Saturday, 4 October 2008

European small business fund

There's a proposal today for a £12bn "small business fund" to help companies across Europe through the current crisis. As owner of a small business, I would naturally be grateful for access to such a fund - but is it economically sensible? Let's look at how it could be structured to make the most impact with the minimum of interference with market mechanisms.

  1. Access to credit. Probably the most obvious area where small companies may be suffering in the current environment. This has always been a constraint for small businesses, and the UK government already has a good system to address it - the Small Firms Loan Guarantee Scheme which guarantees loans by banks to small firms. It was expanded in the 2008 Budget and the criteria for accessing it were relaxed. The economic justification? First, that the external returns to the economy for supporting the foundation of new businesses exceed the risk-adjusted returns available to capital. So if the Government can help me get a £20,000 loan to start a business, the knock-on effects in employment, innovation, competition and tax revenues will be much greater than the risk the government takes by insuring the loan. Second, that the market is illiquid - because the resources that the banks have for evaluating, funding and securitising corporate credit are expensive, and geared towards multi-million pound credit lines or corporate bonds - and are not worth applying for small loans. The state can intervene to open up this market and reduce transaction costs.

    In the current credit environment, these problems are exacerbated. Although an accountant did tell me the other day that the banks, unwilling to lend to each other, are keen to lend to quality corporate borrowers instead. I'm not sure how accurate that is - the banks are clearly keener to lend to the ECB than to corporates. A version of this scheme across Europe therefore seems to make sense.

  2. Anti-contagion. There are lots of businesses which depend intimately on each other for income, with lots invested in complex supply chains and 'soft intellectual property' built into their relationships. One example from my own business looks like this:

    Freelance programmer <- Inon <- other software company <- property management company <- management consultancy <- oil company <- petrol retailer <- consumer If any one company in this chain has liquidity problems, all the others below it will suffer. Some of them are operating on a thin equity base (very common in small businesses which tend to reinvest most of their profits) and so they could be at real risk. Naturally, if any of these businesses lose their clients and are not viable, they should be allowed to fail. But if a business fails for the sake of one or two months' revenue, thus destroying several years investment in intellectual property, training, employee and client relationships, this is wasteful. The intellectual capital and goodwill invested in many of these businesses is not recoverable in a liquidation, so a solution that allows survival in some form is economically preferable. How could this work in a government-sponsored fund? One way is to provide credit insurance for long-term supply contracts, if it could be implemented with minimal moral hazard. This would allow each party in the above chain (or even just one of them) to insure against the failure of its customer, thereby protecting themselves and everyone below them. Another mechanism is to provide coordination for the pooling of risk. Government could play a role in bringing together several software companies or several property management companies, so that if one comes under pressure the others can take it over or work with it - preserving the intangible investment in each. Naturally the merging companies would need to reduce staff numbers, but they would generally be able to preserve most knowledge within the combined entity. This is exactly what the authorities are doing for banks - could they also manage it for industrial companies?
How far would £12 billion go?

Extrapolating the small business figures from the UK (3 million businesses) to the rest of Europe, we could estimate around 20 million across the EU. (in fact this paper says 23 million)

Around 90% of these consist of just one person - and it seems more logical that the fund would be focused on companies with employees, for political reasons as much as economic ones. So maybe 2 million businesses would be eligible.

Assuming 75% of these do not need any assistance, the £12 billion would be available to 500,000 businesses - an average of £24,000 per company.

While £24,000 on its own would make little difference to the viability of a firm, if targeted accurately it could unlock a lot of private sector leverage. A £24,000 loan guarantee premium would allow a company to borrow £100-200,000 - enough to allow them to invest seriously in marketing, product development or systems for growth. £24,000 of coordination or marketing support might help a company to access 100-200 new opportunities for mergers, other cooperation or new business.

It's hard to know whether government is an effective mechanism for distributing this support, but if the resources are not available from the private sector then it may be a viable alternative.

Edit: it turns out the plan is for early release of a planned £12bn small business fund from the European Investment Bank. Indeed Brown is now requesting the entire £25bn fund be made available. This would be loan money direct to small businesses, so the equivalent of a £48,000 loan for 25% of all businesses in the 27 EU countries - or, say, £240,000 if only 5% of businesses are eligible/apply for it.


Lloyd Sewell said...

The Small Firm Loan Guarantee Scheme is fantastic - if you can actually get it.

Let all all who have tried and succeeded - comment here - those who have not secceeded can also comment - should be interesting.

Leigh Caldwell said...

I have successfully applied for SFLGS twice - although it was over ten years ago. I am talking to my bank just now about another one, so I will let you know.