At the start of March, the British Business Bank (BBB) published here its annual Small Business Finance Markets Report for 2022/2023 (Report). The Report contains a wide-ranging and deep analysis of data covering all aspects of debt and equity finance, and trade financing, available to SMEs throughout the United Kingdom, as well as focussing on two key strategic objectives of BBB: innovation and “Building the Modern Green Economy”.

BBB operates throughout the United Kingdom, is UK -Government-owned and funded. Until February, BBB fell under the responsibility of the Department for Business, Energy and Industrial Strategy (BEIS). With the recent dissolution of BEIS, BBB is now the responsibility of the Department for Business & Trade, remaining ultimately UK Government owned.

BBB does not lend directly, but through financial partners covering the full spectrum of financial institutions from banks to asset financiers to venture capital funds. From its inception under the Conservative/LibDem coalition government of 2010 – 2015 this has been the approach of BBB, with its aim being to increase the supply of funding to the SME market through the unlocking of significant funds to the market. Now, BBB is one of the levers that the UK Government can use in this market alongside other government backed institutions including the UK Infrastructure Bank, Innovate, the various Enterprise bodies, and the Scottish National Investment Bank.

Key Lending Trends

Some of the key findings of the Report were:

• gross bank lending (excluding overdrafts) to SMEs in 2022 rose 12.8% on 2021 levels to £65.1bn. This is second only to 2020 lending levels, where Government-backed Covid-19 loans heavily skewed the lending market;
• 55% of that gross bank lending to SMEs was by challenger and specialist banks, the highest nominal amount ever;
• despite a strong start in both Q1 and Q2 2022, the second half of the year saw markedly declining investment activity, coupled with an expectation from 41% of BBB market survey respondents of a continued decrease in early-stage finance in the next 12-18 months;
• “innovative” SMEs accessing finance (66%) outnumber SMEs as a whole accessing finance (58%); and
• equity deals in the net zero market outpaced those in the wider equity market: +33% versus -2%, Q1 – Q3 2022 compared with 2021.

The Report identifies a number of macroeconomic factors – the Russian invasion of Ukraine, Bank of England base rate rises, the impact of the mini-Budget in September 2022 – all of which caused drag on the UK economy. When taken together with sharply-rising inflation and predictions of recession, this suggests ongoing weakness in business investment, with the Q3 2022 equity market decline indicating this has already begun.

In addition, the Report details a sharp rise in new business in the SME asset finance market, with an 11% increase in 2022 following a rise of 24% in 2021. Set against this, though, are ongoing supply chain issues in certain asset classes, increased costs, and increased interest rates, all of which have the potential to impose drag on this market in the coming periods.

Key Scottish Trends

The Report does not contain a regional breakdown of the SME debt financing market, but does for SME equity financings. Scottish equity financings outperformed the UK equity financing market as a whole, with Q1 – Q3 2022 showing a 26% increase in the value of completed equity financings year-on-year. At the same time, in Scotland the number of completed equity deals fell by 15% mirroring the wider trend towards fewer, but larger, equity financings.

Other findings in the Report show Scotland with a below average business density when compared to the UK as a whole. In addition, the Report saw a substantial decrease in the proportion of SMEs considering using external finance (33%, down from 44% in 2021). Successful SME funding applications also fell to 64% from 80% of all applications previously. Although not split out regionally in the Report, the effect of these trends is likely to have been felt by Scottish SMEs similarly to SMEs in other regions of the UK.

Innovation and “Building the Modern Green Economy”

The outlook for innovative SMEs and particularly those SMEs working on climate solutions may be somewhat rosier. The Report found that while UK SMEs lag behind SMEs in other G7 nations in adoption of innovation (with UK SMEs sitting in “mid-table obscurity” in 4th place in the Global Innovation Index), economic growth depends on innovation. It is also clear from the data in the Report that UK SMEs further lag other G7 nation SMEs in actually “being innovative” (43% of UK SMEs versus 79% of Canadian SMEs, for example). In terms of numbers of “innovative” SMEs needing to be created in the UK, this is vast, with a further c. 440,000 SMEs required to reach the average of this metric.

In this context “innovation” can be hard to pin down. The Report considers both “new-to-market” and “new-to-business” innovation in this light and is clear that both must be supported to feed economic growth. SMEs should therefore think of innovation in this broad sense. Not necessarily: “what can I do to innovate?”, but, “how can my business prosper from innovation?”. In other words, it is not simply the case that SMEs must offer, for example, innovative R&D-led products, but that SMEs should also ask themselves what innovative practices/products/services they can adopt and, also, and perhaps more straightforwardly, how can I run my existing business more innovatively?

The Outlook for Scottish SMEs

BBB in Scotland is a strong and established route to all types of financing for SMEs. Its presence is well understood and well-integrated within the broader financing community. Given the Report’s findings around the barriers to accessing finance that SMEs regularly experience, having this established additional route to finance can only be to the benefit of Scottish SMEs.

There can be little doubt that the current wider economic situation and outlook present serious headwinds to SMEs, as they do to the whole of the economy. The Report suggests that SMEs are already experiencing the effects of those headwinds. So where can SMEs find a safe harbour from these challenges, and what should they be doing differently?

SMEs need to be agile in considering financing. The Report contains evidence of perceived reluctance amongst SMEs even to contemplate financing – only 33% of SMEs were using external finance in Q3 2022 and 51% of SMEs were considered “Permanent Non-Borrowers” over the same period. Although the Report is careful not to draw a direct correlation between use of finance and economic growth, it does contain evidence, noted above, that shows innovative SMEs (in the widest sense) as being proportionately more likely to use external finance. And that means external finance in all its forms. With constrained activity and, potentially, strained financial resources due largely to rising costs, SMEs seeking external finance should widen their search to include non-traditional sources. SMEs should consider grants, asset finance, overdraft lending as well as more traditional term loans from both established lenders and, increasingly, the challenger banks. Aligning all sources of financing with a net zero strategy should be a priority for SMEs. This also should be considered broadly by SMEs, both those offering net zero solutions and those whose business can grow by the adoption of net zero solutions.

Searching out a mix of financing more broadly, whilst focussing on how finance can assist innovation and contribute to the just transition to a green economy, should be the focus for SMEs.