West Midlands Finance for Small Business (Spring 2018 update)

This is an update on one of Birmingham Science City’s most popular blog posts, first published in late 2016.

This blog summarises the current picture of access to external finance (not grants) for SMEs and micro businwsses, from public /private sector regional interventions, in the difficult range below £2m, at Local Enterprise Partnership (LEP) and West Midlands level. It represents opinions of the members of Regional Finance Forum, the cross Midlands cross LEP group, providers, and others, individually and as a group. The private sector also provides many other fund sources.

1. Banking relationships and products:

• Normal lending. Bank lending being tight for micros and SMEs is the new normal with which business is living, affected by new capital rules and the prevalence of risk adjusted credit assessment. Various banks have announced initiatives but some of their normal demand is also now being taken by peer to peer and online lending, which has been replacement rather than additional. The small business community generally believe that there is real inherent market failure in this space which needs continuing public intervention, particularly as EU money was (and still is) crucial in helping to fill the market failure gap. This was reinforced by a recent report by Regeneris for DCLG and EIB.
• Banking Referral. The Chancellor has decided now that ‘refusing banks’ must refer requests to 1 of 4 on-line broker mechanisms, namely: Funding options; Funding Xchange; Business Finance Compared; Alternative Business Funding. This referral system, developed by government consultation with small business, is now statutory and the British Business Business website shows more detail. 2.8% of the referrals were initially successful, raising just £3.8m, that and other concerns like referral fees has caused review in mid- year 2017.
• Bank of England continues to monitor small firm funding and access to finance more broadly. A number of RFF members hold meetings with bank officials. The bank publishes a summary of current credit conditions in its regular Agents’ Summary of Business Conditions and Credit Conditions Review.
• Banks appetite. Banks are each operating differently with respect to real appetite, personal approach and imagination, which is not always explicitly acknowledged. The RFF believes that many companies are constrained by cash and perceive that banks: do not wish to lend without security; or at rates that get near to the actual risks; are affected particularly by the risk constraints imposed by official regulation, and shortage/cost of local competence to make detailed assessment. That perception means that they do not even approach banks whose statistics on refusal are therefore significantly understated. Trust of banks and the financial establishment continues low, reinforced by personal experiences and public disclosures. Some of the major banks have recently announced funding initiatives for the region but these are normally directed at the easier high size loans, say greater than £200k.  Many micro and small companies are using consumer finance such as personal credit cards, with their high interest rates.
• Guarantee schemes. Enterprise Finance Guarantee (EFG) Scheme continues as government support for the main banks and, now, other sources. Three local CDFIs (see later), ART, BCRS and CWRT, are accredited. The national offers are now at the reduced rate of around £300m/ year. Whilst there are complaints particularly around the emerging constraint to only use for shortage of security, it is still an important option for companies. It has full national distribution, is a large public intervention, and is a recognition of the inherent economic market failure, as in other countries, irrespective of security, as banks strive for purely financial not community economic return.
• Asset backed investment. Invoice discounting (with modern variations), and factoring continues to grow and can be crucial in funding working capital growth. That and Fixed asset leasing schemes are endemic and supplied by most large lenders/banks. There are some schemes for government support of 10/20% run through the banks and it goes well alongside normal asset – based lending. Some peer to peer is also involved with this.
• Exporting. Support is a national and company concern. Positively, there is now increased government interest in helping exports by the newly branded and developed UK Export Finance. Whilst large contracts have always received public support there is now more interest in SMES too, following October 2017 announcement. It is partnering with 5 major high street banks for finance up to £2m for direct exports but also SME suppliers to larger exporters. Refer to the new brand of UK Export Finance, via Gov.UK web site.

