Equity investment into smaller UK businesses surged towards the end of last year, as highlighted by the British Business Bank’s ‘Small Business Finance Markets 2021/22’ report.
A total of £14billion was invested into the UK’s small businesses over the first three quarters of 2021, representing a 130 per cent increase on the £6.1billion invested throughout the same period in the year before.
Investment in these three quarters alone has exceeded the £8.7billion invested in the whole of 2020. At the same time, the report shows that bank lending has returned to close to pre-pandemic levels, with 2021 lending down 45 per cent from 2020, driven by lower drawdowns of government-supported loans.
The report suggests there could be continued economic recovery throughout 2022, with strong demand expected for investment to fuel business growth. Although 2022 may still provide a challenging environment for some businesses, many others report that they are seeking to pivot towards growth, improve productivity and transition to a net-zero economy.
Small Business Debt
The amount of debt held by smaller businesses has significantly increased compared to pre-pandemic levels due to businesses accessing the government’s Covid-19 emergency finance schemes.
At their peak in March 2021, smaller business debt stocks were estimated to be up 30 per cent. Encouragingly, however, debt repayments are becoming a smaller share of businesses’ cash flow as UK economic recovery helps boost their turnover.
The proportion of small and medium-sized businesses with debt repayments making up more than 50 per cent of turnover has declined since early 2021. For businesses with between 100 and 249 employees, just 2.5 per cent reported debt repayments above 50 per cent of turnover, down from a peak of around 5.5 per cent in February last year.
As well as debt markets overall returning to near pre-pandemic levels, there are other indicators of a rebound in activity. Challenger and specialist banks accounted for just over half of the bank lending (51 per cent) – a record share, up from 32 per cent in 2020 – while private debt, asset finance, invoice finance and asset-based lending, and alternative finance all experienced rebounding levels of activity after a difficult 2020.
“As smaller businesses look to recovery and growth following a challenging economic period, finance will continue to play a crucial role,” said Catherine Lewis La Torre, CEO, British Business Bank. “With our mission to drive sustainable growth and prosperity across the UK, and to enable the transition to a net-zero economy, the British Business Bank will continue to support the country’s smaller businesses by improving access and options to secure external finance.”
Small Business Minister Paul Scully added: “This report shows a massive 130 per cent increase in equity investment into smaller UK businesses, which is a hugely positive step forward in our recovery from the pandemic.
“However there is clearly more to do to get ethnic minority and women-led businesses on to a level playing field when it comes to accessing finance. The Government will continue to work with the sector, including through Start Up Loans and the Rose Review of female entrepreneurship, to ensure everyone has the tools they need to succeed.”
Demand and Supply-side Factors Contribute to Geographic Imbalances in Access to Finance
The data shows that both demand and supply-side factors are contributing to geographic imbalances in finance flows. Long-run data covering 2019 to mid-2021 show London businesses remain more open to using finance, with 37 per cent happy to use finance to grow compared to 29 to 32 per cent of smaller businesses in most other parts of the UK.
While the UK hosts a large number of rapidly growing businesses, external finance remains highly concentrated in the capital compared to other regions. London firms attracted 70 per cent of 2021 Q1-Q3 investment value. This is partly due to the geographic location of the equity investors themselves, which are predominantly based in the capital.
This was also evidenced in the Bank’s first Regions and Nations Tracker, published in October 2021, which showed 82 per cent of equity investment stakes in the UK are between investors and smaller businesses located within two hours of each other.
Despite these inequalities, the British Business Bank’s regional funds programmes continue their success in delivering regional access to finance, with the Northern Powerhouse Investment Fund recently surpassing £300million direct investment, and the Midlands Engine Investment Fund reaching its £150million investment milestone.
Breaking down barriers in access to finance in the regions and Nations remains key to levelling up economic opportunity.
Regional disparities in access to external finance are reflected in the recent Spending Review, at which the Bank was provided with an additional £1.6billion for new regional funds and a further £150million for regional angel investment. In 2021, the Bank’s core programmes are estimated to have deployed more than £979milion of finance to businesses outside of London.
Smaller Businesses View Reducing Carbon Emissions as a Priority
In 2021, 47 per cent of smaller businesses viewed reducing their carbon emissions or environmental impact to be a priority for their business whilst 22 per cent would use external finance to help transition their business to net-zero. Eleven per cent of smaller businesses have already used external finance to support net-zero actions; according to the report.
In contrast, 71 per cent of SMEs viewed maintaining or increasing sales to be a high priority, and 37 per cent would be happy to use external finance to grow their business.
Research suggests equity investors are increasingly considering environmental factors in investment decisions. A survey of UK VC fund managers conducted by the British Business Bank indicated that 83 per cent are now taking into account environmental factors within investment decision making, and 52 per cent see ESG factors as a significant part of their investment decision-making process. This has in turn led to an increase in cleantech investment in the market.
Ethnic Minority-Led Businesses Are Open To Using Finance for Growth
The report indicates that ethnic minority-led businesses are more open to using finance and more ambitious for business growth but access to finance remains an issue.
Fifty per cent of ethnic minority-led businesses are open to using finance for growth compared to 32 per cent of white-led businesses. Sixty-four per cent of ethnic minority-led businesses have ambitions for significant growth compared to 39 per cent of white-led businesses.
Despite this, ethnic minority-led businesses are more likely to be discouraged from applying for external finance and having their application turned down, leading to negative impacts on their business.
Although rejection rates have declined in recent quarters, most likely reflecting the impact of government-backed loan schemes, they remain significantly above those for white-led firms, with data showing that 18 per cent of ethnic minority-led businesses were turned down for finance between Q3 2020 and Q2 2021, compared to only 10 per cent of their white counterparts.
As a consequence, ethnic minority-led firms are around twice as likely to cite access to finance as a barrier than white-led businesses. Additionally, 56 per cent of ethnic minority-led businesses currently using finance agreed they thought it would be difficult for them to obtain finance again, compared to 42 per cent of white-led businesses.
Amongst female-led businesses, appetite for external finance has significantly increased to 31 per cent in Q2 2020 to Q2 2021 but remains lower than for male-led businesses at 39 per cent.
Female-led businesses are also more likely than male-led businesses to be discouraged from applying for finance, citing issues such as uncertainty over where to find finance and concern over the application process being too burdensome. Despite this, only 12 per cent of female-led businesses view access to finance as a barrier, broadly in line with 13 per cent of male-led businesses.