Small businesses need a new source of financing

This article was published in PE News.

Regulatory red tape is slowly but surely wrapping itself around the private equity market. For small businesses in need of growth capital, the beanstalk is getting harder to climb.

Big names like Barclays, HSBC and Lloyds TSB are cutting teams and assets free, to shrink balance sheets and free capital. Many of these teams focus on larger deals, but where they did stray into the small company market, the strategy will almost certainly be to maintain a lean unit, investing in larger transactions (£10m-plus) where the economies of scale make (to them) more sense. It continues to be extremely difficult to borrow modest sums without full asset backing and, for a young growth business with attitude, that does not cut the mustard.

If the banks cannot help, who is going to step into their shoes? The answer 10 years ago would have been 3i Group. In 1997, 3i invested over £900m in 600 UK businesses – an average of £1.5m per company. The new 3i Growth Capital Fund is seeded with seven investments averaging £40m. From 600 investments to seven investments. From £1.5m per company to £40m per company. The old market leader is in a very different place. And so far, nobody has stepped into its shoes.

Equity investment remains the answer to accelerating growth and public and private sector interventions do exist to support these businesses, such as enterprise capital funds or the recently announced National Growth Capital Fund. There are nine ECFs in existence, with Panoramic ECF1 the largest to-date. Since closing our £35m fund in September last year, we have received more than 150 applications from a range of businesses. Buy-and-builds are a common theme. Fragmented markets, retirement sales, reasonable valuations, a need to keep moving are all drivers for consolidation and a chunk of equity capital can make this happen. We are also seeing lots of small buyout opportunities but, with bank debt largely unavailable, vendors are having to leave skin in the game and fulfil the role of senior lender. In general, there is an acceptance that, to accelerate growth, a portion of the business has to be sold to raise the cash.

How does it feel for a small to medium-sized enterprise chief executive to raise venture capital cash and then work with that backer? It should be an exhilarating relationship – a partner whose interests are aligned and with a network of contacts that can help take your business to the next level. Growth can be hard to maintain, and it is easy to slip behind a plan, causing motivation to ebb. A good investor will not let that happen and will maintain momentum, focus and energy.

But not everyone is suited to taking on VC investment. The cash will come with strings and a challenging voice at the table. For small companies in particular, the changes can be dramatic – corporate governance, continuous requests for information, handcuffing around certain decisions. There will be sacrifice, but the upside can be enormous. A good investor will open doors, get involved and drive for an exit. As life-changing as an exit can be, they are difficult to achieve. The business has to be purring, all the parts well-oiled and ready to go.

When there is a limited supply of growth capital, small company growth suffers. SMEs are the bedrock of our economy and the best deserve to be supported. That is why we set up Panoramic, and we are working hard to recreate the buzz 3i had and all small growth companies need.