One of the obstacles that the government will face in turning the UK economy towards growth is in assisting the growth of small and medium size enterprises. The shortage of available commercial lending is felt particularly acutely in the knowledge-intensive, hi-tech, R&D-led sector of SMEs. This is because while it is rich in terms of intangible assets, its relative poverty of physical and cash assets is a barrier to securing financial investment. This is a sector which is vital to future UK competitiveness: long-term trends in advanced industrial economies all point towards knowledge and research-based organisational performance. Innovative industrial policy that can encourage investment in this area is therefore a vital task for government, which could easily take leadership in setting up the market for financing intangible-based SMEs.
As we established in our report, Accounting for Intangibles, current accounting practice does not provide a robust mechanism for quantifying intangible assets such as knowledge, organisational capacity and human capital. In the aftermath of the financial crisis and the difficulties of regulating little understood financial innovations, the prospect of large-scale accounting reform in this area – change that would deliver tangible gains in terms of increased willingness of lenders to lend – seems remote.
What may be more viable are incremental changes that lay the foundations for innovative finance for knowledge intensive SMEs, particularly if this taps into the resources and expertise which already exist in the City of London. One such change could involve setting up a scheme in which a government-backed third party acts as the guarantor, or underwriter, of bank loans and provides assurance to the lending party that the borrower is a worthy investment. The Technology Strategy Board could be utilised to provide a “Quality Mark” of commercial viability for intangible based SMEs, based on an assessment of their growth potential. The Enterprise Finance Guarantee could then enforce this “Quality Mark” as a legitimate basis with which to secure a bank loan, and would provide assurance for banks that the SME has passed an expert test of commercial viability and shows strong potential for profit. This type of scheme has proven itself successful in America, where the Small Business Administration gives state-guarantees to private sector lender, without requiring physical assets on behalf of the borrower.
The expertise for implementing something similar in the UK already exists in TSB and EFG, but at present the EFG requires physical assets to secure its guarantees. Only a small reorientation is required, therefore, to tap into and accelerate the potential development of many knowledge-intensive SMEs. If the TSB took the lead here, it would only have to underwrite a portion (50% to 80%) of any loan, so as to provide guarantees to lenders while not overburdening government with risk. This would establish a market for financing in this specific SME sector, vital for UK competitiveness, and would have the further benefit of leveraging City expertise and innovation in a way that benefits us all.
By our calculations, an outlay of £25 million could easily underpin lending to around 1000 knowledge-intensive SMEs. As the Chancellor looks forward from reducing the deficit to kickstarting growth in the forthcoming budget, drawing on the UK’s innovative potential should be the natural policy choice. In bridging the gap between innovative companies and responsibly innovative finance, the Government can and should take leadership in this area.
(With Andrew Walker and Thomas Jeffery)