The innovative funding methods Scots small firms are using to grow

It's never hard to find reasons for business to despair in Scotland. Are not the odds stacked against small firms? What of tight-fisted banks, or too much regulation, or lack of available finance? And if these were not enough, Brexit uncertainty abounds.

JON SAVAGE PHOTOGRAPHY 07762 580971 6TH OCT 2015 Kirsty Dunsmore THE EDINBURGH BEER FACTORY BREWERY New Micro brewery I've just opened a new microbrewery in Edinburgh with my family. It's called Edinburgh Beer Factory and we're about to launch our first beer, 'Paolozzi' lager. John Dunsmore, ex-CEO of Scottish & Newcastle and C&C Group, has founded a new craft brewery in his home city of Edinburgh. Combining the 'head' of a career at the UK's biggest brewer with the 'heart' of a family-run start-up, the new brewery will bring Edinburgh inventiveness, open-mindedness and playfulness to the beer scene. Housed in a converted industrial unit in west Edinburgh, Edinburgh Beer Factory is an unashamedly modern, urban microbrewery. For the Dunsmore family, Edinburgh is home and inspiration - the best of Scotland in all its creativity and international outlook - and 'Factory' is a tribute to two 'commercial creatives' and personal heroes, Andy Warhol and Tony Wils

Yet key figures on Scotland’s business base continue to defy the sceptics. Official data shows an estimated 365,000 private sector enterprises in Scotland as at March last year – the highest figure since this time series began in 2000.

And while the pace of growth in business start-ups may have slowed, figures for the year to March 2017 show the number of business grew by more than 11,000 or 3.1 per cent.

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The rise has been driven by small unregistered businesses – those not registered for VAT or PAYE – where numbers rose by 8,700 or 4.8 per cent to 189,200.

From café bars to website designers; micro-breweries to fund managers; bakeries to specialist engineers; digital services to farm shops, whisky distillers to IT upgraders – there is no end to the enterprise and ingenuity of those starting or growing a business in Scotland.

This article appeared in Deals 2018. A digital version can be found here.

And who says small firms don’t matter? Scotland’s 363,235 SMEs provide an estimated 1.2 million jobs and account for 99 per cent of all private sector firms and for 55 per cent of private sector turnover.

So where is the money coming from to finance new businesses and help expand existing ones?

Prior to the 2008-09 financial crisis, the conventional ‘first stop shop’ was a bank loan. But the shutters came down, many firms saw their loans called in and overdraft facilities curtailed or withdrawn.

Bank lending to business has since recovered, helped by the government’s £20.7 billion Term Funding Scheme. But entrepreneurs have increasingly turned to alternative sources while banks have showed continuing caution on lending. The British Business Bank estimates banks reject loan applications from some 100,000 small business each year – representing a funding shortfall of £4 billion.

Banks will lend – and do lend huge sums every year – but in the post-financial crisis environment they are more risk averse and are therefore less likely to back more esoteric start-up propositions.

But young businesses and start-ups looking to raise funding now have a wide range of choices for 
early-stage finance, from crowdfunding and angel investors through to 
government-backed start-up loans and P2P lenders.

Angel investors provide backing for early stage and start-up 
businesses in exchange for an ownership stake. Giants such as Facebook and Uber broke into the mainstream thanks to this mode of business funding.

One major attraction is that angel investors can lend their expertise and experience to younger firms – this can be invaluable. Another is that start-up entrepreneurs can access support without the need to meet requirements for collateral or worry over capital repayment and interest.

If a start-up performs well, both parties would reap the financial rewards. But there has always been a high casualty rate among business start-ups: as a rough rule of thumb, three out of every four fail. So the angel investor is reliant on the fourth delivering a bumper pay-back.

Venture capital funding is a form of investment in early-stage companies considered to have high growth potential in exchange for a partial ownership of the company.

Unlike angel finance from high net worth individuals, venture capital is typically provided by a group of private investors, or specialised financial institutions such as venture capital funds, investment banks and pension funds. The length of the investment varies but generally it is between four to seven years. However, venture capital involvement does involve some loss of management control and stakes in a start-up could exceed 50 per cent.

The British Venture Capital Association (BVCA) estimates that some 3,200 businesses are backed by the industry in the UK, and venture capital money going into technology companies in the UK is at an all-time high.

Then there is crowd funding which has grown in popularity. This typically takes the form of a website platform where businesses or individuals explain their project to attract loans or investment from the public.

There is also government funding such as the Enterprise Investment Scheme (EIS) designed to help smaller, risky businesses raise funding to fuel growth. It was set up to encourage more investors to back fledgling businesses by offering generous tax-breaks. If the business fails, investors can claim up to 80 per cent of the investment as tax relief against their income tax bill.

Government funding can also be channelled through local authorities to ventures that might otherwise struggle for funding. For example, Brodies advised on a £800,000 funding agreement between Linwood Community Development Trust and Renfrewshire Council for the Mossedge Village project, which will provide the community of Linwood with a new football and community facility. Eric Galbraith and Laura Taylor from the Brodies’ corporate team led on the two-tier structured agreement, negotiating on behalf of Linwood to regulate the funds awarded by Renfrewshire Council, which in turn received the grant from the Scottish Government.

Finally there is overseas direct investment as a source of funds. According to figures from the Department for International Trade the UK’s Foreign Direct Investment (FDI) performance in 2017 was solid: the UK attracted six per cent more FDI projects compared with 2016, and retained its place as Europe’s number one destination, with total projects rising from 1,138 to 1,205.

And the latest EY Investment Attractiveness Survey found that Scotland remains the UK’s most attractive location for FDI outside of London. The FDI growth rate in Scotland is higher than across the UK as a whole, while the number of FDI projects have increased. It found Scotland attracted 141 projects in 2017-18, up seven per cent on the previous period, and 4,148 new jobs.

Bruce Stephen at Brodies is regarded as one of Scotland’s leading banking specialists and is a member of the Brodies Energy team with experience in both mainstream oil and gas and related services industry funding and renewables.

He has considerable experience in windfarm and hydro and is seen as a leader in Scottish asset backed securitisation.

Michael Stoneham, with more than 30 years’ experience in banking and finance, is one of the most respected and well known banking lawyers in the country, and heads the firm’s energy & infrastructure finance division.

He has experience of a wide range of banking and finance in Scotland and England – including project finance, acquisition finance, development finance, funds finance, real estate finance, financial restructurings and rescues and public and private capital markets transactions.

Key recent transactions are the £370 million bond issue for Aberdeen City Council to finance its infrastructure capital investment programme, and the £300 million acquisition by the Liberty/Simec Group of the Lochaber and Kinlochleven hydro works.