Debt-averse businesses are holding back economic recovery

A report published today, by researchers from the University of St Andrews and the London School of Economics, calls into question UK and Scottish government approaches to small business growth.

Until now policy has been led by the assumption that high-growth start-ups are struggling to secure investment from risk-averse banks and Venture Capitalists. As a result, policy initiatives have focused on increasing the supply of funding within the economy.

However the study, funded by the Institute of Chartered Accountants Scotland and based on analysis of the small business survey, reveals three surprising findings that question this approach:

Rather than young technology start-ups driving economic growth; it is in fact a diverse group of high-growth firms, across a number of traditional sectors, that have the greatest potential to impact the national economy and create jobs

·    High growth firms are reluctant to seek the external finance they need to grow, because they’d don’t want to lose equity or autonomy

·    Demand for external funding, rather than supply, needs to be stimulated.

Although high growth SMEs are nine per cent more likely to seek external funding than other SMEs, the researchers found that high growth firms are more likely to use internal finance and the proceeds of growth to meet their investment needs.  Despite growing rapidly many seem ‘reluctant’ to borrow to expand further.  These ‘reluctant’ borrowers risk holding back growth potential – and the economy with it.  The researchers recommend Government policy initiatives need to be better targeted to the needs of this small but vital group.

Dr Ross Brown, from the University of St Andrews’ School of Management, who undertook the study said:

“This research dispels some deeply held misconceptions in relation to high growth SMEs.  These firms are predominantly funded by bank debt, not equity sources of funding like venture capital. While many use bank lending to fund capital expansion, some draw heavily on their internal resources to fund growth.

“Our research clearly shows that equity funding is not the preferred mode of funding for the overwhelmingly majority of high growth SMEs.  Therefore, much greater emphasis should be placed on helping growth-oriented SMEs, irrespective of their sectoral origin, being able to access non-equity funding mechanisms.”

Dr Brown continued:

“At present, through initiatives such as the Scottish Investment Bank, Scottish policy makers concentrate heavily on assisting young technology-based firms through the supply of co-invested equity funding.  However, most of these embryonic tech firms do not grow and many get acquired when very small.  This is not effective targeting of resources especially if policy makers genuinely wish to focus on producing more rapidly growing firms.”

According to Dr Neil Lee from London School of Economics who co-authored the study:

“The fact that many high growth SMEs are ‘reluctant borrowers’ may be holding back the economy.  Government needs to encourage much greater competition in the market for SME lending, especially from alternative sources of credit.  If banks are serious about developing bridges with SMEs a much greater focus on relational banking is crucial to help encourage borrowing.”

Michelle Crickett, Director of Research at ICAS, said:

“We are very pleased to publish this research focusing on the crucial issue of finance for the SME sector.  Whilst these entities may be small individually, on aggregate they are extremely important to the UK economy.  There has been much focus on ‘discouraged borrowers’. This research identifies a new category of ‘reluctant borrowers’ and we believe that government, banks and others with an interest in SME funding should consider how these debt-shy borrowers can be transformed into willing borrowers in the interests of economic growth.”

Notes to news editors 

The report is available to view at: http://icas.org.uk/brown-lee/

About the research:

High growth firms are defined as those growing at 20 per cent or more for a three year period.

The research is based on a quantitative analysis of the Small Business Survey – a government survey of almost 9,000 firms – and a series of in-depth interviews with high growth entrepreneurs.  Further research is currently being undertaken by the researchers and ICAS to extend this study and this will be published in 2015.

About the authors:

Dr Ross Brown is a lecturer in the School of Management and a member of the Centre for Responsible Banking and Finance at the University of  St Andrews and Dr Neil Lee is an Assistant Professor of Economic Geography at the London School of Economics and Political Science.

About ICAS:

ICAS is a leading professional body for Chartered Accountants (CAs), with more than 20,000 members worldwide. ICAS is an educator, regulator and thought leader. ICAS members have all achieved the internationally recognised and respected CA qualification (Chartered Accountant). Almost two thirds of our working membership work in business with the others working in accountancy practices.

About SATER:

The research project which culminated in this publication was funded by a grant from The Scottish Accountancy Trust for Education & Research (SATER), a registered Scottish charity.