The importance of government intervention to smaller companies
Christopher Allner - 22 July 2010
The recent emergency Budget served to emphasise the importance of Government intervention in supporting the provision of ‘risk finance' to the UK's small to medium enterprises (SMEs). This is a key issue and, following on from the various measures announced, the Government is due to publish a paper on business finance. It has also announced plans to create a new Growth Capital fund to help keep up funding for SMEs beyond the early stage phase. This could provide serious scale in the region of £0.5 billion, in order to deliver support to this crucial part of the economy. We welcome these developments as we believe it's essential that Government intervention in the smaller company space continues.
Investors and advisers will know that the introduction of Venture Capital Trusts (VCTs), Enterprise Investment Schemes (EIS) and various other funding initiatives by the Government over the last fifteen to twenty years has enabled investors to give support to SMEs. However, Government intervention goes back much further than that and it needs to be on a major scale if we are to keep on delivering the support that SMEs need.
This was emphasised in the Rowlands Report, released in 2009, something that the Government will be referring to as it considers how best to help SMEs. That report pointed out that once businesses progress from being small to medium sized, they become part of a group that represents over a third of the UK's GDP, yet they're underserved in terms of funding, both bank and equity financing, and often need help and guidance to be successful. The report recommended more Government intervention to help these companies continue growing.
Looking back at how SME investing has developed over the years underlines this and points towards further intervention in the future. From the mid 1940s, the Government-initiated Industrial and Commercial Finance Corporation (ICFC) existed to provide funding and support to smaller companies. It did this with great success; a Government intervention that lasted over 40 years, which really helped to shape the environment for SME investment, and subsequently the private equity industry. However, originally part owned by the Bank of England and high street banks, ICFC came to be rebranded in the 1980s as 3i, and floated in the 1990s on the stock market. It came to focus more on larger management buy outs than delivering funding to SMEs. This has left a hole in funding provision for small companies, which has only partially been filled by a fragmented array of investment initiatives, ranging from VCTs to the Regional Development Funds (RDFs) and EIS incentives.
Government intervention from the mid 1990s onwards has been on a different scale, encouraging the development of a plethora of small fund providers, few of which have the scale to offer real support to the smaller companies they back. This in turn has led to more modest financial returns in this part of the market, discouraging the private sector from investing, when richer pickings can be found in the larger buy out funds.
In the wake of the financial crisis, the Government has once again stepped in, with invaluable support for smaller companies including the Capital for Enterprise Fund, a one year initiative which we helped manage. However, from this point on, without a large scale, central focus for future Government intervention, the environment for smaller company investing will became a lot more challenging. The Government's longer term potential initiative is the aforementioned Growth Fund, which will be crucial to continuing the provision of funding. It will not only provide funds, but also the scale of fund managers, who can then really make a difference to SMEs.
Success in generating returns by larger scale investment managers would start the virtuous cycle of generating better returns to encourage more private sector investment into this part of the market. 3i and its main competitors in the SME space of the 1980s and early 1990s were commercially successful and there is no reason why their successors should not be too.
It's clear that Government intervention should be much more than about cash - it can provide a long lasting stimulus to create the necessary infrastructure, not just for small growing companies themselves but the whole SME investment market, including fund managers and investors that support SMEs. And these companies are vital to the recovery of the UK economy - they could generate many of the 2 million private sector jobs that the government wants to create, as well as tax revenues and export income. As we enter a period of so-called austerity, they'll be helping to inject some drive and energy into an economy that's only just coming back to life.
