Young Entrepreneurs – passion or necessity?

The Global Picture

Globally, young people are pushed towards an entrepreneurial career through necessity, rather than pulled towards it through genuine interest. The result is that young people are most likely to own their own business in “factor-driven” economies rather than more developed ones. The World Economic Forum defines a factor-driven economy as one dominated by subsistence agriculture and extraction with a reliance on unskilled labour and natural resources. The 2016  Global Entrepreneurship Report finds that 15.4% of early-stage businesses are owned by 18-24 years olds in factor-driven economies (such as India, Cameroon and the Russian Federation) are business owners. In “efficiency-driven” economies (such as Saudi Arabia, South Africa, and Poland), the economy has become more competitive with increasingly efficient processes and higher quality products. Here, we see a slight decline in youth entrepreneurs: 12.3% of early-stage businesses are owned by 18-24 year olds. As economies develop further to rely on knowledge and the service sector expands,  “innovation-driven” economies start to appear, such as Australian, South, Korea, or the United States. In these more economically-diverse countries, only 7.6% of early-stage businesses are owned by 18-24 year olds.

Kethi Ngwenya, 26, is CEO of School Media in South Africa http://www.schoolmedia.co.za/

The higher number of young entrepreneurs in factor-driven economies could be due to the higher numbers of young people as a proportion of the population. These economies are also less likely to send young people to higher education, resulting in young people being forced into income-generating activities far younger than in innovation-driven societies. On the positive side, factor-driven societies are more likely to consider entrepreneurship a good career choice than in innovation-driven societies (62% vs 58%) and are also slightly more likely to consider that entrepreneurs are high-status individuals (72% compared to 70%). In factor-driven economies, 56% of people think they have the right skills for entrepreneurship, as opposed to only 44% in innovation-driven societies. This finding reinforces earlier research that higher education reduces entrepreneurial motivations ((Davey et al. 2011))   Innovation-driven societies are more risk-averse: over 40% of those in innovation-driven societies are prevented from starting a new business by the fear of failure, compared to only 33% of those in factor-driven societies. The social stigma and legal complications of business failure in more advanced economies are possibly more of a deterrent than in countries where it is easier to recover from business failure.

The barriers to youth entrepreneurship

Commentators locally and globally have argued that factor-driven countries have a demographic dividend: an in-built advantage due to a young population that is willing and able to engage in entrepreneurial activity. But counter evidence from South Africa and India indicate that young entrepreneurs in these countries are hampered by poor physical infrastructure such as inadequate transport and communication networks, and a legal framework that fails to protect ownership and intellectual property rights .

Yet innovation-driven countries also have barriers for young entrepreneurs: their lack of credit history and assets to serve as collateral for loans mean that they lack funds to start a business, and then find it hard to scale-up their enterprise.

Young entrepreneurs in the UK

The Small Business Survey of 2014 contains the most recent data for the age of small business owners in the UK. Only 1.1% of all small business owners are aged 18-24, an even lower percentage than the 7.6% across all innovation-driven economies, which indicates that young people in the UK are even less entrepreneurially minded than the European average. The most popular types of industry for young entrepreneurs are SIC codes G, H and I: Accommodation and Food Services, Transportation and Storage, and Wholesale and Retail Trade. This finding counters the popular image of young entrepreneurs favouring technology fields, such as apps, social media or gaming, where there are low barriers to entry and the only equipment needed is a mobile device and internet connection.

little simz
Little Simz, 21, is a singer and a Forbes 30-under-30 entrepreneur https://littlesimz.bandcamp.com/

Turning to profitability, 74% of young entrepreneurs turned a profit in the last year, which is only slightly lower than their older peers, at 79%.

78% of young entrepreneurs did not export internationally, very comparable to their older peers, 76% of whom did not export.

The most surprising finding is that young entrepreneurs are more likely to employ staff than their older peers. It might be imagined that most young entrepreneurs have no employees, as their business is also relatively young. In fact, only 7% of businesses have no employees, as opposed to 14% of business owners aged older than 24. 27% of young business owners have 1-9 employees, as opposed to 19% of their older peers. 48% have 10-49 employees, as opposed to 33% of their older peers, and 16% have 50 to 249 employees, which is only slightly lower than the 19% of older business owners.

