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News : Innovation Last Updated: Jun 30, 2014 - 9:03 AM

High-growth UK startups 'debt-shy'; Micro tech firms that do not grow get funding
By Michael Hennigan, Finfacts founder and editor
Jun 27, 2014 - 10:42 AM

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A report published this week 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 - - policy has been led by the assumption that high-growth startups 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 with micro tech firms that do not grow getting funding while high-growth UK startups are 'debt-shy' because of a distrust of banks and a reluctance to lose control.

The study [pdf], funded by the Institute of Chartered Accountants Scotland (ICAS) and based on analysis of the small business survey, reveals three surprising findings that question this approach:

Rather than young technology startups 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.

This is an old refrain of Finfacts!

A report published in 2012 by the Kaufmann Foundation, America's leading entrepreneurship think-tank, said that state economic development programs, which traditionally target high-tech firms, may be missing 75% of high-growth companies.

"Our analysis of these fast-growing firms shows us that high-growth company founders can come from anywhere," said Dane Stangler, director of Research and Policy at the Kauffman Foundation. "Their firms can be found throughout the country and, rather than following the conventional expectation that high-growth companies are grouped into a narrow technology category, they represent exceptionally diverse industry segments. These findings offer important lessons for economic development leaders, such as to target firms that are high-growth rather than high-tech."

  • 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 9% 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.” 

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.

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