Editorial

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Robin Jarvis

The Institute of Small Business and Entrepreneurship (ISBE) have chosen an interesting time to commission some engaging pieces on Finance and the Funding of Small Business in this quarter's Enterprising Matters. The focus of the debate by the Government and the media, as Manos Schizas points out in his piece, is on bank finance and this is reflected in the number of papers that address this funding issue. There is, however, growing evidence that trade credit is more significant in terms of funding small business than bank lending. This is highlighted in the piece by Paul and Boden, which draws our attention to evidence indicating that in fact ‘…trade credit exceeds the primary money supply by a factor of two ….and constitutes about 37% of total business assets’. So perhaps we should be spending more time considering trade credit as the main source of finance for small businesses and explore the consequences of this reality.

In terms of preferences of funding for small businesses we cannot forget Myers Pecking Order Theory, where the evidence from some admittedly limited research over the years, suggests that retained earnings is the first choice of funding for small businesses. The reasons for this preference include the cost being perceived as lower than other sources, there are no transaction costs and there is no interference from external parties. It is interesting to note in the context of retained earnings that since 1997 bank deposits by SMEs have exceeded bank loans for every quarter apart from two quarters in 2007 and 2008 and figures from the BBA for the last quarter of 2010 indicate that bank deposits exceeded bank loans by £7.128.bn. It is perhaps surprising that retained earnings is not given more attention by the research community and other interested commentators.

In this debate on finance and the funding of small businesses we must remember that the aggregate picture of the demand for finance masks the variations between the nature and various sizes of small businesses and their needs. Small businesses are of course a heterogeneous group, not only possessing size differences but also age, sector, location and growth profile differences all of which will affect their preferences for the way in which they will finance their businesses.

But, let us return to the emotive issue of bank lending to small business, Angela Knight in her piece argues that since the banking crisis the position of small businesses has been confused. I think the evidence supports her claim and that the demand for funding has fallen due to the state of the economy. But, the evidence also points to the banks being more risk adverse and as argued by Ciaran Mac an Bhaird for many small businesses they find that the credit markets are illiquid precipitating the closure of many SMEs. The UK Government’s deal with the UK’s major banks to boost the flow of credit to small businesses - Project Merlin is described in Angela Knight’s piece. Whilst two of the other authors are critical of the Project in terms of being a part of a politically motivated agenda that does not fully address the issues, the scheme still has some virtues. From a research perspective for example, the funding by the banks of a large independent survey of SMEs will provide an important source of information to drive this debate and consequently policy measures forward.

Finally, there is no doubt that small businesses are the main source of growth for the UK’s economy. But as Ciaran Mac Bhaird asserts, the development of a vibrant sustainable small firm sector is dependent on sufficient resourcing of SMEs particularly during periods of tightened credit, wisely concluding that the challenge is to create a financing system that responds to variations in the supply of credit.

Professor Robin Jarvis, ACCA and Brunel University