Business Banking - Detailed Report On Funding & The 3 Funding Gaps

I have been privileged over the last few days to access the unfiltered views of national and regional banking leaders, having been closely involved in both the Manchester British Bankers Association event and the Lancashire Business Week finance event.

This would appear to be what is happening:

1. The business funding debate has become polarised around a perception that the banks are not lending.

2. The banks insist that they are in fact totally open for business.

3. This divergence is explainable through a number of factors, not least that business demand for loans is depressed by ongoing recession and an unwillingness to invest against very uncertain growth prospects. Many businesses have by now failed outright or downsized into more survivable shapes.

4. Another factor is that, beyond the issue of business failure and downscaling, it is now some time since the banks disinvested from some of the riskier fringes of their portfolios. The new realities of lending are in fact not that “new” any more; we are approaching four years from the origins of the credit crunch. There are bank managers and credit controllers now taking decisions in a changed landscape who were not even in position when the finance landscape reconfigured.

5. There is an implicit understanding across banking and business that the bar for raising money has been raised. It is one of those things whereby the rules may look the same but everything has become a big tighter, even though it would be hard to explain exactly how.

6. The banks drifted gradually into a quasi-venture position (more so with bigger business and property than with trading SMEs) and they simply will not be re-entering this position.

7. That said, in these fragile and static times, the clarion call of proposals which might have been unbankable even in the good times is being heard more loudly, particularly in the media.

8. The government, consciously or unconsciously, finds it easy to divert attention from our frighteningly fragile economy by commenting on easy targets: the banks; the Eurozone; the unions.

9. The banks, because of the bail-outs and their reliance on government for permissive regulatory relationships, feel themselves greatly constrained on any public commentary they can make regarding the full story.

The implications of all of this include:

1. Too much surviving/existing business is under-capitalised. Whatever of the ongoing presence of propositions unbankable in any circumstances (although sub-prime banking’s retrenchment could be said to be affecting the chances of marginal businesses progressing onto a sounder footing), too many businesses are limping along in a state of under-investment (and have done for a long time, buoyed up by growth in better times). This is investment simply to sustain and stand still, not the aforementioned issue of many businesses simply not seeking expansion capital in these times of generally weak demand.

2. The invoice discounting sector has been doing counter-cyclically well: too much money is being committed to invoice discounting as reliance on overdrafts and loans retrenches. There is a strong case to be made that much of our SME base is frequently commercial-lending/product heavy and equity underweight.

3. Hence, on a more macro-level, the recession has highlighted this chronic under-funding and the over-reliance on banking products. I have for a long time been considering the differences between good businesses which are the potential recipients of venture capital and those that are not. However one attempts to establish a terminology carries the risk of belittling the latter category. However, companies which are traditionally not within venture capitalists’ radar in fact form a much higher component of our economy than those which do. Hence I have elected to designate the two groups VC-companies and Non-VC companies, relying on a definition which is narrow but which is also non-derogatory.

These things really matter: they help accurately define the nature of the UK’s “funding gap” and they identify where fresh thinking is required within the creation of capital flows.

In the first instance, there are in fact three funding gaps – but there is little funding gap at all in the sense that it is traditionally understood. This traditional understanding is that there is a lack of investment capital directed at exciting, high growth potential businesses.

In a general sense this is simply not so; there is a mountain of capital aimed towards high growth opportunities. However, there are some rarely analysed issues surrounding this resource.

Our own theory of the Quality of Money focuses strongly on:

1. A widespread inability to be able to assess competently very early stage businesses, particularly tech, and thus to be able to utilise risk as an opportunity rather than an absolute barrier.

2. A corresponding predilection for many venture capitalists to act as bankers, seeking to flush sizeable sums of cash through a high growth business already on a steep upwards trajectory.

3. A poor basis for investment, where a genuine co-operation and mutual co-creativity is replaced by hyperbolic promoters in conflict with rapacious investors.

That identifies the first of the three true funding gaps: a shortage (both by region and by quantity) of value-adding VC capable of engaging creatively with early stage projects.

The two other funding gaps inhibit Non-VC projects and businesses. Some of this funding gap in the past may have been filled, at least partially, with bank funding.

The first area is that of seed capital. This is the area in which we remain incredibly weak in the UK – banks were never big on this – and it is an area in which Funding Enterprise is committed to work hard for improvement.

Participation in early stage business remains incredibly elitist. Those who cannot scrape together a Family & Friends round will continue to struggle. Those who do not have assets (usually a home) to pledge against early stage loans will continue to struggle. The banks were in these markets to some extent (whether it was sensible for them to be there at all is another matter) but they are now all-but gone.

Micro-capitalisation and the expediting of non-commercial or less commercial financial support is something which urgently needs comprehensive assessment. The State remains capable of still pouring huge sums into “soft” supports – it needs to get much more focused on the provision of the cash that alone can make certain things possible.

The third funding gap is of development capital for all those smaller, slow or medium growth businesses which make up so much of our economic backbone. Such enterprise includes the likes of a small chain of successful hairdressers, or nicely themed fast food outlets,
which seek to open a new salon or shop, all of them in rented premises. Many people sniff at such businesses getting into the mainstream corporate finance debate…..and that’s half the problem.

Banks do not like these less glamorous, cashflow-backed businesses anything like as much as they used to. Venture capital is never going to go near such sectors. And the new funds which banks have announced for mid-sized development capital will be targeting bigger SMEs and those of a different type altogether. We risk under-supporting whole swathes of viable and sustainable enterprise.

In conclusion, bank bashing is a futile and misguided activity. Sure, they disinvested a bit abruptly from some businesses a few years back. They really do need to complete turning their regional presences around from a sales approach to a much deeper support focus. And they need to be clear and consistent on their own boundaries and to ensure that they are both in a position as far out into the marketplace as is comfortable but also much more vocal about where other provision is necessary.

The government cannot have it both ways, insisting that the banks lend more but also insisting that their rates are low and that their balance sheets are extremely deep and resilient. These are incompatible instructions.

We need to consider where the capital for our recovery and future growth is going to come from. There needs to be more in the corporate finance mix than a mono-focus on the banks. It requires new thinking – and it may, in some areas, require thinking the previously unthinkable.