Asset Finance and SMEs

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2 Acknowledgements The Open University Business School enterprise research team responsible for conducting this Asset Finance report for the Finance and Leasing Association (FLA) is very pleased to thank the owners and managers of the responding firms for their time and effort in completing the survey questionnaire. The Business School is also pleased to acknowledge the financial and organisational support provided by Barclays Bank and the Association of Chartered Certified Accountants (ACCA) in sponsoring the research from which the data presented in this report comes. The Business School is also particularly pleased to acknowledge the generous support provided by FLA. However, it is important to note that any opinions expressed in this publication are not necessarily those of the sponsors or of the Open University. 1

3 Introduction Introduction Asset finance, mainly in the form of hire-purchasing and leasing, is not only an important source of finance for consumers and firms of all sizes but also, as a sector, has had, and continues to have, a significant impact on the UK economy. Despite reports of the Norman entrepreneurs leasing ships to William the Conqueror and some crusaders leasing their armour, modern leasing as a form of finance began in the 1950s. It has grown enormously since then. The latest annual report from the Finance and Leasing Association (FLA) 1 reveals that each year the sector contributes more than 10 billion to the British economy. In 2007, FLA members provided some 95 million of new investment - 66 million to support consumer spending and 29 million as direct investment in firms. As there has been an overall drop in the use of external funding by Britain s large small and medium enterprise (SME) sector (from 81 billion in 2004 to 69 billion in 2007) 2, it is important during the current credit crisis to understand more about current patterns of use by small firms. This report has been directly sponsored by the FLA as a supplement to the main 4th quarter 2008 Quarterly Survey of Small Business in Britain report. The quarterly surveys were started in 1984 for the purpose of improving our understanding of the problems and issues facing small firms and how they respond to them. Small business finance has been a recurrent theme of the surveys. It was first addressed in 1985, though the core questions on equity and loan finance date back to 1991 and have been asked regularly since then (see Table 2 overleaf). The patterns revealed in the successive surveys confirm the findings from earlier major studies such as, Macmillan (1931) 3, Bolton (1971) 4, Wilson (1979) 5 - that most small firms, especially the very smallest and non-growth firms do not make use of external equity and try to avoid debt capital. In general, most small firms in Britain rely strongly on personal and family savings, retained earnings and bank overdrafts. However, focus of this report is not on the majority of small firms but on those that do use external capital to survive, grow and employ, with a special focus on the characteristics of those that make use of asset finance, such as hire-purchase and leasing. Table 1 below confirms Table 1: Sources of, by size of business (number of people employed) Number of people in business No 55% 52% 40% 43% 35% 45% 45% Bank overdrafts 19% 26% 32% 34% 37% 25% 28% Other bank (term ) 11% 17% 21% 19% 22% 27% 18% Asset finance 8% 10% 18% 30% 18% 27% 17% Leasing 4% 8% 10% 19% 11% 20% 11% Hire purchase 4% 3% 11% 12% 11% 20% 9% Loans from owner, director or proprietor 13% 14% 18% 22% 14% 8% 16% Credit cards 12% 12% 15% 19% 13% 18% 15% Mortgage for business premises (incl, your home if used) 8% 10% 10% 10% 11% 10% 9% Business from other financial institutions 2% 3% 8% 7% 6% 10% 6% Debt factoring/ invoice discounting 1% 1% 4% 6% 6% 3% 4% Loans from family, friends 4% 0% 5% 6% 1% 2% 3% Loans or grants from Government 1% 3% 0% 2% 4% 5% 2% Loans from other private individuals 0% 1% 0% 3% 1% 3% 1% Other 1% 0% 0% 2% 1% 0% 1% Sample Source: Table 8, Quarterly Survey of Small Business in Britain, Vol. 24, no. 4, (2009). 2 March 2009

