessed g Jul sog).
3 A Gurria, introduction, Centre for Entrepreneurship, SMEs
and Local Development, Financing SMEs and Entrepreneurs
soI: An OECD Scoreboard, sog, https://www.sanayi.gov.tr/
Files/Documents/cfe-sme-sos-s-nal-eng-86sogoggg6.
pdf (accessed g Jul sog).
4 Te happiness nding is widely available in academic
literature and seems to hold across countries where this

103 Notes
9 An excellent example is Seeds of Change by Andy Davis,
which contains what at the time was a comprehensive table
of alternative nance suppliers; see A Davis, Seeds of
Change: Emerging sources of non-bank funding for Britains
SMEs, Centre for the Study of Financial Innovation, Jul
sos, www.cs.org/les/Seeds_of_Change_by_Andy_
Davis_PDF.pdf (accessed g Jul sog). See also the
Breedon report: BIS, Boosting Finance Options for Business:
Report of industry-led working group on alternative debt
markets, Dept for Business, Innovation and Skills, Mar
sos, www.bis.gov.uk/assets/BISCore/enterprise/docs/
B/s-668-boosting-nance-options-for-business.pdf
(accessed g Jul sog).
10 For example see the Doughty report: Small Business
Taskforce, Fullling the Promise of British Enterprise, Dec so,
www.labour.org.uk/uploads/c;6b6g-g8cq-gbq-odo-
geaeo6bg;d.pdf (accessed g Jul sog), which contains
useful material on US small business funding and its origins
in the gqos and gos. Te nal report of the Small
Business Taskforce contains additional materials on
Germany and its network of local and regional business
lending banks: Small Business Taskforce, An Enterprising
Nation: Te nal report of the Small Business Taskforce, Dec
sos, www.labouremail.org.uk/les/uploads/b6e;fasg-gs-
og6q-6o-;8g88qedo;b.pdf (accessed g Jul sog).
11 Parliamentary Commission on Banking Standards,
Changing Banking for Good Fifh Report, HL Paper s;, sog,
www.publications.parliament.uk/pa/jtsogq/jtselect/
jtpcbs/s;/s;os.htm (accessed Aug sog).
12 BIS, Building the Business Bank.
13 A useful, if somewhat technical, note on SME lending
statistics that also gives a sense of the complexity of the
issues can be found in an article by Michael Lyon and
Sylaja Srinivasan; see M Lyon and S Srinivasan, Lending
research has been undertaken. See P Nightingale and A
Coad, Muppets and gazelles: rooting out ideological and
methodological biases in entrepreneurship research,
FINNOV discussion paper, Sep so, www.nnov-fp;.eu/
publications/nnov-discussion-papers/muppets-and-
gazelles-rooting-out-ideological-and-methodologica
(accessed g Jul sog).
5 Examples are too numerous to list, but the following is
typical: Inadequate access to nance for small and
medium sized enterprises is one of the biggest risks to
economic recovery. We need bold action to x what has
always been a weakness of the UK economy, and since
the nancial crisis has become an urgent problem.
Whilst we are making great strides to reform the
banking system in the UK, more needs to be done to
ensure that it suciently serves the manufacturers,
exporters and high growth rms that drive economic
growth. From the Foreword by Vince Cable in foreword
to BIS, Building the Business Bank, Dept for Business,
Innovation and Skills, Mar sog, https://www.gov.uk/
government/uploads/system/uploads/attachment_data/
le/sogq8/bis-g-;gq-building-the-business-bank-
strategy-march-sog.pdf (accessed g Jul sog). See also
testimony given to the House of Lords Select Committee
on SME Exports, Chapter q: Financing exports.
6 Bank of England, Finance for Small Firms: An eleventh
report, sooq, www.bankofengland.co.uk/publications/
Documents/nanceforsmallrms/nqsm.pdf
(accessed g Jul sog).
7 Ibid.
8 Te foreword continued there are some specic challenges
facing certain types of SME, notably those seeking small
amounts of risk capital; see Bank of England, Finance for
Small Firms.
105 Notes
18 See A Hughes, Entrepreneurship and innovation policy:
retrospect and prospect in V Uberoi et al (eds), Options for
Britain II: Cross-cutting policy issues changes and challenges,
Oxford: Wiley-Blackwell, soo, pp ggs.
19 Te Labour Force Survey captures individuals moving
in and out of self-employment, which gives us a loose
proxy for changes in one aspect of the SME population,
but it oers no understanding of why individuals
circumstances are changing.
