Chancellor/Governor: right move, wrong product

The headlines are suggesting that a panicking Chancellor of the Exchequer and a fragile Governor of the Bank of England are trying to inject £300 billion into British businesses. Quite where this leaves “I, Prime Minister Cameron, never change my mind on anything: what Plan B?” I leave aside for the purposes of discussing what really matters.

Most worthwhile businesses have the finance they need: the FTSE 100 companies are holding billions of pounds. The focus is on the riskier smaller businesses who offer the best opportunity to growth the economy. The problem with the proposed cash stimulant is that it is the wrong product. The situation requires equity not debt financing.

The arguments affecting debt v equity finance

a) The assessment of debt finance is based on proven repayment ability: equity finance anticipates future profits. It can be more visionary.

b) The first source of debt finance, the banks, dislike small businesses (except when the chairman is after a knighthood), reject Government backed schemes (why has the Government Loan Guarantee Scheme been such a lame duck?) and have withdrawn their front line forces from customer interface (I have just opened a business account for a new venture which is fully financed. It took three months and included all the directors being interviewed by the bank. During this meeting we were ‘forced’ to watch a video promoting the bank’s services.)

c) The second source of debt finance is funds. The Government’s record is dire. The Regional Growth Fund, which has piled ludicrous levels of overheads (why so many regional offices?) on itself before making any real contribution, is consistently criticised and if it is working why the panic now?

On average between 25% – 35% of a fund will be spent on overheads. The accountability is usually peer group analysis. The managers are paid regardless of performance.

d) Equity finance offers fiscal incentives (EIS/SEED-EIS schemes as two examples). This can offset the risks of early stage finance. Equity finance is provided by corporate finance companies that are paid by success fees. It’s a market operation and therefore much more efficient. Equity markets (AIM/PLUS Markets/GXG Markets) allow investors to be informed and to buy and sell stock. They provide a base for employee share schemes.

The main argument against early stage equity investment is perceived risk. The FSA seem to have decided unilaterally that investors need draconian protection. They have seriously damaged the operations of the small-cap brokerage community.

So how do they equate their approach with the situation at the China Special Situations Fund? Promoted by the highly respected Anthony Bolton, who, over 28 years at Fidelity UK Special Situations Fund showed a near-20% annual return, he launched his China investment fund two years ago and attracted 75,000 private investors. The FSA will have been elated by the correctness of the documentation and the promotion of the shares.

Two years later the shares have fallen by 26.3%. A £1,000 invested in 2010 is now worth £741.

Britain’s economy needs its small-cap community to be properly financed and to prosper. This can best be achieved by encouraging early stage equity investment markets. The sector needs to argue its case with the Treasury and with the FSA.


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