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A consultation on improving access to growth capital for small businesses
issued by HM Treasury Small Business Service

Comments from ACCA
July 2003

Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to submit its comments on the HM Treasury and Small Business Service consultation document Bridging the Finance Gap: Improving access to growth capital for small businesses.

ACCA recognises that, although access to finance is not a major problem for many small businesses, there is evidence that a number of groups, such as ethnic minorities and women, do have problems in raising finance. There is also a lack of information on the types of finance being used by businesses of different sizes, sectors and locations. ACCA calls on HM Treasury and the Small Business Service to address this matter.

All businesses have particular needs and require funding at different points in their life cycles. ACCA believes that the equity gap identified in the consultation paper, which ranges from £250,000 to £1 million, masks these variations and is too simplistic.

ACCA believes that high technology firms face particular issues in accessing equity finance. There is a lack of understanding of the needs of this sector. High-technology firms are more likely to trade on their intellectual property (IP) and, therefore, often find it difficult to capture money and support.

ACCA believes that thorough research should be conducted to identify the reasons for the lack of take-up of the Small Firms Loan Guarantee (SFLG) scheme. We believe that the process should be simplified and the administrative burden reduced. The banks' policies should be published to help the process become more transparent. The SFLG scheme should also be promoted through key intermediaries and non-traditional channels.

In principle, ACCA supports the model to encourage business angel syndication. We believe, however, that it is important to improve the scope and depth of statistical information on the informal venture capital market. Improvement in these respects will enable the Government to become more aware of the importance of informal venture capital and to have a more accurate perception of where intervention may be required and the optimum nature of this intervention.

The taxation system in the UK does not provide sufficient incentive for internally-funded business growth. ACCA believes that there should be a lower rate of corporation tax on retained profits. There should be changes in tax laws to provide incentives for owners to re-invest in the business and thereby increase the amount of equity to support sustainable growth.

ACCA believes that the US Small Business Investment Companies model should be examined thoroughly before it is transposed in its entirety to the UK. There are distinct economic and cultural differences between the ways in which venture capital investments are made in the US and in the UK. There is also a plethora of programmes already in operation in the UK. We believe that the Government should carefully examine the need for a new scheme, and should consider the alternative of adding to or replacing existing programmes.

Specific Comments

ASSESSING THE FINANCE GAP

1. ACCA welcomes the consultation exercise, which aims to identify and then address the specific market failures which prevent small businesses from realising their full growth potential. Over half of ACCA�s 98,000 members work in or service SMEs (Small and Medium-sized Enterprises).
   
   
2. Access to finance is important for entrepreneurs at varying stages of the life cycle of the business. The following paragraphs identify a number of issues which ACCA believes HM Treasury and the Small Business Service should address.
   
   
   Question 2.1. Do you agree that there appears to be a continuing equity gap facing small and medium-sized enterprises seeking growth capital?
   
   
3. The consultation document correctly makes the point that access to finance is generally not a major problem for small businesses. The latest results from the Bank of England reveal that there is little evidence of firms facing difficulty accessing debt finance. Concern about access to bank finance is not something which the members of UK small business organisations are raising with them. The Small Business Research Centre's European Survey for Lloyds TSB found that access to finance was a constraint on growth for only around 1% of businesses.
   
   
4. This research, however, masks the diversity within what is a disparate small business sector. Research has focused increasingly on the challenges faced by businesses in certain sectors, ethnic or minority groups and those wishing to access finance for growth capital.
   
   
5. Given the drive to support 'fast growth' businesses, it is not surprising that the literature has focused on defining the parameters of the equity gap for growth capital. HM Treasury and the Small Business Service should conduct rigorous research on what types of finance are being used by businesses of different sizes, sectors, locations and at what particular times in their life cycles. This can be achieved by working with key stakeholders including banks, business angels, venture capital organisations and intermediaries who advise small businesses on funding, such as accountants, as well as with small business owners themselves.
   
   
   Question 2.2. If you agree that an equity gap persists, do you agree that it is most acute for firms seeking £250,000�£1 million?
   
