Is Starting a Business in a Recession Wise or Foolish?

It is no secret that the Government is relying on SMEs to stimulate both the economic recovery and jobs.

Lord Young, senior adviser to the Prime Minister, is on record as saying that a recession may actually be a good time to start a small business on the grounds that wages are low, competition may have fallen by the wayside and premises, too, may also be cheaper to get.

That’s all well and good but there is more to starting a business than having a bright idea and the passion and motivation to get started.

There are a number of other factors to consider, especially where the business is something new and innovative and therefore unlikely to raise finance from currently risk-averse banks and investors.

A start-up must carry out research, identify potential customers, set sensible targets and put all of this into a business plan.  If it needs finance it should consider alternatives to the mainstream sources, whether these are friends and family, partnering with existing firms, seed funding, crowd funding or business angels and also investigate what grants and special concessions may be available that will help in the first year or two of trading.

A mentor or business guardian to help set the path and keep things on track can also make the difference between success and failure.  It’s impossible for a novice to do everything themselves without support and joining local business networks can also be a valuable source of advice and support.

If it is the kind of venture that can benefit from collaboration with other enterprises where there is a synergy, this is an option worth exploring since partnering with existing businesses in a market will help a start-up forge relationships with both a supply chain and  potential customers.

When money is tight, entrepreneurs should explore cash saving ideas such as offering equity, or future work, or future discounts, or other benefits in kind to any business that can provide them with useful services. Examples include introduction to customers, advice, market research, book keeping & accountancy, manufacturing prototypes, provision of office space, use of specialist or expensive equipment, and many more ideas that are only limited by the entrepreneur’s imagination.

Recession or not, starting up a business is all about doing all you can to weight the odds in your favour.

Politicians and Economists are failing SMEs

Investment in innovation has to be a long term strategy while the UK’s fixed term parliamentary system and the need to grab headlines encourage short term thinking.

The evidence is piling up for all to see.

Firstly, research by the Big Innovation Centre has emphasised, if it were needed, that there is a “systemic failure” holding back the economy shown in part by the worsening of access to finance to SMEs and in particular to those developing entirely new products and processes.

Yet these new innovative SMEs are the most likely to create new markets and achieve rapid growth, so have a disproportionate impact on employment and the national economy.

The point was reinforced by Tony Robinson OBE, a successful micro-business owner with more than 25 years’ experience and co-owner of Enterprise Rockers, which supports micro enterprises. In an article in the Daily Telegraph business pages, he says that despite the UK’s 4.5million micro businesses providing 32% of private sector employment and 20% of its turnover: “…95% of all government employment support and training funding goes to the largest 5% of UK businesses.”

Sir Hossein Yassaie, CEO of Imagination Technologies, has also weighed in, comparing planned support for innovation in S. Korea over the long term to what happens in the UK, where much of industry has been sold to overseas owners: “…The Government changes and everything is short term…. I think we really need to stop all that.”

In his view, also quoted in the Telegraph, instead questions need to be asked now about what we need to do today to be in markets in ten years’ time and imagination now is the key to future success.

Politicians need to put in place support that is genuinely aimed at SMEs that is more than rhetoric and not prone to change by a new Government, or they need to provide real short-term incentives to investors in innovation that will have the same effect over the longer term.

Examples of such incentives might be to provide soft loans, or offer matched funding alongside new share capital. We don’t want politicians trying to be clever as they have been with the flawed Enterprise Finance Guarantee Scheme which was never going to stimulate business.

It is a great pity that ‘highly regarded’ economists like the BBC’s Stephanie Flanders, who I understand also advises the Government, are unaware of the Small Firms Loan Guarantee Scheme that for approximately 15 years drove much of growth by SMEs in the 1980s and 90s. I asked her recently, and she had never heard of it.

This makes me think that economists like to operate at a theoretical and strategic level rather than try to understand what really makes SMEs tick so they can develop tactical stimuli that promote SME growth. Quantitative Easing is another example of theory not working for SMEs.

Investors need to rethink their requirements

Many of us believe that a change in investor culture is long overdue. We need to incentivise long-term investment in sustainable growth instead of short-term ‘quick flip’ or ‘get rich quick’ schemes that deceive everyone into thinking that making money is risk free and easy.

It is this short-term thinking that has made it more difficult for Private Equity firms to raise new funds for further investment.

Private Equity firms depend on their reputation for making profits for their investors and their problem since the Credit Crunch of 2008 has been that funds have been tied up in businesses that are effectively zombies because of the amount of debt they have, no matter whether these businesses may have good potential for growth.

Similarly both lenders and investors are very wary of taking a risk with new and small businesses, hence the Government’s failure to persuade funders to support start-up companies and SMEs, even profitable ones and those with potential for growth. The only source of funds really available for such businesses are book debt and asset based lenders but these only improve cash flow they don’t provide equity or loan capital for investment.

To address the funding culture issue we need to justify a switch from investing in property to investing in businesses. This will involve understanding a risk rated return on investment that provides for better returns to investors.