4 Introduction that asset-finance is used, to some extent, by firms of all sizes but much less so by microfirms with 10 and fewer employees. However, is an important source of finance by firms at the larger end of the small firm scale and by medium-sized firms (those with 50 and more employees). These findings are consistent with earlier quarterly surveys in this series (see table below) and other recent major studies 2. The main 2008Q4 quarterly survey confirms the message from all leading UK economic indicators that finance for small businesses is once again a pressing business, economic and political issue. Focussing just on the firms that do make use of different forms of loan capital, Table 2 shows an increased SME use of during the 4 th quarter of 2008 compared with previous years. Banks remain by far the most important and most used source of finance for small firms. However, non-bank finance, especially and credit cards, have become more important over the years. Not surprisingly, the use of mortgages to provide investment and working capital for small firms has declined significantly since the 3 rd quarter of 2007 (when the credit crunch was about to make its unwelcome appearance with the run on Northern Rock). The overall patterns of SME finance are important for a full understanding of the impact of the current economic crisis on small firms. However, this report has a tighter focus on the 17% or so of all small firms in Britain that make use of to support their businesses, by considering more closely size, industry and regional effects on what attracts small firms to the use of. Table 2: Sources of, historical comparison Sources of compared with earlier surveys (excluding no /don't know/no response) 1991 Q Q Q Q Q4 Bank overdrafts 74% 60% 51% 52% 55% Other bank (term ) 34% 34% 29% 33% 36% Leasing or HP 29% 31% 22% 25% 33% Loans from owner, director or proprietor 34% 41% 44% 32% 31% Credit card [or similar short-term ] 16% 21% 22% 31% 28% Mortgage for business premises (incl. your home if used) 22% 22% 17% 24% 19% Business from other financial institutions 5% 4% 5% 4% 11% Debt factoring/ invoice discounting 2% 4% 5% 5% 7% Loans from family, friends 12% 12% 8% 8% 7% Loans or grants from Government 5% 4% 5% 4% 3% Loans from other private individuals 2% 2% 1% 2% 2% Other 2% 1% 8% 2% 1% Sample Source: Table 9, Quarterly Survey of Small Business in Britain, Vol. 24, no. 4, (2009). 1. FLA Annual Report Finance and Leasing Association. London 2. Cosh A, Hughes A, Bullock A and Milner I. (2008) Financing UK Small and Medium-sized Enterprises: the 2007 Survey. Centre for Business Research. August University of Cambridge. 3. Macmillan, H (1931). Report of the Macmillan Committee on Finance and Industry. Cmd, HMSO. 4. Bolton J. (1971). Small Firms. Report of the Committee of Enquiry on Small Firms. Cmd HMSO. 5. Wilson, H. (1979). The Financing of Small Firms. Report of the Committee to Review the Functioning of Financial Institutions. Cmd HMSO. 3

5 Firm size Firm size effects Table 3: Number of people employed in business, by use of /other external Number of people in business 1-2 9% 20% 23% 20% % 15% 18% 16% % 33% 25% 28% % 11% 13% 15% % 14% 9% 11% % 7% 11% 10% unknown 0% 0% 1% 0% The firm size effects, with size measured by number of employees, are very clear in the Table 1 in the Introduction. Looking at the sources of finance in each size-band, the proportion of small firms that make use of ranges from only 8% of sole-traders and firms with 2 employees to 27% of medium-sized firms with over 50 employees. Table 3 above shows that microfirms with fewer than 5 employees make much less use of than larger firms. They account for only 19 % of firms that use compared with 35% of firms that use other sources of and 41% of those that do not take out at all. 4 March 2009