Young Entrepreneurs – source of growth for Europe?

In summary, young entrepreneurs in the UK need encouragement and confidence in order to achieve their potential. While the European Commission and OECD have largely relegated youth entrepreneurship to being a policy solution  to persistently high youth unemployment in Europe, our findings indicate that young entrepreneurs actually are more likely to be employing other people than their older peers. In fact, young entrepreneurs are source of job creation, which drives regional employment and growth. Business leadership programmes, such the University of Keele’s Mercia Centre for Innovation Leadership and enterprise education, which encourages entrepreneurship skills in schools and universities, have an important role to play in encouraging more young people in “innovation-factor” economies to take the plunge and start their own business. Evidence in the UK shows that they are likely to be successful.

 

 

 

 

 

 

 

 

 

 

What is the single biggest mistake an SME owner can make?

Today’s blog post is by David Lowe, Entrepreneur in Residence at the MCIL programme. David talks to us about the MCIL programme, how it helps entrepreneurs and shares his many years of insights from working with business leaders.

davidlowe photo
David Lowe

What is your role on the MCIL project?

I’m one of four and soon to be five Entrepreneurs in Residence for Keele’s Mercia Centre for Innovation Leadership.  We co-develop and deliver high quality programme content, alongside the academics from the Keele Management School.  We share practical insights to ensure the content of the programme is suitable for practical implementation. We also coach business leaders on the programme on a one-to-one basis to help them grow and develop their businesses.

What skills do you bring to your role?

Strategy is my personal forte, and as a coach/consultant I have successfully assisted a large number of SME’s over the last 14 years to both grow and to innovate. I’m a problem solver by nature, and I’m fortunate enough to have a talent for the assimilation of wide ranging information; either adding strategic value or simply applying my knowledge towards helping to solve the more practical day to day challenges. My colleagues have complementary skills sets: Will Pritchard is experienced in working with start-ups; Carolyn Roberts is a product innovation expert; David Townson is expert in product design.  This means that there is a lot of synergy as well as a lot of energy across the team.

Why do you enjoy your job?

I get a real kick out of helping businesses to solve their strategic problems and to drive innovation. We challenge all of our participants positively, try to ask the right questions, and we help wherever we can with new approaches. I absolutely love what I do.

What is the single worst thing that a business owner can do?

I’d say that the single biggest bad habit that business leaders get drawn into, is where they are doing so much working in their business that they don’t spend nearly enough time and effort working on their business. Indeed, for me, working with business leaders, no matter what the theme or the headline task, it nearly always means actually getting them doing something tangible as opposed to just saying they do it.

Why is innovation important for a business owner?

I also try very hard to get them to buy into the fact that there is very solid evidence of a strong relationship between innovation, growth and profitability: innovative companies do genuinely tend to have higher profit levels for example. Putting it simply…

Innovation = Good

No innovation = Bad

When helping leaders to see innovation as part of their thriving and surviving, I always do my best to ensure that they understand that ‘doing it’ is what actually matters!

Why should an SME owner join the MCIL programme?

Whether working with me or one of my colleagues, we offer energy, enthusiasm, focus, and commitment to making a real difference. We can help businesses get to where they are going much more effectively than they may otherwise have done without us.We are just entering the final phase of delivery for the very first cohort of MCIL, and its plain for all to see that all the business leaders on the programme have benefited as individuals, and that their businesses are all the better for the experience too!

What has been the most exciting MCIL programme achievement?

Beyond the immediate theme of innovation, what’s got me most excited personally is that the companies we are working with are creating jobs! In fact, they are creating significantly more jobs than we’d originally envisaged. This very tangible ripple of new employment that we are helping to drive will have positive associated benefits for the Stoke and Staffordshire area for years to come. This makes me even more proud in terms of being involved in the delivery of this leadership programme.

To set David’s insights into context, try the reading list below.

