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CHAPTER THREE: FINDINGS OF THE BUSINESS SURVEY

3.1 This chapter sets out the findings from the survey of SMEs that had reported difficulties accessing finance which was conducted as part of this research. Initially, the survey sample is discussed, detailing the process by which the surveyed businesses experiencing bank borrowing problems were found. This is followed by a detailed profiling of the 39 businesses where the survey revealed bank borrowing problems and a detailed examination of their bank borrowing requirements and the application processes undertaken. There then follows a more qualitative section presenting selective case examples of the different types of projects which required bank funding, highlighting the difficulties experienced in applying for bank finance.

Survey Profile

3.2 The survey was drawn primarily from the 64 cases in the 2006 ASBS (Scotland) survey where respondent owner/managers indicated that they had experienced problems in raising external finance during the previous 12 months and had also stated that they would be prepared to be re-surveyed at a later date (see Table 3.1). Further analysis of these responses indicated that just over half (34) had specifically sought bank finance (23 for a loan, 11 for an overdraft and 2 for a mortgage). Given the relatively small number of firms in this sample that had actually sought bank finance, the decision was made to expand the survey by (i) attempting to survey the remaining 30 cases in order to see whether they had considered using bank finance and actually sought it (perhaps at a later date than when the ASBS 2006 survey took place) and (ii) to include the 26 firms in the 2005 ASBS that had indicated experiencing problems in raising external finance during the previous 12 months and that had agreed to being re-surveyed. In the 2005 ASBS (Scotland) cases, it was not possible to predetermine which firms had actively sought bank finance, only that 16 had been unable to raise any finance, one had raised only partial finance and that nine had raised all of the finance required - albeit, after experiencing some problems along the way. The decision was made to try to interview as many of the 2005 firms as possible in order to find out whether bank finance had been sought and, if so, to then focus more in-depth on these cases.

3.3 The researchers attempted to call all 90 cases from the combined 2006 and 2005 ASBS sample and completed 51 interviews. Of these, 42 (82 per cent) had considered using bank finance and 39 (77 per cent) had actually approached a bank for finance. In the three cases where bank finance was considered, but banks were not approached, this was due to the expense of bank finance (2 cases) or lack of confidence (1 case). It is also notable that a higher proportion of surveyed firms from the ASBS 2006 had approached banks for finance: 83 per cent (31 out of 37 cases) as opposed to just 57 per cent (8 of 14 cases) in the ASBS 2005 surveyed firms that had reported problems in raising finance. In the cases where bank finance was not sought, this was largely due to firms predominately requiring grant finance and in one case leasing finance. These firms were typically seeking grant assistance to help them with staff recruitment and training, purchase of equipment and vehicles and premises improvements. One respondent, the owner/manager of a financial services firm based in a deprived inner city neighbourhood, encapsulated the position of these firms when they stated: " We are a small firm, employing local people in a poor neighbourhood and we feel that the government should provide grant assistance to help us to do this."

Table 3.1 Selection Process for SME Bank Finance Interviews

Notes to table
The sample was only drawn from ASBS firms that stated that they would allow a follow-up interview

The remainder of this chapter focuses on the findings from the 39 firms which actively approached banks for finance.

Profile of Firms Encountering Problems Seeking Bank Finance

3.4 Thirty-nine surveyed firms had approached banks during the 12 months prior to the ASBS (Scotland) surveys and reported experiencing problems in accessing bank finance. Generally, these firms are characterised by being well established businesses, typically employing between 6 and 49 employees, operating in manufacturing, retail and wholesale, hospitality and professional services, trading profitably at above the VAT threshold and seeking growth. These firms are profiled in Tables 3.2 - 3.8 below.

Table 3.2 Sector

3.5 Four broad sectors; manufacturing, hotel and catering, retail and wholesale and professional services, represent the vast majority (94.8 per cent) of the firms reporting access to bank finance problems, manufacturing firms (46.2 per cent) representing by far the largest single sector.

