Interim report on Small Firms Loan Guarantee

Teresa Graham of Baker Tilly has produced her interim report and response to submissions on the Small Firms Loan Guarantee scheme.

In November 2003, the Chancellor and the Secretary of State for Trade and Industry commissioned a review of the Small Firms Loan Guarantee (SFLG). Teresa Graham was asked to work closely with the main SFLG lenders and to examine, and if appropriate make recommendations, regarding:

• the structure and rules of the SFLG and their appropriateness to the scheme's effective operation; and
  
• whether the SFLG is proving effective in tackling the financial barriers faced by start-ups and small businesses in the current market.

Publishing the document, Ms Graham said: "I am extremely grateful to all those who have taken the time and energy to respond to the call for submissions published earlier this year. The contributions we have received have been invaluable in supporting our work. In particular, I am grateful to all the lenders who have been so generous with their time.

"The interim report, alongside those responses, sets out our findings on the debt market in the UK, and includes an interesting summary of the statistics showing how the Small Firms Loan Guarantee is currently being used.

"My remit from government was to ensure that SFLG is working effectively and that, through SFLG and other interventions, the Government is doing all that it can to help start-ups and small firms overcome the obstacles that they face when raising finance. My task now is to consider what the objectives and role should be for SFLG in light of the barriers facing SMEs today and to consider how best to focus the scheme where it will make the maximum impact for SMEs".

The review will publish its final report in summer.

Executive summary

The key findings in the executive summary of Ms Graham's interim report are:

The evidence indicates that access to finance does not appear to be a significant barrier facing the generality of established businesses. The market in which businesses raise debt finance has changed since the introduction of SFLG. In particular, developments in credit assessment techniques appear to have reduced banks' recourse to collateral for smaller loans to established businesses.

Despite these developments, the review has found that above around £25,000 collateral is still frequently required, although practice differs between lenders. In addition, new scoring techniques, though beneficial for the majority of borrowers, favour those with a proven track record and good credit history. As a result, some start-up businesses, businesses with non-standard characteristics and those businesses seeking to expand beyond their current asset base may continue to face difficulties accessing finance.

The changes made to SFLG in April 2003, notably the reinclusion of certain sectors, have led to a major increase in the total number and value of loans, following a period in which the number of loans had been falling. In 2003/04 SFLG supported 5,966 loans, worth £409m. Over half of SFLG loans were made to start-ups and young businesses.

The evidence suggests that regional and local delivery of SFLG is patchy, both for demand-side reasons such as the availability of alternative sources of finance and for supply-side reasons such as differences in individual lenders' appetite for the scheme.

During the 1990s, default rates on SFLG loans were around 35 per cent per year, by numbers of loans made. This is likely to be a result of a number of factors, including the fact that the guarantee rate enables lenders to make a commercially viable return at these default levels, allowing the lenders to provide debt to a riskier group of propositions. In addition, younger businesses have historically had a higher propensity to default on SFLG loans and are disproportionately represented among SFLG borrowers.

Responses to the call for submissions to the review have raised a number of questions about the rules for SFLG, the eligibility criteria and the administration of the scheme. The review team understands that these are extremely important issues for the effective operation of SFLG and will take them into serious consideration when formulating their recommendations. The final report, to be issued later in the summer, will consider SFLG in the context of the Government's wider interventions to improve access to finance for SMEs and identify where SFLG should be best targeted in order to maximise its impact.

Small Firms Loan Guarantee Scheme

The SFLG was introduced in 1981 to help individuals overcome the problems obtaining the finance to start up new small businesses and also help small established businesses expand.

It guarantees loans from banks and other financial institutions for small firms that have viable business proposals but which have tried and failed to get a conventional loan because of lack of security.

Loans are available for periods of between two and ten years on sums from £5,000 to £100,000 (£250,000 if the business has been trading for more than two years). The SFLG guarantees 75 per cent of the loan. In return for the guarantee, the borrower pays the DTI a premium of two per cent a year on the outstanding amount of the loan. The commercial aspects of the loan are matters between the borrower and the lender.

To be eligible, the SME must be a UK company with an annual turnover of no more than £3m

(£5m if a manufacturer). Many business activities are eligible but there are a number of exclusions. Loans are available for most business purposes although there are some restrictions.

The responses to the call for submissions and electronic copies of the interim report, are available on the HM Treasury website