20 Te SME Finance Monitor records that s per cent of
SMEs belong to one or other.
21 Business Finance Taskforce, Supporting UK Business: Te
report of the Business Finance Taskforce, Oct soo,
www.betterbusinessnance.co.uk/images/uploads/
Business_Finance_Taskforce_report.pdf
(accessed g Jul sog).
22 Research on the US market cited in the main text
below by Oliver Wyman notes that typical US bank
underwriting procedures for SME loans ask the
business owner to provide two years of accounts and/or
two or three years of personal tax returns and remarks,
either way, these data are essentially out of date by the
time the bank reviews them and may not have been
that accurate to begin with. It is not just a UK
problem, then.
23 pH, Overview of bank borrowing by businesses in the
millionoo million turnover bracket, for British
Bankers Association, soo, www.bba.org.uk/downloads/
bba/pHGroup_report.pdf (accessed g Jul sog).
24 BDRC Continental, SME Finance Monitor, Q sog: Te
uncertainty of demand, p 8, www.sme-nance-monitor.
co.uk/ (accessed g Jul sog). Data in the quarterly reports
to business a new data source, Monetary & Financial
Statistics, Mar sos, www.bankofengland.co.uk/
statistics/Documents/ms/articles/artsmars.pdf
(accessed g Jul sog).
14 Enterprise and Industry, What is an SME?, European
Commission, nd, http://ec.europa.eu/enterprise/policies/
sme/facts-gures-analysis/sme-denition/
(accessed Aug sog).
15 Tese numbers vary over time, particularly the VAT-
registered numbers. Sources include HMRC, HM
Treasury and BIS. See J Frankish, R Roberts and D
Storey, Measuring business activity in the UK, sos.
See also Lord Youngs Growing Your Business: A report on
growing micro businesses, Dept for Business, Innovation
and Skills May sog, https://www.gov.uk/government/
uploads/system/uploads/attachment_data/le/g86/
growing-your-business-lord-young.pdf (accessed g Jul
sog). Special thanks to Dr Richard Roberts for help
with this material.
16 See Oce for National Statistics, Inter-Departmental
Business Register (IDBR), nd, www.ons.gov.uk/ons/
about-ons/who-we-are/services/unpublished-data/business-
data/idbr/index.html (accessed g Jul sog).
17 Te International Finance Corporation tracks SMEs
globally via the SME Finance Forum, but divides them
by micro, small and medium categories or MSMEs. Its
most recent gures show that in soo the UK had .66
million SMEs, of which .q; million were micro, or 88
per cent of the MSME population. Small companies
were o per cent of the population, while medium-sized
companies (dened as employing between o and sqg
people) accounted for just .6 per cent of the population.
Te IFC estimated that MSMEs account for just under g
per cent of total UK employment.
107 Notes
31 Tis is the idea that there is an adverse selection
problem owing to information asymmetries, rst
identied by George Akerlof in the market for used cars.
A lemon is American slang for second-hand car that
turns out to be a dud.
32 Tis is well described in S Dolan, F Brouard and A
Riding, Financing growing rms and the importance of
banking relationships, working paper, sos, www.
swinburne.edu.au/lib/ir/onlineconferences/
agseso/ooooq.pdf (accessed g Aug sog), including a
literature summary. Te key theoretical work was by R
Rajan, Insiders and outsiders: the choice between
informed and arms-length debt, Journal of Finance q8,
no q (Sep ggs), pp g6;qoo.
33 DJ Storey, Evaluating SME policies and programmes:
technical and political dimensions in Te Oxford
Handbook of Entrepreneurship, Oxford: Oxford University
Press, soo6. See also Hughes, Entrepreneurship and
innovation policy; Hughes attributes the gures to
research undertaken in soo6 on behalf the then
government department responsible for business.
34 Te FINNOV project began in March soog.
35 Nightingale and Coad, Muppets and gazelles.
36 Industry Canada has an excellent website, for this
reference see Industry Canada, Small business statistics
July sos, www.ic.gc.ca/eic/site/o6.nsf/eng/os;g.html
(accessed g Jul sog).
37 See DJ Storey, Optimism and chance: the elephants in
the entrepreneurship room, International Small Business
Journal sg, Aug so, pp gogs.
38 Hughes, Entrepreneurship and innovation policy.
are typically presented based on YE QX, or the last four
quarters, which explains the reference gure of so,ooo given
in many of the tables below.
25 Centre for Entrepreneurship, SMEs and Local Development,
Financing SMEs and Entrepreneurs soI: An OECD Scoreboard.