   
6. While the consultation document points to an equity gap of between £250,000 and £1 million for growth capital, there is evidence to suggest that the gap is wider than this. An evaluation of the Regional Venture Capital Fund (RVCF) conducted by KPMG has demonstrated that over half of the investments made are at a maximum £250,000, the average investment made being £191,000. Sir David Cooksey, Senior Director at the Bank of England and founder of Advent Ventures Partners, believes that the gap could extend as far up as £2.5 million. Research by venture capitalist Quester indicates that the equity gap is much wider than that defined in the consultation document, possibly extending up to £5 million. 
   
   
7. Evidence supports the view that there is an equity gap, but that the correct level must be identified, and the needs of SMEs determined, in order to develop appropriate policies. As the consultation document suggests, the amount of funding required will depend on the life-cycle of the business, with the amounts required at start-up, early stage, expansion, management buy-out (MBO) or management buy-in (MBI) varying significantly. The range between £250,000 and £1 million masks these variations and is too simplistic to assist in effective policy making.
   
   
8. ACCA believes that it is important to identify the number of SMEs which are affected by the so called 'equity gap'. Research conducted by Barclays Bank showed that just 1,531 customers, representing approximately 0.25% of its customer base, comprise 'high growth firms' which may suffer from the equity gap as identified in the consultation document.
   
   
9. We also believe that the Government should develop proposals to address the barriers which some groups, such as ethnic minorities and women, face when accessing finance. For example, research suggests that women achieve one third of the funding of men when setting up in business.
   
   
   Question 2.3. Are there particular issues facing high-technology firms in accessing equity finance?
   
   
10. The main challenges facing high-technology firms are the lack of a clear definition of this type of business and the lack of understanding of the particular needs of this sector. Funding institutions, which include High Street banks and venture capital organisations alike, are less likely to agree to fund businesses which they do not understand.
    
    
11. High technology firms are more likely than businesses in other sectors to trade on their intellectual property (IP) assets. These are often intangible, but very valuable assets, such as brands and domain names, which are less easy to quantify than tangible assets such as plant machinery and vehicles. Intellectual Property Rights can be formally registered so they are legally protected. Small knowledge-based firms often regard the process of registering IP as too expensive or time consuming and consequently find that their assets are not recognised by financial providers. High technology firms, therefore, often find it difficult to capture finance and support. ACCA recommends that the Government promotes actively the value of registering IP.
    
    
12. ACCA recommends that the Government should explore a specialist source of funding for high technology firms. They face particular problems which are not necessarily experienced by other businesses, for example, 'front-loading' costs.
    
    
    IMPACT OF EXISTING INTERVENTIONS
    
    
    Question 3.2. What more could be done to ensure that the Small Firms Loan Guarantee (SFLG) is available as widely and consistently as possible to eligible businesses, by raising awareness of the programme among lenders, potential borrowers and their advisors?
    
    
13. Research demonstrates that there is a surprisingly high level of knowledge of the SFLG among potential borrowers. There is a very low rate of take-up, however, by the small business community. The latest figures from the Small Business Service reveal that only 3,916 total guarantees were issued for the last financial year (2002-2003). Before changes in the way in which the scheme is promoted and administered are introduced, ACCA recommends that research should be conducted to identify the reasons behind the lack of take-up.
    
    
14. There are, however, a number of recognised hurdles to the current take-up of the scheme. In the main, these involve the High Street banks. The banks display a distinct lack of common policy on the SFLG, with the criteria used to access and process the applications varying between them. Despite the fact that the SBS is responsible for the promotion of the scheme to small businesses, it may be appropriate for the banks to advertise the scheme directly in their branches to potential borrowers. The SBS can work with the High Street banks to identify and then advertise the banks policies with regard to the SFLG. In addition, the High Street banks do not have any incentive to use and promote the SFLG. This may be another explanation for the low take-up. Again, there is an opportunity for the SBS to work with the banks to ensure that the banks are supportive of the promotion of the SFLG.
    
    
15. A recent ACCA Members� Survey on 'The barriers in accessing finance through formal channels' asked accountants their opinions of the SFLG scheme and if they believed that it was successful. Fifty-one per cent of respondents believed that the SFLG is not successful and provided suggestions for improvement. The main suggestions concerned increasing awareness of the scheme, especially by banks. One respondent commented, "There should be more publicity so that the banks use it as a method of first lending rather than the very last resort". Another stated, "Educate the bankers, they are the ones who do not understand the rules or try to impose their own rules and conditions".
    