3.6 Comparison with the sectoral breakdown for the 2006 ASBS demonstrates that manufacturing SMEs stand out as disproportionately encountering problems accessing bank finance compared to SMEs in other sectors. Manufacturing firms also exhibit twice the proportion of problems per bank application (30.3 per cent) when compared to all other sectors (15.2 per cent). This may be due to banks being less inclined to lend to manufacturing businesses, possibly indicating a lack of understanding about the technical issues relating to the proposals tabled by manufacturing businesses.

Table 3.3 Locations

3.7 Unsurprisingly, the majority (59 per cent) of surveyed firms reporting access to bank finance problems were located within the Central Lowlands, Glasgow and Edinburgh. A further one third were located in Central Scotland.

Table 3.4 Firm Age

3.8 More than one quarter of surveyed firms (28 per cent) reporting access to bank finance problems were young firms trading for less than five years, with three firms reporting seeking finance during their start up process. However, the vast majority of firms (62 per cent) were well established, with trading records of at least 10 years.

3.9 Comparison with the 2006 ASBS (Scotland) demonstrates that there is a higher proportion of new and young firms trading for less than five years amongst the SMEs experiencing difficulties in accessing bank finance; 29 per cent compared to 11 per cent in the ASBS survey (Table 3.4). Whilst this is not a surprising finding, it might be indicative of a need to ensure that the SFLGS, which since the Graham Review changes now focuses particularly on younger firms trading for less than five years, is used more effectively by bank lenders.

3.10 Forty-one per cent of surveyed firms reporting access to bank finance problems were micro firms with less than 10 employees, whilst only 13 per cent were medium sized, with between 50 and 250 employees.

3.11 Comparison with the 2006 ASBS (Scotland) survey as a whole demonstrates that the SMEs experiencing difficulties in accessing bank finance include a higher proportion of businesses in the small firms' employee range, between 10-49 staff (46 per cent compared with 36 per cent). Indeed, the survey sample contains no self-employed/sole practitioners and is also underrepresented in the 1-5 employee range.

Table 3.5 Firm Employment Size

Table 3.6 2006 Sales Turnover

3.12 The majority of SMEs (59 per cent) reporting access to bank finance problems had an annual sales turnover of less than £500,000 during their most recent completed financial year to 2006. Of these, only two businesses (5 per cent) were trading at below the VAT threshold. Amongst the larger businesses surveyed, a number reported that their sales turnover was considerably in excess of £1 million, with the highest reported figure being £4 million.

Table 3.7 2006 Profitability

3.13 More than three-quarters of owner/manager respondents (77 per cent) indicated that their businesses were making a profit during the most recently completed financial year to 2006, although one in seven respondents indicated that their business had made a loss.

Table 3.8 Growth Seeking in the past Two Years

3.14 The vast majority (82 per cent) of SMEs experiencing difficulties with accessing bank finance claimed to have been aiming to grow during the past two years.

Constraints upon Business Performance

3.15 Surveyed owner/managers were asked about the main factors constraining their firm's sales turnover performance during the last two years. Only one respondent suggested that they did not experience any constraints, whilst one third indicated that they experienced at least two forms of constraint. A diverse range of constraints were mentioned, including matters such as international exchange rates and government bureaucracy.

3.16 By far the most commonly mentioned type of constraint was the requirement for project development finance (27 per cent). Whilst this may be indicative of the sample being drawn from firms that were seeking bank finance, it is also a clear indication that lack of finance was perceived as a major constraint to business development. The other most frequently mentioned constraints included: cash-flow problems (10 per cent); the need for larger, more appropriate premises (8 per cent); staff related issues such as recruitment and training (7.8 per cent); advertising and marketing requirements (8 per cent); and legal issues (6 per cent).

Financial Requirements

3.17 This section examines details of the amount of funding required and the range of finance that was considered and sought by the 39 firms which experienced problems in accessing bank finance. There is also an examination of the processes which were undertaken in attempting to secure finance.

Table 3.9 Finance Required

Notes to table
N=39

3.18 All 39 businesses provided financial details of their proposed overall project costs and external borrowing requirements. The overall project costs ranged from £5,000 up to £80 million for a large capital investment by an oil and gas industry service supplier, with the median project cost being £105,000. Table 3.9 indicates that on average 81 per cent of the project cost expenditure was being sought through external finance, rather than through internal sources such as re-investment.