26 Te July sos issue of Trends in Lending concluded that, of the
qo billion of total business loans, some g per cent can be
attributed to SMEs, or 8 billion. Te way the statistics are
released makes it extremely dicult to follow a reliable time
series. And these data do not cover all Mq lenders, hence the
lower total. In general, gures quoted in this report are
correct as of May sog.
27 Te outstanding stock of UK SME loans rose by ;.g per cent
in soo8 and by g.o per cent in soog, but fell by ;.q per cent in
soo and by the same amount in so, according to Centre for
Entrepreneurship, SMEs and Local Development, Financing
SMEs and Entrepreneurs soI: An OECD Scoreboard. Te share
of the overall business loan market accounted for by SME
loans was so.s per cent in soo;, falling to 8.o per cent in
soo8 but returning to so.6 per cent in so.
28 G Hoggarth, J Hooley and Y Korniyenko, Which way do
foreign branches sway? Evidence from the recent UK
domestic credit cycle, Bank of England, Financial Stability
Paper ss, Jun sog, www.bankofengland.co.uk/publications/
Documents/fsr/fs_paperss.pdf (accessed g Jul sog). Te
chart is on page o.
29 House of Lords Debates, sq Mar so, col 8s, www.
publications.parliament.uk/pa/ldsoo/ldhansrd/
text/ogsq-ooo.htm (accessed g Jul sog).
30 Te Bank of England suggested that the major clearing
banks had to make provisions of around g billion. See Bank
of England, Finance for Small Firms.
109 Notes
49 Te Bank of England noted in sooq that deposits appear
to have generally exceeded total lending in the SME
market since gg; and suggest that the health and liquidity
of the small rms sector has, in the aggregate, improved
over the past decade (Bank of England, Finance for Small
Firms). On g July sog the head of RBSs corporate lending
business said on the Today programme that his bank then
had ; billion of SME deposits.
50 BDRC Continental, SME Finance Monitor, Q sog, p 8;.
51 Ibid, p so.
52 Ibid, p g.
53 Ibid, p gg.
54 Ibid, p g.
55 Tis gure is the internal metric used by a major high street
bank and represents applications for secured and unsecured
lending by SMEs. Given the diculty in dening what
constitutes an application (and for example how much
triaging takes place before an application is put forward) it is
unsurprising that these numbers are heavily contested. Te
SME Finance Monitor for example, which is produced for a
group of organisations including the business trade groups,
banks and BIS, uses a dierent number. It nds that in the
year ending Q sog those applying for new money, but not for
the rst time, were given a facility in ;; per cent of overdrah
applications and 6g per cent of loan applications. Among rst
time applicants, g8 per cent of overdrah applications and q
per cent of loan applications resulted in a facility.
56 Te turndown proportion is exactly the same in Canada
see Appendix B.
57 SME Finance Forum, Oliver Wyman.
39 Because these issues are so fundamental, they are explored in
more detail in appendix A, but this material is excluded from
the main text for reasons of length.
40 Nightingale and Coad, Muppets and gazelles.
41 Ibid.
42 BIS, Financing a Private Sector Recovery, Cm ;gsg, Dept for
Business, Innovation and Skills, soo, section g.g,
www.bis.gov.uk/assets/BISCore/corporate/docs/F/o-o8-
nancing-private-sector-recovery.pdf (accessed g Jul sog).
43 For more evidence on this, see pH, Overview of bank
borrowing by businesses in the millionoo million
turnover bracket.
44 See Business Finance Taskforce, Supporting UK Business, p g,
which is referenced to the UK SME Finance survey for soo8
and soog.
45 For comparison and as an indication that these numbers are
reliable, see the Industry Canada equivalents. Its latest survey
covering so notes that g6 per cent of SMEs requested some
type of external nancing, with s6 per cent requesting debt, ;
per cent requesting leasing, 8 per cent requesting trade credit, q
per cent requesting government nancing and s per cent
requesting equity nancing
46 See SME Finance Forum, Oliver Wyman how new-form
lending will reshape banks small business strategies, sog,
smenanceforum.org/post/oliver-wyman-how-new-form-lending-
will-reshape-banks-small-business-strategies (accessed g Jul sog).
47 Report of the Committee of Inquiry on Small Firms, Cmnd q8,
London: HMSO, g;.
48 See Young, Growing Your Business.
111 Notes
relates mainly to whether banks correctly inform
applicants that they have a right to appeal. Te SME
Finance Monitor suggests that only about per cent of
rejected applicants are aware of the scheme, so there is
room for improvement.
