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COMMUNITY UPDATE

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Comprehensive cuts have dominated recent UK headlines meaning reduced public sector funding for much of Britain’s small- to medium-sized enterprises (SME). Of the 4.8 million businesses in the UK, 99 per cent are SME, which collectively employ 50 per cent of the UK workforce and contribute £1.5 trillion to the GDP. But should banks do more to support ‘the engine room of the economy’? And what incentives could the UK government introduce to encourage entrepreneurial enterprise?

If smaller and younger companies, rather than larger multinationals, are to be the engines of UK growth and jobs over the next five years, it is essential that they receive encouragement and support from the government, lenders, advisors and business networks.

The subject, owing to its sheer depth and breadth, will be explored further in a series of Criticaleye articles, focusing on the networks and the lending options available to help SMEs achieve growth. This newsletter gives a broader taste of the topics covered, with reference to:
  • The responsibility of banks
  • Angels and demons
  • Networking power
  • From Big Society to Entrepreneurial Culture
  • The role of the government

The responsibility of banks

Small businesses have very few funding options available to them: the big four high street banks account for over 90 per cent of all lending to small businesses. And, since the economic crisis hit, there’s been a decline in total business funding through business loans: in June 2009, average monthly business loan new lending was £833 million; in 2010, this fell to £564 million (British Banking Association, 2010). So, is the banking sector providing the right kind of support for business?

Steve Cooper, MD of Barclays Business in the UK Retail Banking division at Barclays Bank, agrees that the banking community clearly has a responsibility to helps SME start, survive and grow, but believes it should not share this responsibility alone. He says: “In the UK, there are numerous bodies that want to invest in SME and who also have money to do so. But they want a business they can understand and believe will generate cash and profit ultimately to repay them. For taking the risk, they will want a share of the potential prize. For each investment that pays out well, there are many more where the investment is lost.”

Here, Steve poses the typical questions that a bank will ask when approached for a loan:
  • Ask yourself and others why someone should give you the loan
  • Do you have a business plan and does it make sense?
  • Is it easy to understand?
  • Does it show what the money will be used for and how the business will generate cash to repay it?
  • Do the assumptions behind the business plan stack up?
  • How have you tested this?
  • What happens if the business plan does not work as expected?
  • How resilient is the business to a drop in sales, profit margin or debtors taking longer to pay?

Angels and demons

Whether seeking funding from the bank, friends and family, angel investors or a venture capitalist (VC), questions about how much you need and what you are prepared to offer in return will influence which route you take.

“There are some general pros and cons of funding”, says Emma Jones, Founder of Enterprise Nation, a homeworkers’ community website. “The ‘pro’ is that you are raising funds to accelerate your business so you can grow faster than you could have done without the funds. Some business owners may consider it a ‘con’ to hand over equity to raise these sums and therefore lose an element of control of the business. This is why it is advisable to look for a source of funds that delivers more than just capital; can you approach an angel investor who brings skills and experience as well as cash? Or approach a venture capitalist that can facilitate introductions to their portfolio of companies as well as injecting money.”

Chris Allner, Chairman of the Investment Committee at Octopus Investments, says: “The VC industry clearly needs to do more to breed understanding about how it can help. VCs bring excellent experience to bear and, for an entrepreneur facing the challenge of securing investment for the first time, having the right investor onboard can mean solutions are found early on. We have made 12 investments from some 600 propositions this year and what’s clear is the need for a business really to differentiate itself with anything that can help to grab the attention of the investor.”

Chris’s tips to get your proposition ‘investment ready’ include:
  • Do due diligence on your business - gather data on product sales and competitors
  • Put yourself in the shoes of the investor - seek out the competition and profile other investors
  • Get the right advice from the right advisor - strike a personal accord and align expectations
  • Do due diligence on your investor - speak to the investor’s portfolio companies
  • Consider whether you have maximised all the commercial relationships

Of course, some SMEs only require small amounts of capital to start and grow, which is where micro-credit could be an option. Peer-to-peer lending services like Zopa.com allow entrepreneurs and business owners to lend to each other. Going further, Funding Circle (www.fundingcircle.com) launched in August 2010, allowing savers and investors to sidestep banks and lend directly to small businesses.