6 Firm size Table 4: Annual turnover, by use of /other external Turnover size band Less than 50,000 1% 3% 5% 4% 50,000-99,999 7% 15% 19% 16% 100, ,999 13% 19% 19% 18% 250, ,999 18% 18% 17% 17% 500, ,999 24% 16% 11% 15% 1m+ 36% 29% 29% 30% unknown 1% 0% 0% 0% Tables 4 and 5 on this page show firm size as measured by sales turnover. They confirm the picture that is used less often by the very smallest micro-firms than by the larger small firms and medium-sized firms. Table 4 shows clearly that is much more popular among firms with 500,000 or more annual sales turnover compared with all other forms of debt finance taken together (and, as Table 5 shows, is second only to bank overdrafts as a source of debt capital for these larger small firms). The use of asset finance increases with firm size. Table 5: Sources of, by annual turnover Turnover size band Less than 50,000 50,000-99, , , , , , ,999 1m+ No 62% 55% 49% 41% 33% 45% 45% Bank overdrafts 12% 19% 25% 31% 44% 27% 28% Other bank (term ) 8% 13% 15% 19% 27% 19% 18% Asset finance 4% 8% 12% 17% 28% 20% 17% Leasing 4% 4% 9% 11% 17% 12% 11% Hire purchase 0% 4% 3% 9% 15% 14% 9% Loans from owner, director or proprietor 23% 8% 15% 24% 19% 13% 16% Credit cards 12% 11% 13% 17% 19% 14% 15% Mortgage for business premises (incl, your home if used) 0% 11% 8% 8% 14% 9% 9% Business from other financial institutions 0% 4% 3% 5% 10% 8% 6% Debt factoring/ invoice discounting 0% 1% 2% 3% 4% 6% 4% Loans from family, friends 8% 3% 3% 6% 4% 2% 3% Loans or grants from Government 0% 0% 2% 1% 2% 3% 2% Loans from other private individuals 0% 0% 0% 1% 0% 3% 1% Other 0% 0% 2% 1% 0% 1% 1% Sample

7 Industry Industry effects Table 6: Sector of business, by use of /other external Sector Agriculture 10% 5% 3% 5% Manufacturing 23% 17% 12% 15% Transport 5% 5% 3% 4% Construction 7% 9% 10% 9% Wholesale 8% 9% 11% 10% Retail 15% 21% 20% 20% Hotels & Restaurants 6% 9% 5% 6% Business Services 21% 16% 28% 23% Other Services 7% 10% 7% 8% Table 7 below shows that is most often used in the agriculture, manufacturing and transport, travel & communication sectors. Table 7: Source of, by sector of business Agriculture Transport Wholesale Manufacturing Construction Retail Hotels & Restaurants Business Services Other Services No 32% 36% 41% 48% 50% 50% 37% 50% 46% 45% Bank overdrafts 47% 37% 21% 32% 29% 28% 33% 21% 19% 28% Other bank (term ) 24% 29% 21% 9% 11% 15% 24% 16% 23% 18% Asset finance 35% 25% 21% 12% 14% 13% 15% 15% 14% 17% Leasing 18% 16% 7% 3% 6% 9% 13% 13% 9% 11% Hire purchase 24% 17% 17% 11% 10% 4% 7% 4% 7% 9% Loans from owner, director 9% 23% 24% 15% 14% 16% 9% 17% 7% 16% Credit cards 18% 21% 17% 15% 14% 10% 17% 12% 16% 15% Mortgage for business premises 12% 13% 10% 5% 6% 9% 26% 6% 9% 9% Other financial institutions 0% 9% 14% 5% 7% 5% 9% 3% 7% 6% Debt factoring/invoice discounting 0% 10% 3% 0% 3% 3% 0% 4% 2% 4% Loans from family, friends 3% 5% 3% 0% 1% 2% 13% 4% 2% 3% Loans or grants from Government 9% 6% 0% 0% 1% 0% 0% 1% 0% 2% Other private individuals 3% 1% 0% 2% 0% 1% 2% 2% 0% 1% Other 0% 2% 0% 0% 0% 2% 0% 0% 0% 1% Sample March 2009

