PLUGGING THE FINANCE GAP – with Big Innovation Centre’s Entrepreneurial Finance Hub

As it stands, there is a significant finance gap at the bottom of the funding escalator for firms with an ambition to grow. As the idea for a firm comes together, initial capital usually comes from the personal funds of the owner (such as through savings or re-mortgaging a home), in addition to contributions from friends and family. As the idea develops, the firm gains access to business angels and early stage venture capital funds, but their availability is limited. If the firm manages to become a start-up, it can then access bank loans and overdrafts. However, as we previously explained, these bank services can be difficult to secure – especially for firms with the greatest potential for growth.

Only a few firms will succeed in getting past this stage to receive venture capital. However, it is crucial to point out that a firm which does not gain access to further finance may very well have considerable potential to grow. As we put forward in our previous blog, our research on finance has shown that a tiny proportion of the capital raised in the UK is invested in innovation. SMEs are a vital part of our economy, but our research shows that innovative SMEs find it harder to access finance than other firms, and this has only worsened since the financial crisis.

Traditional banking business models are currently failing to accurately value the intangible assets (such as specific knowledge, brands, human and organisational capital, and intellectual property) which drive growth and job creation in modern, and particularly young, SMEs.

This is unsustainable. We believe that the services offered by banks can evolve to ensure that they better support our economy.

The long-term solution will lie in the evolution of how banks make money. Banking business models are responding to the reality of a modern intangible asset based economy. However, in new markets such as peer-to-peer lending, banks are emerging too slowly and could easily lose out to new, more innovative, businesses.

In a data-driven economy, banks are increasingly positioning themselves as knowledge-intensive service providers. Information is becoming increasingly valuable and banks could use this opportunity to expand their role in the financial ecosystem. By becoming value-added information brokers, banks could substantially increase lending to fast–growing, innovative firms and sectors. We would need to find new ways of valuing innovative business models based on intangible assets, and new alternative financial platforms and instruments to finance these business models. Alternative lending instruments such as peer-to-peer lending and new financial products tailored for young and growing SMEs could be the disruptive technologies to drive this change in banking business models.

Our research identifies three potential policy prescriptions to address this problem:

New and better ways of valuing innovative and knowledge-based businesses to grant them access to finance. Big Data will play a decisive role in valuing IP and intangibles and companies like Inngot are already helping firms value their IP, which will help them with both debt finance, by properly valuing intangible collateral, and with equity finance, by getting an accurate value of the business;

More angel and seed funds towards the bottom end of the funding escalator, as equity financing is better at valuing innovation and intangibles. Some initiatives are already helping to fill the finance gap outlined above, such as Enterprise Capital Funds. These Funds use both government and private sector resources to establish funds that operate within the ‘equity gap’; targeting investments of up to £2m that have the potential to provide a good commercial return;

Innovating banking business models such as new platforms-as-a-service business models for finance, and alternative financial technologies such as mezzanine finance(look out for a blog on this later this week) and ‘Flexible Project Investments’, to foster innovation and growth.

We don’t deny that there are many challenges to overcome if we ever want to see a financial system which supports innovation every step of the way. There will be a number of practical issues to address, some of which we have looked at in this blog, as well as some tough policy questions to answer. Nevertheless, tackling these issues is absolutely necessary to taking our economy forwards and we believe it is an ambitious but achievable goal. If we as a country are serious about returning to growth, this topic should be of upmost importance to our financial policymakers.