3.19 Not surprisingly, there is a direct association between the amount of funding requested and the size of the business. Smaller firms with less than ten staff were typically applying for considerably lower levels of external finance (mean £107,250, median £35,000) than those with 10 or more staff (mean £4,578,636, median £275,000). Similarly, younger firms trading for four years or less were typically seeking less (mean £176,182, median £70,000) than their older counterparts trading for 5 years or more (mean £3,722,519, median £90,000).

Table 3.10 Types of Non-Bank Finance Considered and Approached

Notes to table
% of N=39

3.20 Nearly half of the surveyed firms (49 per cent) encountering access to bank finance problems only approached banks for external finance, with almost one third (31 per cent) approaching one alternative type of funding and the remaining 20 per cent approaching two or more alternative sources of funding. The most frequently mentioned alternative sources that were considered and approached were grants and soft loans, these being perceived as less expensive and more affordable options to bank finance.

3.21 Nearly one quarter of businesses considered equity finance, but in three cases this was not pursued because of concerns over the ownership of the business and also because " …venture capitalists are not interested in assisting small businesses seeking less than a million and this represents a gap in the equity market." Whilst this research is concerned with access to bank finance, for businesses seeking a combination of financial options, including bank and equity finance, this perceived gap in the equity market is a concern.

3.22 There was also some fall out between the numbers of businesses considering soft loans and grants and those actually approaching these types of funding providers. This was mainly due to perceptions of red tape, slow processing of applications and the costs of providing match funding in some grant schemes. The leasing option related to acquiring new vehicles and equipment, whilst other types of funding considered and approached related to taking out private (non commercial) loans and mortgages.

3.23 An interesting finding is that only one third of the surveyed firms approached more than one bank, with two-thirds of respondents applying for bank finance only from their existing bank. It is perhaps surprising that so few firms 'shop around' when seeking bank finance, although given the evidence discussed later in this report (see section 6.5) of the importance placed by lenders upon having a relationship with the finance seeker, this behaviour may be entirely rational. There is also a heavy dependence amongst the surveyed businesses on using the two main banks in Scotland.

3.24 Table 3.11 indicates that the Royal Bank of Scotland ( RBS) and the Bank of Scotland (BoS) were by far the most frequently approached banks, representing more than three quarters (76 per cent) of the total applications for bank finance.

Table 3.11 Banks Approached

Use of External Assistance

3.25 Just over half of the surveyed businesses reporting problems accessing bank finance had used external assistance to support their application (Table 3.12). The most frequently mentioned source of assistance was the firm's accountant, which was mainly in respect of providing financial information, such as annual accounts, cash-flow projections and profit and loss scenarios. Business Gateway and Scottish Enterprise were mentioned by one fifth of respondents. Scottish Enterprise was typically approached by the larger businesses which were seeking grant, soft loan and equity finance, whilst Business Gateway was approached by new, young and smaller firms seeking information about funding sources, but also requiring advice with business planning and cash-flow projections. Two of the larger businesses surveyed employed consultants in order to undertake due diligence work required for proposed acquisitions. It is notable that nearly half of the firms surveyed indicated that they did not use any form of external assistance with their applications.

3.26 Personal finance was generally avoided and there is little evidence of the use of external assistance in this respect. Two respondents specifically mentioned using external advice, one from a Citizen's Advice Bureau and one from a bank, with regard to exploring personal finance options. In both cases, this was as a last resort, after failing to secure sufficient business loans from banks and in both cases resulted in taking out a mortgage on the owner-manager's home. This finding is indicative of the surveyed owner-managers' aims to avoid the use of personal finance, particularly mortgages over personal property. Two other respondents mentioned seeking advice from friends and family members, initially with regard to making bank loan applications, but eventually relating to receiving personal loans from those people. In two cases personal credit card finance was used as temporary bridging finance.

