Looking beyond banks: Private capital to provide much needed lifeline to SMEs during COVID-19 turmoil

As we enter the second national UK lockdown, many business managers see a bleak future.

Looking beyond banks: Private capital to provide much needed lifeline to SMEs during COVID-19 turmoil

As we enter the second national UK lockdown, many business managers see a bleak future. 

Fladgate’s Restart Capital report found that 84% of SMEs consider themselves to be in distress or just about sustaining their business. One in three (35%) SMEs (and 43% of medium sized enterprises) do not expect to be in business for more the 12 months. 

As the backbone of the UK economy, this is frightening – but there are also glimmers of hope. 

The vast majority of investors polled (95%) had seen no more than a slight decrease in the value of their overall assets as a result of coronavirus. There is clear appetite to deploy this investible capital, and, in particular, to invest these funds in distressed SMEs. Nine in 10 (87%) either had experience of dealing with distress or an interest in doing so. 

The ability and willingness of investors to invest in SMEs is encouraging given the rate at which SMEs are looking for an injection of capital. Half of SME respondents had either recently raised, were currently raising, or were considering raising money.

However, only half have found those fundraising efforts successful. 

Over-reliance on bank lending limiting SMEs’ fundraising success

Our research showed that the most popular source of funding for SMEs by far is bank lending. This is unsurprising; banks are familiar territory for many of us. One in four (26%) SMEs conducting fundraising and half (49%) of those considering raising funds are turning to banks. This compares to the next most popular method of fundraising, crowdfunding (26%) and direct investing (20%).

Banks, however, have tight restrictions on their lending. They look for tangible security, and apply rigid lending criteria. This leaves many promising business out in the cold. Banks often feel unable to lend to pre- profit (let alone pre-revenue) businesses or those suffering a period of financial loss (as many SMEs will currently be experiencing). Banks may shun businesses whose value relies on people and ideas rather than land and stock, and their extensive administrative structures and heavy reliance on professional advice adds costs for lenders. 

With 8 in 10 SMEs in distress or just about surviving, it is therefore not surprising that SMEs and high street lenders are experiencing a mis-match in expectations and limited success when it comes to their fundraising

The Government’s initial response to the coronavirus pandemic offered an alternative to bank lending. For a time, direct government support could fill the gap. The furlough scheme and the eat out to help out scheme were the most high profile initiatives by which government provided direct subsidies to businesses. These schemes have, undoubtedly, offered some respite for struggling concerns. However, the inevitable limit in time or availability of such subsidies, and the inevitable long-term detrimental consequences of coronavirus for the business community, means that direct government assistance was never going to be enough. 

As the UK locks down and businesses close up shop for the second time this year, it is clear that government support is now finite and bank lending not viable for many. Thousands of small and medium-sized businesses are facing the question of how they are going to survive long enough to adapt to a changed consumer landscape.  

At Fladgate, we firmly believe private investment is the solution. It is time for the private sector to step up and deploy the untapped funds at its disposal to rejuvenate the UK’s SMEs, offering badly needed capital, strategic advice and network of contacts, services which go beyond what a traditional bank can typically provide. Our belief is supported by the data. As banks turn away from firms in distress, investors see an opportunity. One in three private investors is willing to support distressed businesses across the UK. 

Government urged to encourage the deployment of private capital

Despite being a viable lifeline for many firms, our research found an awareness gap amongst SMEs when considering where to turn for financing. Only a minority of SMEs are considering alternative means of finance on offer by private investors.

We’re urging the government to do more to bridge this awareness gap as a first step. To really facilitate the quick and effective deployment of private capital, we’ve presented some ‘quick win’ policy measures for government to introduce. Backed by SMEs and investors alike,  they include tax incentives for investments into distressed business (similar to the popular enterprise incentive scheme but adapted to fit typical distressed investors). We think there is merit in delaying the introduction of preferential status for HMRC, currently scheduled to be introduced in December 2020. We’d like to see government guarantees for loans or other risk sharing for private investors (similar to, but broader than, the CBILS scheme). Finally, we think providing grants to SMEs to access early advice on strategic options would meaningfully help business leaders explore survival options they might not have thought about.

In addition to these policy recommendations, investors and SMEs need to think creatively about investment structures which allocate risk and reward in a way which best suits the parties. Where the size of the project will bear it, parties should move beyond secure loans and ordinary share subscriptions to think about more nuanced approaches- convertible securities, preference shares, weighted voting rights and management ratchets. In smaller cases, compromise is needed on simpler deal structures. 

Many businesses face a difficult, and uncertain future. However, if we can create an environment which helps match investors with businesses, private capital may be the way through. Let’s use our contacts as businesses, professionals and advisers to help this happen. 

Jeremy Whiteson
Jeremy Whiteson

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