63 Nesta, Measuring Business Growth: High-growth rms and their
contribution to employment in the UK, Oct soog.
64 Ibid.
65 An important point here is that, unlike an overdrah, a loan
cannot be recalled unless the borrower is in breach of its
terms or has failed to make scheduled repayments.
66 BDRC Continental, SME Finance Monitor, Q sog, p q6.
67 See numerous speeches and articles on the Quoted
Companies Alliance website: www.theqca.com
(accessed g Jul sog).
68 See London Stock Exchange, Abolishing stamp duty on aim
shares is a bold and decisive policy from the government,
press release, s Mar sog, www.londonstockexchangegroup.
com/newsroom/sogpressreleases/stampduty.htm
(accessed g Jul sog).
69 A Hilton, Small rms need nurturing, and fast, Evening
Standard, ; Mar sog, www.standard.co.uk/business/
markets/anthony-hilton-small-rms-need-nurturing-and-
fast-8sq68.html (accessed g Jul sog).
70 C Mayer, Firm Commitment: Why the corporation is failing us
and how to restore trust in it, Oxford: Oxford University
Press, sog, especially pp s;qo.
71 Ibid.
58 Ibid, pp sg.
59 A ne example of this can be found in Small Business
Taskforce, An Enterprising Nation.
60 For obvious reasons this material has been anonymised,
but the author would like to thank the sanctioner who
generously worked through real case examples in real time
in order to explain the credit process. Tis eld research
was conducted in June sog.
61 An important caveat here is that SME loans are
increasingly sourced via specialist brokers, some of them
former loan ocers, some independent nancial advisers.
Tis is an area where there is very little information, but
one implication of a growing role for brokers, including
internet-based services, is that SME lending competition
is actually healthier than the purely bank-sourced
numbers imply. Te job of the broker is to shop around
on behalf of the SME to secure the best rate available,
on a commission basis. Clearly, there is also scope here
for the next mis-selling scandal were a bank sanctioner
to enter into a corrupt relationship with a broker.
62 Tere is now a formal independent appeals process, run
by Professor Russell Griggs. Its rst annual report noted
that, In the rst year of the process there have been s;;
appeals and gg. per cent have been overturned. An
overturn is where the bank and the customer reach a
satisfactory conclusion to a lending application. Tis
does not mean that the business has received exactly
what they asked for initially, but that they have reached
a lending agreement with which both parties are
satised. See Better Business Finance, Banking Taskforce
Appeals Process Independent External Reviewer Annual
Report soII/soIs, sos, www.betterbusinessnance.co.uk/
images/uploads/Annual_Report_Master_sos.pdf
(accessed g Jul sog). Any controversy about this
113 Notes
72 See appendix B.
73 See World Bank and Global Partnership for Financial
Inclusion, Impact Assessment Framework.
74 A recent report sponsored by Royal Bank of Scotland and
produced by Aston Business School on closing the
generational start-up gap contains much useful information
on this topic. See M Hart, J Levie and MK Shamsul, Closing
the Generational Start-Up Gap, Royal Bank of Scotland, sos,
www.rbs.com/content/dam/rbs/Documents/News/sos/og/
Youth-Enterprise-Closing-the-Generational-Start-UpGap.
pdf (accessed g Jul sog).
75 D Sainsbury, Progressive Capitalism: How to achieve economic
growth, liberty and social justice, London: Biteback
Publishing, sog, especially Chapter g passim.
76 See BIS, Boosting Finance Options for Business; Davis,
Seeds of Change.
77 Parliamentary Commission on Banking Standards,
Changing Banking for Good.
78 Nightingale and Coad, Muppets and gazelles
79 Ibid.
80 Industry Canada, Key Small Business Statistics, sos,
www.ic.gc.ca/eic/site/o6.nsf/eng/h_os68g.html
(accessed g Aug sog).
115
References
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sme/facts-gures-analysis/sme-denition/
(accessed Aug sog).
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activity in the UK, sos. See also Lord Youngs Growing
Your Business: A report on growing micro businesses, Dept for
Business, Innovation and Skills, May sog, https://www.gov.
uk/government/uploads/system/uploads/attachment_
data/le/g86/growing-your-business-lord-young.pdf
(accessed g Jul sog). Special thanks to Dr Richard Roberts
for help with this material.
