Entrepreneurs should rely on investors, not banks’

START-UPS and growing small businesses should reject bank debt as their main funding because of the significant burdens and risks, the head of the London Stock Exchange has warned.

Xavier Rolet, chief executive of the LSE, instead claims a “diversified funding ecosystem” involving investors taking medium-term stakes in innovative businesses could better boost SMEs’ export prospects in booming markets such as Asia.

Rolet, ahead of a speech to the Asia Scotland Institute later this month, said: “Bank debt is the wrong way to  finance small businesses, and start-ups in particular.

“You need medium-term funding provided by investors to get things going when an innovative business star is born. Bank debt is wrong,  say, for an academic leaving a university such as Edinburgh, Durham or wherever, with a good business idea, because they have to pay interest and provide collateral upfront.

“They cannot afford to start paying interest right away, and the only collateral they have may be their house. That makes bank debt unsuitable for many entrepreneurs.”

Rolet said such funding was also risky for the banks because they could only get fixed, capped interest “200 or 300 basis points above a benchmark such as Libor, when it is well known one in three start-ups can go bust in the first three years regardless of the quality of the idea or management”.

By contrast, the LSE chief, whose Aim market for smaller companies is booming, said medium-term investors were better prepared to take on the risk inherent in new businesses “because they have unlimited potential upside”.

He cited the fact that 20 to 25 per cent of corporate funding in the United States is from bank debt, compared with 75 per cent in the UK and Europe.

Rolet said a “funding ladder” including institutional and private investors, financial market players and potential international partners could also unleash the export potential of small businesses.

He said that typically small businesses only received 30 per cent of their revenues from exports, but that this rose to nearly 70 per cent when they floated on the stock market.

“They acquire the means to tap into new exciting markets such as Asia, and it can have a huge impact in terms of new business and job creation,” said Rolet, who took over the LSE helm in 2009.

Asia, he added, was an increasingly sophisticated consumer market that was keen on “high-end engineering” and luxury products such as Scotch whisky.

He is expected to tell the audience at his speech that the abolition of stamp duty on Aim stock transactions from this April has created “a completely different ball game. Even since last August we have seen a near-200 per cent increase in traded retail volumes on Aim-listed companies.”

Rolet speaks at the University of Edinburgh Business School on 29 January.