Table 3.12 Sources of Assistance

Table 3.13 Types of Assistance Received

3.27 As Table 3.13 shows, the main forms of external assistance reported were for financial projections (44 per cent), such as cash-flow forecasts, and business planning (33 per cent). One fifth of respondents mentioned seeking assistance with finding alternative 'soft' finance options such as grants and soft loans, whilst one in ten respondents mentioned receiving help with interview preparation and coaching for their meetings with bank lending officers. Other forms of assistance included attending business training courses with Business Gateway and advice from a solicitor with regard to business acquisition.

3.28 The surveyed owner/managers were also asked if there are ways in which external assistance, with regard to accessing finance, could be improved. Just under half (46 per cent) of those surveyed suggested that improvements could be made. These suggestions related to five main themes (with the majority of suggestions relating to improving access to grants and soft loans). The most frequently mentioned improvement (7 cases) related to improving access to non-bank finance such as grants, soft loans and equity investment; three respondents mentioned lack of knowledge of where to find assistance; three respondents wanted advice to be "…clearer and more coherent…"; three respondents complained about there being "…too much red tape and hassle involved with grant applications…" and the "…slow procedure of grant and loan applications…"; whilst two respondents complained about the cost of assistance, particularly in respect of professional services such as accountants, where these services were required to support bank loan applications. One respondent, who had spent over £2,000 on accountancy and consultancy services, was particularly annoyed that this had been a bank requirement and that despite complying with this their loan application had still been turned down.

3.29 More than two-thirds (69 per cent) of surveyed owner/managers knew about Business Gateway's services. Views were wide ranging about Business Gateway, with several respondents suggesting that they did not think that Business Gateway was relevant because "…it is for start-ups…", "…only for very small firms…" and "…has no specialist sectoral knowledge or experience." There was also an even split between those that thought that Business Gateway was a "…useful and positively helpful organisation…" which tended to be start-ups and younger businesses that had actually benefited from their services, and respondents who felt that Business Gateway was "…ineffective and a waste of time…", the latter being those who had been unable to obtain grants and soft loans, or who had not recently used their services.

Application Process

3.30 One fifth of the 39 SMEs experiencing problems with accessing bank finance were dissatisfied with their meeting with the bank lending officer, feeling that it had not been as successful as they had hoped. In one case, a respondent indicated that their request for a bank loan had been dealt with by telephone and that they were not offered any opportunity to attend a formal meeting at the bank. This was deemed to be entirely unsatisfactory.

3.31 Generally and from the perspectives of owner-managers themselves, where meetings had not progressed well, this had been due to problems of insufficient trading record and lack of collateral, rather than the presentation of poor business plans and financial projections. Indeed, almost one third of respondents (31 per cent) considered that insufficient collateral and/or a lack of a trading record were the main reasons for failing to obtain a loan, whilst only 18 per cent indicated that they had failed because of a poor business plan or financial projection. Where business proposals were less successful, it is worth noting that manufacturing businesses, in particular, encountered difficulties, in some instances reflecting problems in presenting complex technical development plans. Moreover, some manufacturing owner/managers voiced concerns about the lack of sectoral knowledge of bank lending officers. It was also noted that some more established businesses indicated that they had not been required to present a business plan. Several respondents complained that they "…were never given an adequate or clear reason for being turned down."

3.32 Some owner/managers were either unable or unwilling to put their own money, or business funds into the projects for which they were seeking bank finance. This is highlighted above (Table 3.9) where it was demonstrated that on average 81 per cent of project costs were sought from external funding sources, including banks. To some extent this related to new and younger businesses where respondents were unable to invest their own personal funds and unwilling to obtain external funds which required taking security over their personal property and possessions. Several respondents mentioned that "… the bank required an unreasonable amount of security…" with one respondent condemning their bank for requiring "…a ridiculous 130 per cent security for the loan, based on my home …. this was outrageous and entirely unacceptable…" Some respondents from more established firms were unwilling to use internal funding resources due to the impacts that these might have on cash-flow, other project development work and contingency funding requirements.