There are a number of ways of achieving this change of investor behaviour, one is to penalize investment in property by taxing them, another is to provide for matched funding from banks alongside new equity, possibly with a Government guarantee, another would be for debt forgiveness by banks to restructure their ‘zombie’ client loans alongside new equity, others could be an expansion of the Enterprise Investment Scheme and Seed Enterprise Investment Scheme, or simply a reduction in the corporation tax rate.

But all this requires a Government to confront those who view property as their source of security.

Is it all doom and gloom or are there rays of sunshine on the horizon?

It started mid-May with the Bank of England governor Sir Mervyn King upgrading the economic forecast for the rest of this year.

The British Chamber of Commerce (BCI) was also slightly more optimistic in its forecasts and reports on business confidence.

In the last few days we’ve had three forecasts on monthly performance for the manufacturing, service and construction sectors, all of them showing signs of growth.

While no-one is denying that there are some years to go on paying down household and business debt, as the Telegraph’s CItyAM editor Allister Heath emphasises this week, is his doom-laden piece predicting an even more cataclysmic crisis really justified?

He cites the need to further massively cut the welfare state and also to what he calls the “terrifying recklessness” of the Government’s proposed Help to Buy scheme that could stoke up another credit-fuelled housing bubble.

It doesn’t help that we are only building 100,000 new houses a year instead of the 300,000 that we need to satisfy demand.

However, if the scheme were to stimulate house building we might stem house price inflation and avoid a bubble. It could also be used to redress the scarcity of smaller homes for both first time buyers and older people wanting to downsize as well as provide jobs for the approximate 20% of all SMEs that a thriving construction industry could employ.

We all know that “bad news” sells papers but there is also a converse argument that we need businesses to believe they have a future. With some measure of confidence in the future, businesses and SMEs in particular might begin to invest in growth.

So are you a pessimist, a realist or an optimist?

Calls for Private Equity investment to stimulate growth

There has been a chorus of voices recently wanting to see private enterprises or Private Equity firms investing to stimulate a recovery and growth, both in the UK and Europe.

It’s all very well demanding someone else invest money but why should they? There are many ‘zombie’ companies that could be ripe for investment but in effect are overvalued due to the debt burden which will almost certainly never be repaid. These firms need restructuring with bank lenders prepared to take a hit if they are to be attractive for investors.

The chorus may not be aware that investors normally rank behind the bank, or are they hoping investors are naïve enough to underwrite the bank debt by pouring good money after bad? Private Equity companies rarely have either the time or the patience to spend on business improvement as most rely on financial restructuring followed by a swift exit to deliver a huge return on investment to their own investors.

Another factor is Private Equity’s reliance on cheap and easy money to recover their investment by refinancing assets and to realize profits by funding a sale where the lending market underwrites their returns. This is how many of the banks were left with bad debts so it may be a while before they return to providing cheap and easy money.

Private Equity firms, like most alternative investments, depend on their ability to attract funds from investors who want to see an adequate return, normally in a relatively short period. 

Since the financial crisis began many investments by Private Equity have been locked in due to the inability to refinance or sell their investments, which has impacted on their return to investors and thus on their ability to raise new funds.

Rent seeking is a drain on growth

There has been more media doom and gloom about the High Street, with the news that 10 out of 12 of the Portas Pilots have suffered an increase in empty shops and the CBI’s May retail health check showing the steepest falls in sales this year, not only on the High Street but also online.

This is not solely about the squeeze on household budgets but also about the fact that the High Street, like many SMEs, is not competing on a level playing field.

Economists have a word for financial gain that doesn’t do anything to stimulate either real production or economic growth.  It is called rent seeking. It covers everything from income gained from vast financial sector fees, bonuses and charges on transactions to actual rent received by landlords.

Sports Direct owner Mike Ashley has given landlords a deadline of today (May 31) to accept a deal to reduce the rents on the Republic chain that he “rescued” in February from administration or he will walk away and the 116 shops will close. 

The BBC also recently highlighted the plight of one trader in electrical goods in the “Portas” town of Nelson in Lancashire, who needs to move to larger premises. He has identified an empty property vacated by a national chain but it is still tied to a long lease so the landlord has no incentive to re-let at a lower rent.

Add to that the ridiculously high town centre business rates that are no longer justified in the current climate and that the Government has not reviewed since 2007 – arguably another form of “rent seeking”.

How are SMEs supposed to be the engine of growth when even those with potential to grow are facing such impossible odds?

Two steps forward and one step back is the new normal

“It seems that every time an upward trend in sales volumes seems to be emerge it’s quickly snuffed out. While disappointing, trades data are a reminder that despite some positive upward indicators, the ongoing squeeze on incomes means there’s a limit to how quickly growth can pick up”.

This reported comment from Simon Wells, HSBC’s chief UK economist, in the London E. Standard may seem to be a statement of the obvious but it bears repeating in a world where every tiny short term uptick is seized on as evidence of recovery from the global economic crisis.