    
16. The role of advisers is key to the successful promotion and take-up of the SFLG. Research by the Federation of Small Business found that small firms seek advice most often on accountancy matters, business planning and access to finance issues. Small firms most frequently sought advice from accountants rather than from the banks or government-funded business support schemes and were most satisfied with the advice which they received from accountants as compared with other sources of support. It is, therefore, important to promote the SFLG to key intermediaries so that they can support and advise small businesses when they are making applications.
    
    
17. The major clearing banks were responsible for 97% of all the SFLG schemes granted in the year to 31 March 2002. The promotion of the scheme by non-traditional channels should be encouraged. The operation of the scheme by trusted organisations, such as the Princes Trust, in disadvantaged areas of the country may have positive spin-offs for the wider business community.
    
    
    Question 3.3. Is there scope to reduce further the administrative requirements of the SFLG?
    
    
18. The ACCA Members' Survey referred to at paragraph 15 above identified a number of concerns about the application process. Accountants who work with their small business clients to make applications for the SFLG feel that there is a great deal of complexity in the approval system and that this not a particularly 'easy' loan to obtain. One respondent's comment reflects the feelings of many, "it should be made more flexible, the process should be simplified and the administrative burden reduced". A significant number of members felt that the process would be made easier if clear guidance on how to apply were produced. Greater clarity and transparency in the system, particularly in regard to the right of appeal, would reduce the administrative burden.
    
    
    Question 3.8. Should the Government play a key role in encouraging more formal angel groups in the UK? If so, what are the key constraints on establishing such groups? Would there be significant demand for more flexible provisions designed to support structured groups?
    
    
19. ACCA believes that the model to encourage business angel syndication as described in the consultation document is attractive and appears to make good business sense. There are already, however, a number of structured business angel groups in the UK which the Government should examine before considering the development of more formal angel groups. While some schemes, such as one promoted by Scottish Enterprise, are successful, others have met with failure.
    
    
20. Although the informal venture capital market is the main source of external risk capital for SMEs in Europe, there is a lack of reliable information on the scale of this market. ACCA believes that before developing any initiatives to promote the take-up of business angel finance and venture capital by entrepreneurs, the SBS should address this data gap from a UK perspective. An improvement in the scope and depth of statistical information will give a better understanding to the Government of the importance of informal venture capital and of where, and in what form, intervention may be required.
    
    
21. A number of different approaches can be suggested to address the lack of information on the informal venture capital market. Information could be collected from the business angel networks. A representative panel of business angels in each country/region could be surveyed each year. Organised angel syndicates could be identified and used to collect annual investment statistics. Such approaches should give a useful indication of the characteristics of business angel investments and of trends over time in the nature of investments.
    
    
22. The Government should, however, also be aware that there is some evidence that a significant proportion of owner-managers are unwilling to access business angel or venture capital finance as this would mean giving up a share of their business and possibly having less control.
    
    
    Question 3.11. Would replacing the CGT incentives with enhanced income tax relief have a positive effect on the overall supply of funds?
    
    
23. The taxation system in the UK does not provide sufficient incentive for internally-funded business growth. It is often as advantageous to the owners of small companies to draw money out of the business as it is to re-invest it to generate growth. ACCA believes that there should be a lower rate of corporation tax on retained profits. There should also be changes in tax laws to provide incentives for owners to re-invest in their business and thereby increase the amount of internal finance available to support sustainable growth.
    
    
    SMALL BUSINESS INVESTMENT COMPANIES
    
    
24. Small Business Investment Companies (SBIC) have been widely reported as a success in the US, funding 58% of all venture capital deals and 11% of all deals in dollar value in 2002. ACCA believes that the SBIC model, should however, be examined thoroughly before it is transposed in its entirety to the UK. There are a number of key factors which must be taken into consideration. First, there is a distinct difference between the ways in which venture capital investments are made in the US and in the UK. This has its basis in economic and cultural factors and involves fundamental differences as regards concepts such as business failure. There is a positive attitude towards being a serial entrepreneur in the US, whereas this is viewed with suspicion in the UK. The second factor concerns the number of venture capital schemes and programmes which are already in operation in the UK. There is an issue here about introducing a new scheme in addition to or as a replacement for existing schemes. The introduction of SBICs must, therefore, only be taken forward after extensive consultation with potential investors who would make the scheme viable.

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