Funding shortfall amongst SMEs creates acquisition opportunities

While the UK economy remains in the throes of the COVID-19 pandemic, the hope offered by vaccines means that many businesses will be looking beyond merely surviving the crisis and considering how they can grow after it.

However, for some of the UK’s most promising companies, including innovative, high-growth-potential SMEs, the state of the domestic economy means that being able to generate growth will be problematic.

A lack of long-term funding options are leading to concerns that, as the pandemic begins to recede, promising UK SMEs are facing a credit squeeze and funding shortfall that could cause their growth to stagnate at precisely the time it should be accelerating.

While government ministers and trade bodies could spend months debating the best ways to plug the funding gap for the UK’s most promising young businesses, the people behind them are unlikely to be willing to sit on their hands and wait for help to arrive.

This creates a situation where fast-growing SMEs are often more open to equity investment or acquisition by parties with the cash to bankroll their development and a desire to reap the rewards from such an investment as the UK economy rebounds.

A lack of investment

In 2020, BSR discussed the potential for a funding shortfall among the UK’s fastest-growing SMEs. While many of these companies haven’t necessarily faced the immediate threat of collapse due to the pandemic, the stasis gripping the economy has created concerns that their progress could be stymied.

According to a report from ScaleUp Institute, Innovate Finance and Deloitte, COVID-19 caused equity funding for fast-growing SMEs (those where either sales or employee numbers are increasing at more than 5 per cent per year) to drop 40 per cent in Q2 2020 compared to the same period in 2019.

While the report noted that fundraising on the AIM stock exchange doubled in Q2 2020, the amount secured for growth was down 45 per cent. This slowdown in equity funding and growth capital was predicted to account for a drop of around £5 billion from 2019, which could further be exacerbated by a forecast £2.5 billion fall in early-stage venture capital and a recurring annual funding shortfall of £7.5 million.

In its end of year report, the ScaleUp Institute highlighted the funding problems continuing to face UK SMEs, with 4 in 10 saying they did not have the right funding in place to match their current growth ambitions, putting the issue on a par with talent as the biggest barrier to future growth.

Bearing out the earlier claim that investors were focusing on firms in their existing portfolio and were more hesitant to invest in newer companies during the pandemic, half of angel investors reported that their investments had been negatively impacted by the pandemic.

In particular, angel investors reported a 41 per cent drop in the value of initial and follow-on investments. While, of particular concern for new businesses, seed-stage investment fell to £128 million in Q3 2020, down 20 per cent from the previous quarter and the lowest amount since Q3 2017.

In its 2020 report, the ScaleUp Institute wrote: “This widening growth capital gap is now pressing and the structural challenges outlined above must be addressed to avoid the risk of a lost generation of innovative businesses unable to access the right capital to continue to scale and go global, at a time where growth is more crucial than ever.”


A continuing lack of funds

As we move into 2021, a lack of funds to enable growth is a core issue for UK SMEs. A recent report from Rangewell has highlighted that bank lending is currently overwhelmingly focused on COVID-19 support schemes, which do not address the long-term needs of growing businesses.

Rangewell’s Nic Conner said: “As firms move from survival to recovery in 2021, the Treasury needs to help lenders, particularly non-bank lenders, in getting funds to British businesses.”

While Conner praised the impact of COVID-19 business interruption loan programmes, such as the Bounce Back scheme, he added: “The trouble with lending being so concentrated on the COVID schemes is that it will create a funding gap where firms in a strong position and which will be looking to expand and diversify in 2021 will be ushered into COVID emergency loans, which are just not appropriate for them.”

Bounce Back loans are low-value, short-term loans, offering smaller companies from £2,000 up to 25 per cent of their turnover to a maximum of £50,000. In comparison, the Coronavirus Business Interruption Loan Scheme (CBILS) offers companies with turnover up to £45 million loans of up to £5 million, while the Future Fund offers innovative companies convertible government loans of between £125,000 and £5 million, subject to equal backing from a private investor.

Despite Bounce Back Loans offering far smaller, more short-term financing, over £43 billion has been lent under the scheme as of December 2020, compared to £19.64 billion under the CBILS and just £975.5 million under the Future Fund.

While it is understandable that smaller loans will be easier to access, the success of Bounce Back Loans in comparison to other lending programmes point to some long-standing issues with other schemes. CBILS, for example, has been criticised, as we covered here, for the low amount lent.

As CBILS loans are only 80 per cent government-backed, there have been accusations that lenders are unwilling to grant CBILS loans and take the 20 per cent exposure on their balance sheets. This is borne out by the statistics: of close to 1.9 million applications for Bounce Back Loans (as of December), 1.4 million have been approved; in contrast, of over 186,000 CBILS applications made by December, just over 86,000 were approved.

While Bounce Back Loans have undoubtedly been important for some small companies’ survival, they do not offer the financing SMEs need to grow. Without more flexible, long-term financing options, such as invoice or asset financing or growth capital loans, being more readily available, promising companies across the UK will continue to face a credit squeeze and a funding gap.

Potentially compounding the problem, some businesses have complained that they have been locked out of the government’s most recently announced £4.6 billion COVID-19 grant package as a result of having already reached the €4 million cap in the European Commission’s temporary state aid framework.

With the UK now having left the EU, business owners are obviously frustrated at being excluded from potentially valuable financing due to an EU rule.

In light of this kind of confusion and the seeming difficulty of accessing really considerable funding under government schemes, it is understandable that ambitious business owners may seek financing from other sources.

An opportunity to drive an SME’s growth

Both the Rangewell and ScaleUp reports feature recommendations on how the Treasury could look to plug the funding gap facing UK SMEs. However, for those SME owners desperately looking to grow their businesses as the country comes out of the back-end of the pandemic, waiting might not be an option.

These companies will be hungry to emerge from COVID-19 in a strong position in order to fully take advantage of any post-pandemic upturn in the UK economy and, as a result, will be looking to kickstart their next stage of growth as soon as possible.

Of course, with a third of UK businesses having less than three months of cash reserves, mere survival will also be a pressing considerations. However, the importance of securing sustainable growth before the pandemic ends will mean that many companies would rather access more long-term forms of financing than COVID business interruption loans.

This could then create a window of opportunity for acquisitive parties who have both the cash and the willingness to inject equity into an SME in its attempts to grow out of the COVID-19 crisis.

Surrendering equity is, of course, not a new option for SMEs looking to unlock the next stage of their growth. Small business owners regularly turn to acquisitive buyers to offer not just financing, but the strategy, expertise and security they need to kick on.

However, due to the current factors in play, many SMEs that might ordinarily have turned to financing from banks, venture capital or government-backed growth schemes could prove more open to an acquisition.