3.33 Around one third of owner/managers were satisfied with their treatment by the banks, whilst the remaining two-thirds were dissatisfied, making a range of criticisms. Table 3.14 below summarises their main complaints and indicates that delays in the decision making process were particularly problematic, affecting one fifth of businesses. In some cases these delays led to lost business opportunities, such as the failure to secure acquisitions. These owner/managers were at pains to stress how disappointed they were with the bank's tardy approach. One respondent stated that; "Banks keep putting up barriers and objections and you just have to keep battling away and stick with it, until they give in to you." Another respondent stated that "…we first made our application thinking that we would be able to secure the funds within a couple of months, but it dragged on for more than six months and it almost killed the deal."

3.34 Nearly a quarter (23 per cent) of owner/managers complained that that the bank lending process was either confusing or misleading. Several mentioned attending meetings with local bank staff who gave an impression that the application would be successful. However, when these loan requests were referred to more senior staff, centrally within the bank, they were refused. Several respondents complained that overdraft facilities, which they believed would be made available, were withheld or not offered. This was highly problematic for new businesses and buy-outs in sectors such as retailing and hospitality, where stock purchase is essential and can lead to initial cash-flow difficulties in new businesses. One respondent, who had taken over a bar and restaurant in Edinburgh, recounted how their bank had not provided them with an overdraft facility from the outset, despite being promised this service; "…we needed to order products and our request for an overdraft of a few thousand pounds was rejected. We were staggered, as this had been promised and we had to borrow the money from our family just to get by. It could have bankrupted us from the start!" Confusion also occurred where the banks' lending requirements were unclear. In one case a commercial loan was restricted to around two-thirds of the amount requested and the remainder had to be sourced via another lender. The bank did not specify how this should be achieved and the owner/manager resolved the matter by taking out a personal loan with another high street lender.

3.35 The lack of linkages between banks and other lending options, such as equity investment and grants was also highlighted as a shortfall in the banking service. Three respondents specifically mentioned the lack of knowledge and understanding of their business activity within the bank. One tourist related business in Aberdeenshire complained that local banks only understood the oil industry and "…it was only when we referred our loan application to the neighbouring region that the banks showed an interest in our proposal." Two respondents mentioned the expense of the application process, particularly with regard to requirements for professional services for due diligence and accountancy, relating to business acquisitions.

Table 3.14 Main Complaints about the Bank Lending Process

Funding Secured

3.36 The surveyed owner/managers were asked about how much funding they were actually able to secure, including bank borrowing. Overall, funding was secured by 26 out of the 39 surveyed cases (67 per cent) that reported difficulties in obtaining bank funding. However, less than half (46 per cent), just 18 cases, actually received bank finance. The amounts received varied from £5,000 to £32 million, but the median value was £125,000 (Table 3.15).

3.37 Surveyed owner/managers were asked how long the process had taken, between first approaching the bank with their initial application and finally receiving a decision about the finance applied for. Eight respondents were unable to answer this question, perhaps in part due to the ongoing nature of their applications.

Table 3.15 Overall Funding and Bank Funding Received

Notes to table
N=18

3.38 What is striking about the findings recorded is that more than two-fifths (42 per cent) of respondents indicated that the process had taken more than 6 months, with two respondents indicating that the process had taken at least two years. Although the majority of these longer cases were unsuccessful, this is indicative of the difficulties that the owner/managers have faced in trying to obtain bank finance. Several commented on: the "unwieldy process"; the considerable number of "objections and obstacles" that arose; the "delays in waiting for centralised decisions", which were frequently different from what had been indicated by the local lending officer. There were also complaints about the lack of overdraft facilities or the delays in putting such facilities into place and sometimes this was the only form of bank funding that was received.

Table 3.16 Time taken to receive Bank Funding Decision

Notes to table
8 respondents were unable to provide an answer

3.39 More than half (56 per cent) of the surveyed businesses that had been seeking bank finance were able to undertake the whole of their proposed project. This included five firms that did not eventually receive any bank finance. A further one in eight respondents stated that they had been able to proceed with their project, but that this had been scaled down according to the level of funding raised, whilst almost one third stated that they had not been able to go ahead with their proposed project in any form.