Further Reading

Working in the Business, not On the Business Geri Stengel for Forbes, June 2012

Dynamic Delegation: Shared, Hierarchical, and Deindividualized Leadership in Extreme Action Teams Klein K., Zieghart, J., Knight A., Zhao Y. (2006), Administrative Science Quarterly, vol: 51 (4) pp: 590-621

 

 

Risual: what a high-growth firm looks like

Risual: what a high-growth firm looks like

The MCIL August 2017 leadership session was all about sales. The two-day session for SME leaders emphasized the importance of ambition and culture in achieving better sales. Luckily, Alun Rogers, co-founder and director of Risual  was on hand to explain how he achieved better sales through a focus on managed growth.

Alun Rogers Risual Aug 2017 photo
Alun Rogers, co-founder of Risual shares his secrets of managing growth

Risual are a Staffordshire based company who provide IT consulting, managed services, and technology to clients globally. Their sales figures continue to be impressive: they achieved a 40.6% increase in sales in 2015, and a 41.4% increase in 2016, based on their latest submission to Companies House. Risual are clearly a high-growth firm.

Alun ascribed their sales success to a number of growth-oriented attitudes:

  1. Being Ambitious: “We wanted to do something and to take it as far as we can”

Alun and his friend Richard Proud set up Risual in 2005 based on a mixture of credit card loans and faith. While ambitious entrepreneurs no longer need to turn to credit cards to source funding (a previous blog post describes the variety of funding sources available: from government grants , to business loans to equity funding), sheer hard work in the early days crucial. Early research into firm growth described the passion of firm owners:

“Small businessmen frequently tend to identify themselves with their firm and to view it as their life’s work, as a constructive creation to which they can point with pride.” Edith Penrose “The Theory of the Growth of the Firm”, 1955.

Illustrating this dedication to their firm, Alun and Richard virtually lived in the business for the first 18 months. They worked 16 hours a day, 7 days a week to pay back their debt and build up client goodwill.

Their determination and effort is typical of the “Introductory” stage of the firm below.

firm lifecycle stages

The lifecycle theory of the firm argues that sales increase as the firm grows over time. As Risual  moved into the second year of their business, they moved into the “Growth” stage. This required them to invest their cash reserves into recruiting more staff.

  1. Focus on Growth: “If you are the product, you don’t scale”

During the next few years, Risual would meet the OECD  definition of a high growth business:  “a firm of 10 or more employees that grows either its employees or turnover by an average of more than 20 per cent per year for three consecutive years.” It is important to note that there have been cautions against using this definition (Daunfeldt, Johansson, & Halvarsson, 2015), particularly as firms grow in different ways. Growth can be organic (as in the case of Risual, which grew through sales) or through acquisition (where a company buys another company and instantly adds jobs and turnover to its balance sheet).

Alun and Richard were looking for organic growth and quickly realised that they needed to recruit more staff in order to grow their business. This was a wise decision. SMEs who recruit more staff than they immediately require (as Alun and Richard did)  are said to have “slack resources” (George, 2005). The slack resources argument suggests that additional staff or funds provide a cushion that allows firms to respond quickly to new orders or to initiate a change in strategic direction. SMEs with slack resources have been found to grow more quickly than those without (Moreno & Casillas, 2007).  Risual now have over 100 employees and are focussed on sales growth and product diversification.

  1. “Stop doing what you love to start doing what you love.”

Over time, Alun realised that he had to focus less on technical innovations (which he loves) to set up processes and structures for the business. In time, this would mean that the business would run itself and he could re-focus on working with technology. One example of how a new process helped manageable growth was in the area of recruitment. Risual use the SWAN formula for staff recruitment which was originally developed by the American Management Association (Thompson & Tracy, 2011). The acronym stands for: Smart, Works Hard, Ambitious, and Nice. Alun explained how he applied these 4 characteristics to Risual:

  1. Smart” people have the right skills for their job.Jim Collins describes the importance of smar people in his business classic, Good to Great, where he wrote about “getting the right people in the right seats on the bus.” (Collins, 2001).
  2. People who “work hard” are essential for growing SMEs. People who are unaccustomed to hard work do not fit with Risual’s culture of doing what it takes to succeed and dedication to the job.

    3. “Ambitious” staff should clearly demonstrate why they want the job.Risual only promote from within. This means that staff do not have to compete with external candidates for a promotion. But staff do have to be self-motivated to provide the leadership that Risual required as a growing company.

