The Government’s SME (small and medium-sized enterprise) strategy aims to increase access to finance, so businesses have enough capital to grow.
On geography, the strategy covers place-based disparities in access: businesses outside London and the South East face additional barriers to getting finance.
The strategy includes both debt and equity. Centre for Cities has recently examined the geography of equity and the reasons for its concentration in a small number of cities.
But does debt follow the same pattern?
Debt is much less geographically concentrated than equity
Centre for Cities’ Angels’ Delights report shows that more than 80 per cent of equity finance goes to businesses in urban areas.
This is not the case for debt. As shown in Figure 1, debt value is almost evenly split between urban and rural areas (48 per cent vs. 52 per cent). Debt is actually slightly less urban than the location of firms (53 per cent vs. 47 per cent).
Figure 1: Debt is evenly split between urban and rural areas
This suggests that there is no single geography of finance. Equity and debt are distributed very differently across the UK. Equity is concentrated in urban areas, while debt is more evenly spread.
A lot more businesses take on debt than equity deals
This reflects the different roles these two forms of finance play.
Fewer than 1 per cent of SMEs access equity finance every year. These firms are typically high-growth, innovative and based in cities. They are often start-ups in the ‘intangible’ economy, based on ideas rather than physical products, and may therefore struggle to access collateral-based finance. Long research and development cycles often mean they cannot generate sufficient short-term revenue to pay back debt.
By contrast, about 40 per cent of SMEs take on debt of some form (credit cards, overdrafts, loans, etc.). These firms are not always looking to grow or innovate, as the most common reason for borrowing is to address short-term cash flow issues. This means that, unlike equity, lending is applicable to all types of businesses across sectors and across the entire country, rather than just start-ups with high-growth potential that locate primarily in cities.
Debt does not vary across places in the same way as equity
Lending is not concentrated in cities. But it doesn’t seem to be linked to cities’ economic performance either.
Figure 2 shows the amount of debt in each place per business and its relation to city productivity.
The three cities with the highest amount of debt per business are Belfast, Dundee and York. None of them is among the most productive cities, and all of them are outside the more prosperous Greater South East. On the other hand, London is middling in the amount of debt per business among cities despite its high productivity and status as a financial hub.
Broadly, the variations across places are not correlated with their economic strength. For example, Newport and Edinburgh have similar levels of lending despite the former having a much less productive economy.
Figure 2: Debt outcomes do not vary significantly across places
This variation in debt does not appear to be linked to the North-South divide either. Cities within and outside the Greater South East have very similar average amounts of debt per business (£461,000 versus £473,000).
Not only is this different from the geographic variation in equity, but it is also different from the assumption that businesses in less economically prosperous areas face additional barriers to debt due to their perceived higher risk.
This adds to other research that finds lenders are mostly assessing business debt applications fairly and rationally across places.
Debt and equity should not fall under the same strategy
Taken together, this indicates that, despite being grouped under the same “business finance” strategy, debt and equity serve distinct roles and have different dynamics.
From a geographic perspective, place-based barriers appear much more relevant to equity than to debt. Businesses in less productive or more deprived cities do not seem to have worse outcomes from lenders.
This has policy implications. Applying the same diagnosis and policy tools to both types of finance is unlikely to be effective. The Government should recognise the special role of equity for high-growth businesses in addressing the underperformance of large cities outside London, and the need to improve the business environment in cities to improve national productivity.
For debt, the Government may choose to reduce the cost of capital to improve the national business environment, but it should understand that the firms benefiting from this may not be growth-driven. Nor does it need a place-based angle for this, such as targeting less productive cities outside the Greater South East.