2. Non- Bank Loans:

• New entrants. National emphasis is continuing to encourage new entrants of all kinds into the market as a fundamental competition policy. The new referral legislation and action, as above, if take-up does improve, could be a significant move as new entrants will have guided access to existing banks’ customers.
• CDFIs (Community Development Finance Institutions and now also called Responsible Finance Providers). These institutions with some public support to encourage economic development, are crucial to dealing with inherent market failures below around £150k. They lend after a bank decline, as an additional source of finance. All CDFIs nationally and locally are seeing strong demand and are seeking additional capital to lend from local, regional and national sources: public and private, including using a personal tax relief to investors- Community Investment Tax Relief (CITR). They are missing ERDF and the closure of RGF, as a first loss mechanism, which needs some replacement for CDFI successful survival.
  • ART Business loans has extended from the Birmingham area, to the wider region in the last three years on loans up to £150k. ART also operates targeted loan funds to Birmingham businesses of £10k to £100k in partnership with Birmingham City Council. It is accredited for the Enterprise Finance Guarantee (EFG) scheme.
  • BCRS business loans, based in the Black Country, now lends across the West Midlands, up to £150k, with a loan book of around £12.5m. Overall, in the last year it has lent around £4m with an objective of around £7.5m in the next financial year.
    • It has used a variety of capital sources including individuals, local authorities, LEPs, Regional Growth Fund, other public bodies and sympathetic lenders.
    • It is accredited for EFG, with its valuable practical and reputational support.
    • In late 2017, BCRS won Midlands Engine Investment Funds of £17m to supply Small Business Loans £25k to £150k, over the next 5 years.
  • CWRT Business loans in Coventry/Warwicks. is less active, lending up to £100k, but may emerge with new ERDF programmes.
  • Impetus in Pershore also lends mostly in Worcestershire and the Marches.
  • Big Society Capital. A new £30m national fund for foundation community investment nationwide, including Scotland, has just been announced in Feb 2018 but it is not yet clear about its relevance to the West Midlands.
• Internet Based/peer to peer activity. Established sites identified, include Zopa, Funding Circle, Lending Works, Esme, Assetz, and Funding Knight with others emerging frequently on the net. Thincats, a local player, is now trending away from smaller loans. Rates are commercial and mostly security is required but they lend when banks will not or are not trusted. Most major lenders have applied for FCA approvals, with the market becoming more regulated as viability concerns increase. This activity is now becoming more a challenge to traditional lenders, with less inherent costs, rather than a good value supplement. Peer to peer for equity, including crowd funding, is not so established and there are more doubts about its viability for investors and companies. Finance brokers can recommend fitness for purpose.
• Finance Birmingham (see later also)
  • Loans are still available, but less of a priority, in the £100k to £1m space covering the whole Greater Birmingham LEP area, including Solihull. They are also involved in Government Start up loans for businesses. See below.
  • Supply chain funding. Advanced Manufacturing Supply Chain Initiative (AMSCI) is currently closed, but was mainly for West Midlands LEPs run nationally by Birmingham City Council/Finance Birmingham, expanded to a national scheme. It originated to help the automotive supply chain serve growing automotive development and tooling.
• Start Up Loans are a recent product, government backed, delivered from the British Business Bank by local partners. An individual can borrow £500 to £25000, to start or grow a business. This is an unsecured personal loan; but is of course expected to be repaid. Interest rates are 6% per annum and repaid over a period of 1 to 5 years. Currently there is doubt it will continue.
• Midlands Engine Investment Fund (MEIF) has provided a larger loans product between £100k and £1.5m to support scale-up activity across the whole Midlands Engine geography with around £50m available for the West Midlands, delivered by Maven. This is a new product, now available.

3. Specific Regional Risk capital and support

Funds established by the former-Regional Development Agency, from single pot and also European Regional Development funding,  are running down and now replaced.