8 Regional Regional effects Table 8: Region of business, by use of /other external Region North East 6% 3% 4% 4% North West 11% 7% 9% 9% Yorkshire & the Humber 9% 10% 7% 8% East Midlands 6% 8% 7% 7% West Midlands 10% 9% 8% 9% East of England 5% 9% 8% 8% London 5% 10% 12% 10% South East 24% 22% 24% 23% South West 13% 11% 9% 10% Wales 5% 2% 4% 4% Scotland 8% 8% 7% 7% Asset finance is less often used by small firms in London than elsewhere. This is almost certainly related to the fact that London has fewer agriculture, manufacturing and transport firms than the other regions and that it is the region with the highest proportion of firms with fewer than 5 employes. Table 9: Source of, by region of business North East North West Yorkshire & the Humber East Midlands West Midlands East of England London South East South West Wales Scotland No 44% 52% 38% 48% 40% 50% 45% 47% 41% 59% 37% Bank overdrafts 26% 20% 30% 30% 37% 24% 23% 27% 42% 15% 30% Other bank (term ) 30% 15% 13% 14% 29% 16% 13% 18% 20% 7% 30% Asset finance 26% 20% 18% 14% 19% 10% 8% 17% 21% 22% 19% Leasing 15% 15% 10% 6% 6% 9% 5% 13% 16% 15% 7% Hire purchase 11% 9% 10% 12% 15% 7% 5% 6% 8% 15% 13% Loans from owner, director 11% 9% 20% 18% 18% 19% 11% 17% 21% 7% 15% Credit cards 11% 12% 18% 20% 16% 7% 11% 15% 22% 11% 11% Mortgage for business premises 19% 8% 10% 6% 8% 10% 8% 11% 11% 19% 2% Other financial institutions 0% 6% 8% 8% 6% 2% 8% 4% 11% 7% 4% Debt factoring/inv. discounting 11% 2% 10% 2% 0% 2% 3% 5% 3% 0% 4% Loans from family, friends 4% 2% 5% 4% 0% 3% 3% 3% 3% 4% 11% Loans/grants from Government 4% 2% 2% 2% 2% 0% 0% 0% 7% 7% 2% Other private individuals 0% 0% 2% 0% 0% 0% 1% 1% 1% 4% 4% Other 0% 2% 0% 0% 0% 2% 1% 1% 0% 0% 0% Sample

9 Drivers Drivers Perhaps not surprisingly, in contrast to other small firms, users of have most often needed capital over the past year to fund investment in equipment and other assets. As Table 10 shows, small business users of asset finance were also much more likely to be seeking funds for business growth. Table 10: Drivers of need for capital, by use of /other external Drivers of need for capital over past year Fund investment in equipment and other assets 55% 34% 23% 32% Fund business growth 38% 35% 18% 27% Manage cashflow/bad debts 37% 48% 23% 33% Fund increased operating/staff costs 29% 22% 14% 19% Fund investment in new buildings/premises 23% 17% 10% 14% Fund increased marketing/promotion 13% 15% 11% 12% Manage increased credit restrictions 13% 15% 6% 10% Fund research/development/innovation 11% 12% 8% 10% Other (please specify) 2% 5% 5% 4% None/No response 14% 17% 45% 31% Table 11: Sales expectations over current quarter, by use of /other external Sales expectations over current quarter Up 23% 35% 26% 28% Same 25% 25% 38% 32% Down 52% 40% 36% 40% No response 0% 0% 0% 0% Balance -29% -5% -10% -12% 8 March 2009

10 Drivers Table 12: Investment expectations over current quarter, by use of /other external Investment expectations over current quarter Up 15% 10% 7% 9% Same 59% 62% 77% 69% Down 26% 27% 16% 21% No response 0% 0% 0% 0% Balance -11% -17% -9% -12% Asset finance users are more pessimistic about their sales prospects for the current quarter than other firms (Table 11). Their expectations on sales in the current quarter are well below other firms that use all types of debt finance and they are more likely to be considering shedding staff. More positively, they are marginally more likely to be positive about increasing current investment (Table 12). This may well be related to the fact that agricultural firms and those in transport, travel & communications, both heavy users of, are the most negative about immediate prospects. Table 13: Employment expectations over current quarter, by use of /other external Employment expectations over current quarter Up 9% 9% 7% 8% Same 65% 68% 77% 73% Down 26% 22% 15% 19% No response 0% 0% 0% 0% Balance -17% -13% -8% -11% Table 14: Importance of being able to take advantage of capital allowances, by use of /other external Being able to take advantage of corporation tax capital allowances Very important 43% 26% 27% 29% Quite important 29% 37% 27% 30% Not relevant or not important 27% 34% 36% 34% Don't know/no response 1% 3% 10% 6% 9

