The Dirty Secret of Credit For Small Business: the Failure of the EFG Scheme

26 OCT 2009

In his speech last week at Thomson Reuters, George Osborne asserted that there are two issues holding back UK business: credit and confidence. I could not agree more. Whilst he did not touch on what he might do about confidence, I think that in the context of existing small businesses and potential startups, the best way to increase confidence is to reduce real risk. And we can decrease risk by improving the skills of our entrepreneurs so that they make fewer mistakes. Its about education.

As for credit, well, that’s another kettle of fish entirely. Anecdotally there is no doubt that it is more difficult for small and young businesses to get commercial credit, ie loans. Mind you it has alway been difficult and probably rightly so. Commercial and retail banks (the kind that take deposits and lend it back out using the spread to make a profit) have historically been conservative lenders because the margin of profit has been slim. Working on a spread of less than 10% they cannot afford for loans to go bad, or if they do, for there to be no way to recover their money.

Thus, they have historically been asset-backed lenders; that is they have always looked for assets worth the value of the loan to secure the loan in case it went bad. That could be machinery in the business, or your family home and a personal guarantee. I have never had a problem with this given how little they make on the money they lend. But it does make commercial lending inappropriate for young businesses, most high tech businesses and many small businesses without hard assets.

The logic of the Small Firm Loan Guarantee Scheme (SFLGS) which was recently renamed the Enterprise Finance Guarantee (EFG) has always been sound: if a firm could show that it could service a debt the government would step in and provide up to 75% of the asset backing, thus broadening commercial lending to those firms that were cash flow positive or could become cash flow positive, but did not have adequate assets to support the loan.

It is a shame then that the banks have used the EFG primarily to reduce their risk to lend to firms that they would otherwise have already lent to rather than broaden the scope as the scheme was intended. How do I know? Because I have repeatedly sent companies I have invested in, or mentored, in pursuit of loans and in each case the banks involved have always looked for the firm to have assets or guarantees that covered not only the 25% of the loan that was at risk, but the 75% that was not at risk. They justify this on the grounds that they “do not want to have to go to the government after the other 75%.” Meaning, in simple English, that they want the firm to have precisely the same lendability criteria it would have if the scheme didn’t exist!

Thus, when George Osborne calls for a national guarantee scheme, I begin to think that we are merely reducing the risk of the current portfolios of the banks. Perhaps we should look for remedies that don’t involve the banks at all. Perhaps we should be looking for means of encouraging people to directly invest or lend to small or young businesses. What we shoulld do and how we should do it is for another post but I will say one thing. From the front lines, it is perfectly clear that these schemes, under their old name or under their new name should be called RBR Scheme, because Reducing the Banks Risk, is all they really do.

I am holding a full day workshop on November 18th in London at the Royal Institution. It’s called Find, Pitch & Close: The Art of Securing Investment. In addition to looking at the various government schemes that work (or don’t), we will be working through the ways you can really raise money, and what you will have to do to get it. If you are interested, just go here to sign up:

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  2. Maybe we should set-up a micro lending/investment scheme so popular and successful in developing countries. I’d certainly be willing to invest SMALL LUMPS of money to start-ups with potential which wouldn’t mean I was risking my mum’s retirement fund!


  3. Exceptional post. I work in the US and the situation here is not much different. Programs designed to work with banks to make loans more available to strong small businesses never seem to work out that way in the aggregate.

  4. We work with a lot of London-based startups and have found the Enterprise Finance Guarantee scheme to be more of an exercise in time wasting and frustration than a viable credit source.

    My feeling is that a separate, designed for purpose government funding body that is not administered by banks is what is required.

  5. We have tried to go through the EFGS for finance. One bank, Natwest, wanted us to go 50/50 on the amount we wanted to borrow, which was completely pointlless and then tried to get us away from the EFGS and put us onto asset lease with a 2year repayment plan.

    We have a bank (HSBC) now willing to back us, but the process is so long winded and drawn out, it makes me wonder if the bank actually wants to lend under the scheme. We have found our subsequently that banks will only lend around 15% of their lending book to the EFGS.

    It didnt matter that we had a £15,000 grant to cover the first 18-24months of repayments plus a business making a profit, the process is on a go slow!

    Very frustrating!!

  6. I couldn’t agree more with what is being said here.

    Banks are out to make money and I’ve not got an issue with that. However, most banks if not all will close you down without a second thought and not lose an hour of sleep over it.

    Why on earth the government (read tax payer) bailed them out to the tune of £850B I have no idea. If that were you or me we’d have been flushed down the pan along with hundreds of other “small businesses” (hate that term).

    I guess up to now I’ve been lucky in not having to borrow anything in the 8 years I’ve been in business but boy “the times thay are a changin” as Bob Dylan would say.

    Just like to add a Merry Christmas and Happy New Year to everyone.

    ATB, Paul

  7. Great post! keep them comin… thanks for all your hard work.