• Midven, Birmingham based with a team of 17 people, has a portfolio of c. 50 West Midlands companies employing over 500 people, and is the leading West Midlands’ general equity gap firm not concentrating on technology. It provides progressive equity investment from start-up to maturity, with experienced staff to help identify and develop businesses. Successful investments include consultancies, a vets’ practice and a tour operator.
  • Midven has been equity investing in the region over the last 15 years plus, including ERDF, and other national and regional UK public funds, in around 10 mainly West Midlands companies each year. Over 30 cash millionaires have been created by Midven portfolio companies, nearly all of them in the West Midlands.
  • It has just, in February 2018, been awarded around £35m from the MEIF West Midlands Equity Fund: the main single package of equity from that fund, which is now to invest partially below £250k but up to £2m, into single companies.
  • Midven is also raising an EIS fund using the latest government tax benefits for individuals, resulting in the deployment of circa £5m per annum, much of it in the Midlands, to support early stage businesses. It already has experience of investing alongside private money from previous funds.
• Mercia is run out of Henley in Arden, with 7 further offices across the Midlands, North of England, and Scotland; over 70 employees, and is now recognised as one of the most significant national high-tech investment businesses after IP group. Mercia has 19 university partnerships (9 in the Midlands) which account for circa 25% of investment activity. It broadly provides a ladder of investment from idea to maturity with experienced staff to help seek and develop technological opportunities. Overall, Mercia invests approximately £50m per annum across the group from managed funds and own resources.
  • Mercia has just been awarded the proof of concept package of up to £750k lots (and much below £250k) for the whole Midlands from the MEIF fund, adding c £23m to its funding, to support its other packages, traditional and new.
  • Mercia raises EIS/ Seed EIS Hybrid funds (every year over the last 6 years) to deploy c. £12m per annum, much of it in the Midlands, using the latest government tax benefits for individuals, supporting early stage businesses.
  • It has over £330m in third party managed funds for early stage support (venture, growth, and debt)
  • Mercia has an additional £50m to selectively scale businesses with high growth potential via its managed funds by investing its own capital from its balance sheet.
  • Mercia (as a listed investment business) benefits from the ability to co-invest alongside some of its shareholders, including Woodford investment management and Invesco Perpetual as it has done recently with Psioxus (University of Birmingham spin- out) Abzena (University of Warwick spinout) and Oxford Genetics.
• Finance Birmingham has a comprehensive set of funds available to Greater Birmingham LEP area but also sometimes to the rest of the West Midlands and Nationally. It has recently expanded and reorganised its activities by sectors and arranged them as:
  • Growth capital: A variety of financial instruments from £50k to £2m, including loans, venture capital and mezzanine, concentrating on growing business or larger transactions but will consider all opportunities, including start-ups.  It is generally available across the West Midlands but with major concentration in the WM Combined Authority and Birmingham.
  • Sector Specific Funding.
    • Advanced Manufacturing Supply chain. Building on West Midlands and Liverpool initiatives with manufacturing needs; particularly automotive and aerospace (currently closed).
    • National Rail supply growth. This is a new emphasis based on the growing need and market in rail supply.
    • National Tooling Loan fund. This is supporting nationwide the design development and manufacture of tooling.
  • Property Investment. They are offering flexible loans, potential grants, and equity funding. Particular need has been identified within the WMCA and some adjacent authorities for property and land development support, particularly brown field sites and within niche demands including stalled housing. This matches the perceived needs of the region and includes finance to unlock the growth of property development.
• National funds. There are many national and other commercial venture capital providers in the region such as LDV, but generally in investments larger than £1m.  British Business Bank (BBB) in now more active and Innovate UK are also becoming more active beyond grants, launching its Innovation Loans earlier this year.

4.  Angel/ Start up activity/personal involvement.

Tax relief for private individuals, investing by the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS), at the seed level is very generous with over £1.5B raised nationwide in the last year at a cost to the exchequer of over £500m in lost tax. A recent report (reference below) has calculated that SMEs in the West Midlands use less than a third of EIS UK average per SME.  The RFF was very keen that focussed encouragement of angels should be part of the MEIF development as there are issues with network costs and it may emerge. Thus, further initiatives are still required.