Gurria A, introduction, Centre for Entrepreneurship, SMEs
and Local Development, Financing SMEs and Entrepreneurs
soI: An OECD scoreboard, sog, https://www.sanayi.gov.tr/
Files/Documents/cfe-sme-sos-s-nal-eng-86sogoggg6.
pdf (accessed g Jul sog).
119 References
Small Business Taskforce, An Enterprising Nation: Te nal
report of the Small Business Taskforce, Dec sos,
www.labouremail.org.uk/les/uploads/b6e;fasg-gs-og6q-
6o-;8g88qedo;b.pdf (accessed g Jul sog).
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Enterprise, Dec so, www.labour.org.uk/uploads/c;6b6g-
g8cq-gbq-odo-geaeo6bg;d.pdf (accessed g Jul sog), which
contains useful material on US small business funding and its
origins in the gqos and gos.
SME Finance Forum, Oliver Wyman how new-form
lending will reshape banks small business strategies, sog,
smenanceforum.org/post/oliver-wyman-how-new-form-
lending-will-reshape-banks-small-business-strategies
(accessed g Jul sog).
Storey DJ, Evaluating SME policies and programmes:
technical and political dimensions in Te Oxford Handbook of
Entrepreneurship, Oxford: Oxford University Press, soo6.
Storey DJ, Optimism and chance: the elephants in the
entrepreneurship room, International Small Business Journal sg,
Aug so, pp gogs.
World Bank and Global Partnership for Financial Inclusion,
Impact Assessment Framework: SME nance, Oct sos,
www.gp.org/sites/default/les/documents/SME%so
Finance%soImpact%soAssessment%soFramework%so
GPFI.pdf (accessed g Jul sog).
Mayer C, Firm Commitment: Why the corporation is failing us and
how to restore trust in it, Oxford: Oxford University Press, sog,
especially pp s;qo.
Nesta, Measuring Business Growth: High-growth rms and their
contribution to employment in the UK, Oct soog.
Nightingale P and Coad A, Muppets and gazelles: rooting out
ideological and methodological biases in entrepreneurship
research, FINNOV discussion paper, Sep so, www.nnov-fp;.
eu/publications/nnov-discussion-papers/muppets-and-gazelles-
rooting-out-ideological-and-methodologica (accessed g Jul sog).
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are/services/unpublished-data/business-data/idbr/index.html
(accessed g Jul sog).
Parliamentary Commission on Banking Standards,
Changing Banking for Good Fifh Report, HL Paper s;, sog,
www.publications.parliament.uk/pa/jtsogq/jtselect/
jtpcbs/s;/s;os.htm (accessed Aug sog).
pH, Overview of bank borrowing by businesses in the
millionoo million turnover bracket, for British Bankers
Association, soo, www.bba.org.uk/downloads/bba/pHGroup_
report.pdf (accessed g Jul sog).
Rajan R, Insiders and outsiders: the choice between informed
and arms-length debt, Journal of Finance q8, no q (Sep ggs),
pp g6;qoo.
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London: HMSO, g;.
Sainsbury D, Progressive Capitalism: How to achieve economic
growth, liberty and social justice, London: Biteback Publishing, sog,
especially Chapter g passim.
121
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2013 Demos
10 ISBN 978-1-909037-40-3
Tere is an ongoing and heated debate in the UK about
the importance of small and medium-sized enterprises
(SMEs) for economic recovery, and the willingness of
traditional banks to lend to them. Despite repeated eorts
by policymakers to stimulate this lending, it has not been
forthcoming, and this, so the argument runs, is holding
back growth.
Tis report, the rst from Demos Finance, the new
nancial services research unit at Demos, uses new analysis
of the sector to explore this question, and explode some
myths. It nds that most SMEs do not wish to borrow from
a bank and of those that do, 90 per cent have no problems
getting the nancing they want. Equally, the majority are
not signicant contributors to economic growth, despite
the crucial role they play as existing employers, customers
and suppliers.
Te report therefore argues for two fundamentally
changed assumptions. First, rather than thinking small,
we should think growth, focusing our eorts on those
businesses with the will and potential to deliver growth
regardless of size. Second, to target the parts of the
economy where growth is achievable, we may need to look
beyond bank lending and devise a funding environment
able to support the risks associated with innovation and
start-ups. Such an approach would help to ensure that
those businesses with the capacity to grow receive the
funding they need, paving the way for economic recovery.

Andrew Freeman is Director of Demos Finance. He is also
Risk Fellow at the Cambridge Judge Business School and
was previously Banking Editor of the Economist.