Black Country Businesses suffer due to shortage of Equity Capital

Q: Are Black Country businesses failing to grow and develop due a shortage of Equity Capital in the Region?

Tony Seaton, Associate Director, Blue Sky Corporate Finance explains why he believes this to be the case and suggests possible solutions that could be adopted to overcome it:

Although there are several areas to which this issue applies, Tony believes the two most affected sectors are the Start Up business and the established manufacturer.

Start Up businesses have historically been a high risk sector and have been supported by a combination of the Business Angel Networks and part public funds, such as the Advantage Early Growth Fund (AEGF).  Whilst the Business Angel Network in the Midlands is active it is still a relatively scarce resource and the returns requested by investors can often be quite daunting.   This is a sector which is of little interest to debt providers, unless there is significant security, which is rare, and it is not anticipated that this position is likely to change in the very near future.   Tony believes a possible solution to this shortfall would be to establish a local fund specifically aimed at investing in Start Up businesses.  The “Fund” could invest up to £250K in the businesses, with some form of matched funding, by the way of the owner/3rd party investor.  Given the high risk nature of Start Ups it is considered that some element of public/ European finance would be required to establish such a fund and would need to work alongside the Angel networks.

Likewise, established manufacturing businesses are not immune from this lack of available investment.  In the past this sector has been serviced by the banking sector, and expansion opportunities funded by a combination of asset and cash flow lending.  Whilst the asset based lending market has remained fairly consistent during the past few years, the access to cash flow funding for SMEs has become much more difficult.  The Government introduced the Enterprise Finance Guarantee Scheme in an effort to service this gap, but for numerous reasons this has not been the success that was anticipated.  This has lead businesses to seek other forms of finance to assist growth, finance increased working capital requirements, by way of grants or equity finance.

Typically SMEs looking to expand/invest in new facilities need to raise finance of between £50K – £1M, whereas SMEs requiring investment for a possible acquisition of a new plant, new tooling etc are looking for investment in the region of £100k – £1m. At the lower end of the market, Community Development Finance Institutions (CDFIs) have filled this gap but funds are limited and have a  relatively low ceiling of £50K-£100k.

The government have recently announced several new initiatives to help SMEs raise investment finance but they are not without their limitations and a general lack of awareness in the business community.

  • NatWest/RBS and HSBC have been allocated £95M nationally to provide grants of up to 20% on investments where the company is unable to fully fund deposits/projects.  This scheme is likely to be exhausted very early and other grants at a significant level are very scarce.
  • The Advanced Manufacturing Scheme is a £25M Regional Growth Fund initially established by a combination of LEP’s, including the Black Country, to support the automotive and aerospace supply chains.  This has now been expanded by BIS into a national £125M scheme and it is vital Black Country businesses are fully aware of this scheme and supported in making applications.
  • The Steel Enterprise Fund, offers both loan and equity finance from £50K – £750K and has made a number of significant investments into Black Country manufacturing businesses in recent years.  However, there appears to be a lack of knowledge of this fund locally.

Other than those mentioned above there are very few funds which operate in the Black Country at the sub £1M level, highlighting the urgent need in the current difficult economic conditions to find a way to support businesses in the Black Country gain easier access to finance.

So, what could the possible alternatives be?

Tony suggests some form of Black Country/Midlands Manufacturing bank, which understands the dynamics and needs of a typical Black Country SME.  These businesses would need to be both profitable and cash generative, but should not realistically be expected to generate the returns expected by Venture Capitalist.

Black Country manufacturing businesses have traditionally had a reluctance to take third party equity and release some control.  Therefore, the solution needs to be a combination of equity and loan funds and the Fund should be controlled by local people/organisations which have experience in the region at SME level.

It may be necessary to give stakeholders differing rights with regard to repayment, security etc to ensure the particular lenders needs are met.  Ideally, the loan range would be from £100K – c£1M, with the characteristics more of a Mezzanine loan, rather than traditional banking.

The Equity funds should seek to achieve lower returns than traditional VC’s, but should still be able to show double digit returns, possibly by way of dividend policy/redeemable shares to avoid the issues historically seen in the Black Country.

These proposals would also benefit from the provision of knowledge capital in the form of non-executive directors working alongside the businesses where investment is made by the new manufacturing bank/equity fund.

With some thought and ingenuity, it is possible to find creative alternative ways to raise capital and support the regions manufacturing businesses.