Irrespective of who is to blame we should remember that high price inflation and minimal salary inflation plus the current uncertainty about employment have meant a real squeeze on incomes. Both businesses and consumers remain focused on paying down debt.

While confidence might rise this can only translate into a rise in credit and in people’s ability to service debts.

We are also in the midst of a global economic rebalancing that is shifting power and influence away from the so-called developed world to other economic centres and this is likely to take a long time to stabilise.

Every business, and not only the retail sector, that is looking at restructuring for growth needs to bear all this in mind whether it is considering developing exports or its home market.  It will be about focus on the longer term, about real innovation, about providing value for money and about close attention to customer service to achieve success and growth.

Is blaming the weather for a downturn in High Street trade a red herring?

With the somewhat slow and tentative arrival of Spring have come the by now regular comments blaming the weather for the struggles of High Street retailers.

But there are signs that the High Street might not be dead quite yet and that actually the weather is only a small part of the picture.

Research from analysts Kantar recently has revealed that 70% of us still like to try a product before we buy despite the boom in online shopping and that even with the rise of online shopping 90% of retail spending last year had taken place in actual shops and stores.

While trading conditions are difficult in the continuing economic crisis it may be that what is going on is actually a restructuring process between online, out of town malls and the High Street. 

Recently Tesco has cancelled some plans to build larger retail outlets but in common with other large supermarkets continues to develop smaller drop-in stores both in town centres and suburban local shopping areas. Some formerly online only stores are also moving into physical stores in a process called “showrooming”.  They include the Kingfisher-owned Screwfix, furniture store Oak Furniture Land and SimplyBe, owned by online fashion group JD Williams.

Small independents are also said to have a place on the High Street but as a specialist in turnaround and restructuring I would want to look at their business plans, costs and potential cash flow before recommending that they go ahead.

What would help most of all, however, would be for the Government to finally get the point that Business Rates, last revised at the height of the pre-crisis boom and now at an artificially high rate, which increased again in April, are no longer either justifiable or affordable for SMEs like the independent retailers.

According to Graham Ruddick of the Daily Telegraph, even the Policy Exchange, which is said to have close ties to senior Conservatives, is recommending freezing business rates for two years until they can be thoroughly reviewed. http://tinyurl.com/pxm2c2y

In our view a review and revision downward is urgent. Freezing them will only allow the Government to avoid having to consider revaluations and reductions in the hubristic hope that growth will return to pre credit-crunch “normal”.

When will businesses invest in the future?

It is hardly a closely-guarded secret that the UK’s largest companies are holding onto a large pile of cash, estimated to be more than £300 billion.

While the Government is expecting recovery from the 2008 economic crisis to come from the private sector, the latter remains focused on minimising tax bills and maximising short term rewards to shareholders and CEOs, while avoiding risky investment at all costs.

One of the major complaints among businesses at all levels is that they are finding it hard to recruit the skilled and educated people they need. At the same time investment in research and development is dwindling.

There can be no future reward without taking some risks and thinking for the longer term but businesses also have to recognise that their activities are also made possible because of the benefits they derive from a combination of the physical infrastructure and education system, the so-called public goods that are often taken for granted.

Perhaps it is about time that businesses realised that if they want to grow and develop and if they want a supply of educated people, they need to take some responsibility by unlocking some of their capital to support innovative new enterprises, to invest in Research and Development in our universities and in their own companies and to help the existing and future workforce to acquire the skills companies say are in short supply.

This may require a degree of restructuring of companies’ own operations and at the very least restructuring their current short term, risk-averse thinking to enable investment over a longer period.

While the Government is considering closing the loopholes that make tax avoidance possible it could perhaps also consider a tax on unused capital sitting on company balance sheets to stimulate some investment in the economic future of UK Plc.

UK Business Growth

There are indications of consumer confidence in the UK. One the sale of new cars where during the first three months of 2013 the sale of new cars in UK was up 7.4%, while elsewhere in Europe they were down in Germany 12.9%,  France 15.6%, Italy 13%, Spain 11.5% and Cyprus 41.6%. In March alone new car sales in UK were 394,806, against 281,184 in Germany, 165,829 in France, 132,020 in Italy and 72,677 in Spain.

This would suggest that we in UK are emerging from a long-term malaise if not depression while it would appear that Europe remains mired in a torpor with declining confidence.

So where is the engine for business growth? the above evidence would suggest it won’t be Europe which some eminent economists such as Professor Nick Crafts at Warwick University argue will be approximately 1% a year until 2030.

I don’t believe we want it to be driven by consumer confidence due to property inflation as this will become another bubble.

We need industrial, manufacturing, service and professional businesses that add value and we need export sales. These require investment in developing ideas, training people, building capacity and marketing them.

I would urge everyone to get this message across to every politician you come across as we need policies that stimulate and justify investment in such businesses.

As for the increase in car sales, how many UK manufacturers are benefiting from the new sales? The lack of a UK car industry is down to short-sighted and weak politicians who supported fundamentally flawed restructuring plans like the Phoenix Four’s failed attempt to save Rover.