11 Drivers Firms using more often than their counterparts who don t use report that when deciding on sources of financing for the acquisition of assets, corporation tax allowances and the separation of business and personal assets are very important (Tables 14, previous page and 15, below). These are the most important considerations when deciding on financing for assets. A corollary of this is that firms in agriculture and manufacturing and medium-sized and larger small firms (the heaviest users of, see Tables 5 and 7) more often than the others say that tax advantages are very or quite important and that separation of business and personal assets is very important. Table 16 below shows that users of also rather more often than others note that flexibility to change the asset is important. However, users of are little more likely than those which do not use to say that not having to show the value of the assts in your annual accounts is very important when deciding on sources of finance (Table 17). The International Accounting Standards Board (IASB) is proposing that all leases should go on balance sheets from Table 15: Importance of having asset secured on business asset, by use of /other external Having the asset secured on a business, rather than personal, asset Very important 43% 34% 24% 30% Quite important 28% 27% 24% 26% Not relevant or not important 27% 34% 43% 38% Don't know/no response 2% 5% 9% 6% Table 16: Importance of having flexibility to change asset, by use of /other external Having flexibility to change the asset if business needs change Very important 33% 18% 22% 23% Quite important 32% 34% 27% 30% Not relevant or not important 32% 42% 42% 40% Don't know/no response 3% 6% 9% 7% Table 17: Importance of not having to show value in annual accounts, by use of /other external Not having to show the value of the assets in your annual accounts Very important 11% 9% 10% 10% Quite important 20% 21% 12% 16% Not relevant or not important 66% 64% 68% 67% Don't know/no response 3% 6% 9% 7% 10 March 2009

12 Performance Performance Table 18: Top three problems, by use of /other external Problem in top three? Economic climate or demand 68% 60% 57% 60% Cashflow, payments or debtors 36% 37% 20% 28% Total tax burden 30% 23% 20% 23% Competition 27% 26% 30% 29% Government regulations 26% 21% 33% 28% Inflation or cost of inputs, etc. 24% 31% 22% 25% Lack of time/capacity 21% 16% 15% 16% Interest rates or access to finance 16% 26% 14% 18% Lack of skilled employees/high pay 15% 14% 11% 13% Internal (management, marketing etc.) 5% 9% 6% 7% Users of seem more often than non-users to rank the economic climate and the total tax burden as top three problems. They also, however, more often rank lack of time/capacity as a top-three problem, suggesting a disproportionate number of busy firms (Table 18). Concerns and pressures from the worsening economy dominate as small business problems with cashflow, bad debt and slow payments moving sharply from 6 th place last quarter to second rank now. Fewer users of than those who use only other forms of loan finance indicate that interest rates or access to finance is a top-three problem. Users of more often than other small firms report that their customers owe more to them than they owe to their suppliers (Table 19). Use of does not appear to be closely related to age of business or entrepreneurial rating. Users of asset finance rate themselves as 6.0 on the entrepreneurial scale, compared with 6.3 for those which use only other types of and 5.7 for those with no external. Table 19: Debtor/Creditor balance, by use of /other external Debtor/Creditor balance YES, customers owe more 61% 49% 46% 50% NO, owe more to suppliers 24% 26% 17% 21% Have no debtors/creditors or in balance 15% 21% 34% 27% Don't know (not prompted) 1% 3% 3% 3% 11

13 Performance Table 20: Sales performance over past year, by use of /other external Sales performance over past year Up 49% 41% 34% 38% Same 17% 19% 33% 26% Down 33% 39% 34% 35% No response 1% 0% 0% 0% Balance +15% +2% +0% +3% Table 21: Investment performance over past year, by use of /other external Investment performance over past year Up 28% 19% 14% 18% Same 54% 58% 72% 65% Down 17% 22% 14% 17% No response 1% 0% 0% 0% Balance +11% -3% -0% +1% Users of more often than the others report positive sales and investment over the past year (Tables 20 and 21), suggesting that they may have used to fund this growth. Manufacturers and agricultural firms, both heavy users of, were among the most positive sectors about sales performance over the past year. Table 22: Employment performance over past year, by use of /other external Employment performance over past year Up 22% 19% 15% 17% Same 52% 55% 70% 63% Down 25% 26% 15% 20% No response 1% 0% 0% 0% Balance -3% -7% +0% -3% Overall, the whole survey confirms that the small firms which make use of are rather more dynamic than those that do not and that they are more considered in selecting their sources of finance. 12 March 2009