Table 3.17 Impact of External Funding on Proposed Project

Views on SME Relations with Banks

3.40 All of the 51 surveyed SME owner/managers ( i.e. those who had difficulties accessing finance generally) were asked for their views about the relationship of banks with small businesses in Scotland. The general consensus was that "…the banks could do a lot more…" and that they "…do not understand the needs of small businesses…" The main findings were:

• More than two thirds (68 per cent) of respondents felt that their banks had been unhelpful.
• 72 per cent stated that banks should offer a broader service for SMEs as well as providing finance.

3.41 These findings are, perhaps, unsurprising, given that a majority of these firms were unsuccessful in their applications for bank finance. Whilst some respondents were satisfied with their banking experience and mentioned that they could receive a range of helpful services from their banks, overall, there is a clear message that the banks could do more.

3.42 The main complaints levelled at the banks related to the length of time taken to provide decisions on funding applications. Several respondents complained about the amount of bureaucracy involved, mentioning "…seemingly endless requests for further information and details…" and the "…huge amount of paperwork involved in the process." There was also reference to the "… mixed and conflicting signals received…" between local bank staff and more centralised decision makers within the bank. This led a couple of respondents to suggest that there should be a return to more autonomous local bank lending officers, more akin to "…the old fashioned local bank managers." Several respondents also mentioned that the banks were unsupportive of small businesses and new start-up firms' cash-flow issues and had caused considerable difficulties by refusing to offer relatively small-scale overdraft facilities. A couple of respondents complained that the banks charge too much, particularly with regard to overdrafts, although others did mention the benefits of free business banking services, typically received during the first year of service. There was also a general consensus that the banks should be better at giving advice, which is highlighted by the responses relating to what services the banks should offer.

3.43 The surveyed owner/managers were asked what services, other than the provision of finance, banks should offer. Table 3.18 demonstrates that the most frequently requested service was generic business advice, which was particularly pertinent to very small businesses and new and young businesses. These respondents presented the idea of the banks giving them a broad business service, in return for their custom and felt that they could benefit from developing a closer rapport with a specific person at the bank. To some extent this type of service is already provided by some banks in the form of business relationship managers, but these are not always locally based in the manner of the 'traditional local branch bank manager'. Other more specific forms of advice mentioned related to business planning, financial planning and start-up/new start business assistance. In this respect, there is perhaps a role for banks to direct their customers to Business Gateway for this type of advice.

3.44 Nearly a fifth of respondents mentioned that it would be really helpful if the banks were more integrated with other forms of finance and could act as a type of 'one-stop-shop' for sourcing funding. In this respect, some respondents mentioned linkages to venture capitalists, whilst others mentioned access to grants and soft loans. Some of these respondents' views were compounded by the failure of Business Link and Scottish Enterprise to assist them in finding additional funding to augment their bank loan applications. Three respondents mentioned that banks should have sectoral specific knowledge. This response is more about banks needing to exhibit a better understanding of the requirements of businesses in particular sectors, rather than a desire for sectoral advice.

Table 3.18 Additional Bank Services

3.45 To summarise, therefore, the key findings of the analysis of the 51 interviewed SMEs that experienced problems in accessing finance are that:

• They were generally well established businesses, although there was a high representation of younger businesses ( i.e. less than five years old) than in the ASBS (Scotland) survey panel as a whole.
• Manufacturing SMEs were more likely to experience problems in accessing bank finance than their counterparts in other sectors.
• Typically four fifths of the cost of undertaking investments was sought from external sources.
• Bank finance was secured by just under half of the businesses survey (46 per cent) and in five of these cases (13 per cent) funding was less than had been expected and the proposed project had to be reduced in scope.
• In five cases where bank funding was secured, there were considerable delays of over six months, in receiving bank finance.
• The majority of SMEs do not 'shop around' for bank finance, with only a third of surveyed firms approaching more than one bank.
• Only one third of the SME owner/managers who had experienced problems of accessing finance said that they were satisfied with their treatment by the banks.

3.46 The next chapter takes a more qualitative in-depth approach to examining specific case examples where bank funding problems may have exhibited an element of market failure on the part of the banks.

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