• Mercia has funds, as above and there are others operating on a smaller scale.
• Midven is planning to introduce a new EIS fund alongside its MEIF equity fund. It expects to deploy around £5m per annum alongside its new MEIF equity fund of c £35m. Wait for details of how angels can be involved.
• Responsible Finance has a system of tax relief for individual investors: CITR. In summary it provides an equivalent up-front tax relief to EIS, but over 5 years, providing an effective minimum 5% per annum tax free interest.
• Minerva with HQ at Warwick Science Park, but presence throughout the region and beyond, has been the major independent regional Angel network with 22 investments in the last 3 years. However, the leader has recently retired, and future is uncertain.
• Each LEP could develop its own Business Angel networks: independent, linked to larger players in funds, or to others in the Business Services community such as CAs /IODS.
• Science Parks. Many of the science parks, which are considered amongst the best in the country, have incubation centres both actual and virtual which can provide signposting to finance people and services, often with the support of public funds. These include Innovation Birmingham, Birmingham University Bizz Inn, Warwick Science Park, Keele University Science and Innovation Park, Malvern Hills Science Park, Coventry University Technology Park, University of Wolverhampton Science Park, and new ones are emerging. They all need angel investors. Many are working with established banks, new peer to peer, and other web-based investors, particularly for technology start-ups. See their web sites.
  • Start-ups. There were formerly ERDF funded activities in virtually every LEP area. In the new programme it is not so clear, try their websites.
  • Proof of concept. There are former funds in Staffordshire, Worcsestershire and Cov/Warwickshire, that could be replicated, depending on what replaces ERDF post Brexit.

5.  Midlands Engine Investment Fund (MEIF)

The Regional Finance Forum identified the opportunity for a ‘fund of funds’ using recycled AWM and ERDF funds, and EIB borrowings, when AWM closed. They researched and developed the idea with all the West Midlands LEPs and government departments, which has become MEIF.

It is a game changer in the amount of funds available and has being added to and organised by the British Business Bank (BBB) in cooperation with all the local LEPs. The distributor details have been announced on Feb. 20^th 2018 and are already covered earlier in this paper in the relevant sections but are pulled together here for clarity.

MEIF has the following characteristics:

Approximately £250m has been allotted from ERDF, EIB, BBB, and RDA legacy funds for 5 years, across the whole Midlands i.e. including East and some South East Midlands with the Midlands Engine Investment Fund (MEIF) label. 4 Lots have been procured involving the West Midlands within the initially specified framework below. Approx. 10% unallocated.

• Small business loans: initial allocation of total c £17m: Each investment £25 k to £150k. Announced Summer of 2017.
• Debt: initial allocation of total c £90m: Each investment £100k to £1.5m. Announced Feb 2018. Covering the Whole Midlands.
• Proof of concept/ early stage funds; initial allocation of total c £23m: Each investment up to £750k. Announced Feb 18. Covering the Whole Midlands.
• Equity: initial allocation of c £35m; Each investment 20% below £250k, up to £2m. In the West Midlands.

6. Research and Development (R and D) Tax credit

It can be very difficult for SMEs, to raise money for R and D but there is tax relief or tax credit for R and D expenditure, which constitute real cash support. In 2002 the government introduced a scheme to encourage scientific and technological innovation in the United Kingdom which currently costs them over £1bn for SMEs. It has been changed over the years and in 2015 the relief a company can get was increased to 230% of their qualifying R and D costs. The potential tax credit can be up to 14.4% of that qualifying cost if the company is loss-making i.e. c 1/3 of the R and D cost.  The definition of qualifying costs is precise, but broadly it involves; seeking an advance in a field of science or technology (not just a company’s own knowledge), and scientific or technological uncertainty that competent professionals can’t readily resolve. It is intended that this is not just about ‘white coat’ R and D and product, but also ‘brown coat’ and processes.

In some circumstances SMES are not eligible e.g. having received a notifiable state aid; doing a project under contract; or not subject to corporation tax. In which case they may be eligible for Research and Development expenditure credit scheme (RDEC), which is less generous and similar to the large company R and D scheme.

There are of course strict guidelines on the qualification and relevant costs etc. HMRC are helpful www.hmrc.gov.uk/gds/cird/attachments/rdsimpleguide.pdf.  and accountants often have a paid on-success basis.

7. Useful reports 

• A full independent review, driven by RFF, of West Midland’s access to finance, by Regeneris under the supervision of European Investment Bank (EIB), for consideration by EIB and DCLG in potential use of EU funds 2010-2020 is a fact-based background reference for this paper: very enlightening.
• A helpful national publication, the Business Finance Guide, on sourcing finance and other support has been issued, by the ICAEW in cooperation with BBB.

Final note: This whole blog must not be seen as totally comprehensive and authoritative as it is a complex and changing scene. Web sites of the organisations mentioned are a good and necessary check.

Norman E Price, Regional Finance Forum