    4. “Nice.” Risual’s culture is positive, supportive of others and unconventional. Risual’s values have been crucial to building long-standing relationships with their customers and energizing their workforce. For an example of Risual’s unconventional approach to corporate life, enjoy their “Zombie Employee of the Year” video below:

https://www.youtube.com/watch?v=9NU6ngFwQtM

Risual are now firmly in the “Maturity” stage: confident, with a solid revenue stream from consulting and managed services that funds the innovations developed by their technology division.  Their growth ambitions required hard work, long hours, and structured management processes. They have never lost sight of their values, and have embedded their culture into all aspects of their business.

 

Reading List

Collins, J. (2001). Good to Great: Why Some Companies Make the Leap…And Others Don’t. New York: Random House. https://doi.org/0712676090

Daunfeldt, S.-O., Johansson, D., & Halvarsson, D. (2015). Using the eurostat-OECD definition of high-growth firms: a cautionary note. Journal of Entrepreneurship and Public Policy, 4(1), 50–56. https://doi.org/10.1108/JEPP-05-2013-0020

George, G. (2005). Slack Resources and the Performance of Privately Held Firms. Academy of Management Journal, 48(4), 661–676. https://doi.org/10.5465/AMJ.2005.17843944

Moreno, A. M., & Casillas, J. C. (2007). High-growth SMEs versus non-high-growth SMEs: a discriminant analysis. Entrepreneurship & Regional Development, 19(1), 69–88. https://doi.org/10.1080/08985620601002162

Thompson, M., & Tracy, B. (2011). Now, Build a Great Business. New York: AMACOM.

 

A Short History of the Purchase Funnel

Grant Leboff is back! This time with a short video about how today’s short attention spans have transformed marketing. Grant explains how the classic “purchase funnel”, which describes how customers decide to buy a product, no longer works.

The image below shows the classic “purchase funnel” with a wide opening.  SMEs fcus on raising awareness over a wide audience, then help “funnel” customers towards a purchase decision. The problem is that large numbers of potential customers are required for this model to work.

classic purchase funnel

 

In his video, Grant argues that the classic purchase funnel is outdated. This is because social media has drastically shortened our attention spans. SMEs can no longer rely on capturing the attention of large numbers of potential customers. Instead, SMEs should work on building long-term relationships with individuals who will recommend their products to friends and family. Check out the short video below where Grant recommends a purchase model for the digital era.

Financing SME Growth: Banks vs Equity Capital

Financing SME Growth

Our leadership development session included an inspiring workshop from Professor of Practice, Gary Crowe, of Keele Management School. Gary used his extensive experience in the banking industry to deliver a challenge to SME owners. How are they going to finance their growth ambitions? This post will look at why growth matters for SMEs, how credit finance can be used to increase growth, and why SMEs been reluctant to resist growth to date.

Finance to solve growth problems

Governments want businesses to grow so that more jobs are created and more taxes are paid. Firm owners want their businesses to grow so they can make more profit, keep up with their competitors, and expand into new markets. For a start-up, firm growth means a sole trader moving her office out of the spare bedroom and into a business park and hiring staff to help her run the business.

maslow growth quote

However growth can be expensive to achieve. Firms need to buy expensive equipment, hire skilled people, and build bigger offices to house their new assets. Small firms may not have the reserves to pay for these costs, so the expectation is that they will borrow to finance their growth.

However, the vast majority of SMEs are not borrowing at all, let alone for growth. The 2015 Small Business Survey showed that only 17% of SME employers had sought external finance in previous 12 months . This was a 2% decrease on the 2014 figure and a 9% decrease on the 2010 SBS figure. The 3-year decline in SME borrowing is surprising given that bank lending to SMEs has increased since 2014. The British Business Bank reports that the net flows of bank loans for small business turned positive in 2015  with four consecutive quarters of growth in bank lending totalling £1.6bn through to Q3 2015. The SME Finance Monitor reported that 70% of all loans in 2015 were successful. This shows that when SMEs do apply for finance, the majority of firms are successful.

Finance requirements change through the firm lifecycle

Given that only a minority of SMEs are seeking financing, at what point do growth-oriented SMEs seek investment for growth? The 2015 Small Business Survey showed that demand for bank finance increased with the size of the business. There is clearly a connection between the size of the company and their appetite for risk: 27% of mediums sought finance in the last 12 months, compared to 16% of micros.

