Stock markets are up, but where is the equity finance for small and mid-sized businesses?
As I write this, stock markets around the world are trending upwards following news that not one but two Covid-19 vaccines have achieved success rates in excess of 90% in clinical trials. Whether or not you believe share prices are a good indicator of a nation’s economic health – and there are plenty of reasons to be cautious about that – I think it’s fair to say that the crisis thus far has demonstrated the incredibly important function that mature stock markets serve. Despite the huge economic damage inflicted by the coronavirus this year, stock markets have continued to supply large, listed companies with a ready source of capital. The rapid stock market gains in recent days will surely provide valuable support to these big businesses as they rebound from the Covid-19 crisis.
Unfortunately, the picture is not nearly so rosy for the thousands of small and medium-sized businesses that are not listed. At the very same time that stock markets are awash with capital, these smaller firms are struggling to make ends meet. To get through the crisis, many have had to rely on emergency government support, which will soon run out. Not only that, but initiatives such as the Coronavirus Business Interruption Loan Scheme (CBILS), while a necessary measure in the short term, have saddled many of these businesses with debts, which will constrain their growth. A report by industry group The CityUK has estimated that by the end of March 2021, small and medium-sized businesses will owe between £33-36 billion of unsustainable debt.
The problem is that small and medium-sized businesses are simply not given enough funding options in this country. Crucially, they lack access to equity finance, which is what sustains listed companies. The consequences are serious. While the UK has a genius for giving birth to innovative businesses, we fail at giving growing businesses the financial fuel they need to turn them from start-ups into scale-ups. That failure acts as a significant constraint on economic growth, and limits the potential of creative, innovative companies to solve the big challenges we face as a nation, and as a planet. As governments around the world lay out their vision for a post-Covid future, it is more important than ever that we support the entrepreneurs and business owners who are making a difference. They have an essential role to play.
In a recent report, published in partnership with growth investor BGF, my co-author Stephen Welton and I have tried to quantify the problem. Using research conducted for us by PwC, we identified a set of at least 21,400 businesses in the UK that are currently not well served by equity funding. We call these companies “the growth economy”, because they are growing, on average, at twice the pace of GDP. These businesses are dispersed across the four nations of the UK, providing employment in every region, both in urban and rural areas.
These businesses are not tiny start-ups. In fact, they are defined as having turnover of between £2.5-100 million a year. They have typically outgrown the kinds of early stage funding available to very young businesses. However, they are not yet large enough to attract the interest of private equity, nor are they big enough to float on most stock exchanges.
Putting a number on the funding gap facing these businesses is difficult. However, following similar research by the ScaleUp Institute, Innovate Finance and Deloitte, we estimate there is a shortfall of approximately £15 billion in funding for the growth economy. That is the difference between the funding that these companies need to reach their full potential, and the amount that is currently available to them.
Without this funding, these businesses simply will not grow. As my co-author Stephen puts it, we risk creating a generation of “bonsai businesses”, when we ought to be growing oak trees. The consequences for the future dynamism of the UK economy could be dire.
So, what should we do about it? In our report, we lay out a plan to create what we call a National Renewal Fund made up of investment from the pensions industry, insurance firms, listed investment vehicles and government. Although government has a crucial role to play in convening these investors, and creating incentives and breaking down barriers through smarter regulation, any and all investments will be made purely on commercial terms. We envisage the investments being coordinated by a regional network of investment specialists spread out across all four nations of the UK. BGF’s network of 14 offices across the UK is a useful model to adopt.
It’s worth mentioning that this problem, what we call the growth economy gap, is not new. In fact, a shortfall in funding options for small and medium-sized businesses was observed at least as long ago as 1931, when the Macmillan Report – named not after the politician but after a Scottish lawyer, Hugh Macmillan – identified a gap between what small and medium-sized businesses needed and what was available to them. Nearly 90 years later, that gap is still with us and, alarmingly, it could easily widen into a chasm as a result of the economic damage caused by the coronavirus. Now is the time to act, not merely to protect jobs in the short term, but to secure the long-term prosperity of this country by supplying equity funding to the growing businesses of the future.