By Dominic Buch, managing partner and co-founder, Caple
UK productivity has been stagnant since the financial crash, leading to concerns of a ‘lost decade’ for both businesses and workers.
Helping small firms grow into mid-sized firms would boost productivity across the economy. But for many of these firms to grow, they need access to appropriate forms of funding, and that is not as straightforward as it should be.
What’s the issue?
Productivity, measured as output per worker, is the main driver of long-term growth and higher living standards, yet its growth has stalled over the last 10 years.
Figures from the Office of National Statistics (ONS) show that labour productivity, as measured by output per hour, for July to Sept 2019 has risen by just 0.1% compared with the same quarter in 2018. This follows four previous quarters of contraction.
The causes of this lack of productivity growth are complex and numerous. However, that so many small firms have not grown into mid-sized businesses is one clear explanation for such lacklustre growth.
The UK is a nation of small businesses. It would do much better as a nation of small and mid-sized firms. In 2018, of the 1.14m businesses trading in the UK, 1.13m had between 1 and 10 employees. Only 35,000 had between 50 and 249 employees. Large companies with more than 250 employees make up a fraction of the total with just 7,510 firms. But these small businesses make a significant contribution to the economy, employing 60% of the private sector’s workers and accounting for 52% of its turnover.
The impact on productivity
Importantly, the data shows different levels of productivity by size of business. Workers at firms with fewer than 10 employees each produce £51,000 of output. Medium-sized firms with 50-249 workers produce £81,000 – or 60% more. So significant productivity gains can be achieved by growing small firms into medium sized firms.
However, whilst the UK is good at starting businesses, it is less successful at helping them grow. The Scale Up Institute, a think tank, estimated that in 2016 just 13,665 business in the UK increased headcount by more than 20%.
How can we better support small businesses?
Investing in skills and infrastructure and lightening the regulatory burden on businesses is part of the solution. However, access to the right kind of finance is key to solving productivity. It is that which helps small firms become medium-sized businesses.
Unfortunately, too many small firms struggle to grow because they are unable to raise suitable finance, which hampers their productivity.There is a funding gap both in terms of the size of loans, often between £0.5m and £5m, and type of loan, growth finance, in the SME lending market.
Micro businesses can increasingly access finance from peer-to-peer platforms. These platforms have automated the process, lowering the cost of lending. Larger businesses, or those with assets, are well served by banks where the return on the loan will justify the likely costs involved.
The significant issue is for growing businesses, the ‘missing middle’, which need to borrow between £500,000 and £5m and do not have assets to use as security. This is because while banks can fund an amount that reflects the tangible assets in a business, they can’t help if a business has no further such assets to borrow against.
For these slightly larger and more complex SMEs, the lack of genuinely unsecured lending is a significant barrier to growth. So the lack of unsecured lending in an asset light, service-based economy such as the UK also holds back overall productivity.
Lending that is fit for purpose
To tackle productivity, growing firms need lending that is fit for purpose. Lenders should not focus on a business’s physical assets. Instead they should look at the future of an individual business and assess what cash flows it will generate.That is called “unsecured lending”. It will help small firms become medium-sized businesses and boost productivity across the economy.