Networking power

Funding Circle is already seeing evidence of lenders clustering in ‘circles’: groups that lend to businesses with commonly valued characteristics. Andrew Mullinger, Co-Founder and Director of Funding Circle says: “A north-west business circle, for example, might enable lenders to work together to lend to businesses in that particular area. These circles will make it easier for people to come together to use their savings and investments proactively to help shape the community and economy in which they live.”

Bernd Junghans, Founder of the Dresden based start-up, Anvo-Systems says: “In Germany we have a microelectronic cluster around Dresden called Silicon Saxony. Almost 300 companies, R&D institutions and universities working in that area come together for different joint activities, which is rather useful for helping start-ups. Clusters and networks can provide some of the support for growth that is needed to drive SME growth, in much the same way that Criticaleye supports its own network of leaders.”

It’s clear that there is a wealth of knowledge available to be tapped into, whether it’s banks, professional advisors, local business people and networking societies. Steve Cooper says: “It’s not a coincidence that business owners who use Facebook or Twitter are three times more likely to experience high growth than those who do not. It’s nothing to do with Facebook or Twitter, but rather the mindset of the person - they are networking, constantly reaching out for ideas, advice, knowledge and support, and, of course, new customers.”

From Big Society to ‘entrepreneurial culture’

Can the UK ever produce a hotbed of entrepreneurial activity to rival Silicon Valley, which has produced many of the most successful entrepreneurs of the past 30 years and now accounts for one in three of every VC dollar spent in the US?

“I think Britain suffers from a 'class hangover', where VCs and banks back those with the right 'school tie',” says Mark Weber, Non-executive Chairman at BDP Atticmedia. “By contrast, Silicon Valley has a culture where ideas, and the courage to do things differently, are more important. If people fail, it is not held against them; what matters is determination.”

Doug Richard, Founder of the School for Startups and the Entrepreneurs’ Union, has been lobbying the UK government to think not just about a ‘Big Society’ but also about a society that is entrepreneurial. He says: “If the enterprise-led recovery is to happen, the government must address some of the fundamental obstacles to entrepreneurship in this country. We have a requirement to speak up for Britain’s small businesses or we risk becoming a country with no regard for its most important workforce.”

The role of the government

In October 2010, the Business Finance Taskforce produced a report ‘Supporting UK Business’. Many of its findings were discussed in the inaugural meeting of the Small Business Economic Forum. Should the government set an example by being more entrepreneurial itself?

“An incentive could be some form of risk-reduction, such as some additional tax benefits, to make SME riper for venture capital investment,” says Mark Weber. “In the entrepreneurial spirit of the new Coalition Government, ideally the government recoups that 'risk-reduction' if the VC backing of the SME is successful. Once we give them the taste and habit of dealing with new, unknown SMEs, hopefully it will become part of everyday practice.”

Ian Harley, Criticaleye Associate, says: “I would like to see a more overt and structured push from government to impact the operational strategy of the existing ‘state-owned’ banks like RBS, Lloyds and Northern Rock, with a view to influencing their lending policy and marketing emphasis in the short-term. In the longer term, I think the proceeds of disposal from these stakes, or the profit which accrues from their sale, should be used to capitalise an autonomous ‘national development bank’, which would be mandated to focus on the areas of start-up finance and innovation going forward.”

Bernd Junghans says: “Much like what is required in Germany, I think the UK government should foster a proper venture capital environment. Maybe, at the beginning, the government could share some risk to encourage VCs to invest in certain areas, which are of national interest, although I’m not suggesting that the government steps in as a venture capitalist. In Germany, the government funded a so-called hi-tech start-up fund, HTGF, which is supposed to support start-ups in the hi-tech area with seed money. But they are very rigid and their only motivation, as bureaucrats, is to be mistake-free.”

Vital though support for SME undoubtedly is, it requires a dizzying breadth of engagement. That is why the UK government has asked for ideas on how to do this in its recent Green Paper ‘Financing a Private Sector Recovery’. Ultimately, it will require the ideas, support and contribution of the whole of UK society to succeed.

I hope that you enjoyed reading this Update. Please get in touch directly if you have any comments about the issues raised here.

I hope to see you soon,

Matthew

www.twitter.com/criticaleyeuk