Whatever their size, most SMEs will go to their bank for credit. However, for firms with growth ambitions, equity finance is a more attractive provider. Equity finance requires the firm owner to sell part of their ownership interest in the firm in exchange for their money. Equity investors therefore buy part of the firm and are looking for firm growth, so that their investment will deliver strong returns. As a result, equity investors are more likely to support growth-oriented plans. As small firms start to grow, their equity financing needs start to change.

We can see how the appetite for equity finance changes throughout the business lifecycle.  Gary provided a slide showing how sources of finance evolve from more informal sources of equity finance, such as friends and family in pre-start stage, to more formal, demanding types of private equity, such as the stockmarkets and mezzanine finance during the more mature stage.

Equity Funding Ladder

Source CBI – Slice of the Pie, Tackling the under-utilisation of Equity Finance

http://www.cbi.org.uk/cbi-prod/assets/File/pdf/cbi_equity_finance_report_3_feb.pdf 

Why firms don’t want to access credit

However, both equity finance and bank lending remain under-utilised. The reality is that, despite the availability of finance, most SMEs do not want to grow. The 2015 Small Business Survey showed that the top three reasons for accessing finance were to fund cashflow (62%), to buy property or equipment (39%) or to buy land (14%). Only 9% were looking to fund expansion (growth) and only 3% to invest in growth-enhancing R&D.

The majority of SMEs remain “happy non-seekers” of finance, content to remain small and unencumbered by debt. Another, less complimentary term, for this type of SME is “muppets”, or marginal, under-sized, poor-performing enterprises. These low-growth firms are described in Alex Coad and Paul Nightingale’s influential paper, Muppets and Gazelles: Political and Methodological Biases in entrepreneurship research. Coad and Nightingale argue that biased policy-makers and poor research practices have led to an over-estimation of the extent to which SMEs contribute to the economy. Coad and  Nightingale find that the majority of SMEs do not want to borrow money because the average SME owner is not capable, nor interested, in growing their business. “Muppets” are marginal because they lack the ambition or ability to grow or innovate, have high business failure rates and are poorly understood by government statistics or academic research. They are undersized because they remain too small for the efficiencies of scale needed to compete with the dominant players in their industries. The inevitable result is poor performance: “muppets” have poor productivity and low levels of innovation. These firms are simply incapable of accessing the credit market.

Even ambitious firms are reluctant to borrow due to bad experiences with banks. Many indebted SMEs found that their lenders became less supportive once the credit crunch began. Banks examined their loan agreements for covenants that the borrower might have breached and, if they found any, they called in the loan or altered its terms. In other words, bank debt was actually behaving like equity finance: the bank lender became a part-owner of the business, able to dictate terms and potentially even causing the business to fail. High-growth firms were more likely to access finance from highly leveraged and unstable banks; therefore, researchers argued, the effect of the credit crunch on business failure of high growth firms was amplified. A persistent memory of badly behaving banks has caused many SME owners to avoid seeking credit.

 

How can policy-makers support financing for growth?

Policy-makers have long been concerned about why SMEs are not interested in accessing finance for growth. There are calls for the government to help build an equity culture in the UK, including a pre-capital market equity investment house. Other policy advisors recommend a Business Academy Network, similar to our own MCIL project. Business Academies, backed by the government, could help business owners to be more confident their growth and financing plans. The British Business Bank was set up as a result of government concern about the lack of options for bank lending. The government-underwritten bank now funds start-ups and businesses wanting to grow.

In conclusion, SMEs now have a wider range of financing options for growth than ever before. However, SME owners remain, on average, uninterested in growth. Those who are accessing finance are going to bank lenders, rather than equity capital who may be more able to help them with long-term growth ambitions.

The “muppet” show isn’t over yet.

Further Reading

Coad and Nightingale (2011). Muppets and Gazelles, political and methodological biases in entrepreneurship research: https://academic.oup.com/icc/article/23/1/113/670219/Muppets-and-gazelles-political-and-methodological

Du, J., Gong, Y., & Temouri, Y. (2013). High Growth Firms and Productivity – Evidence from the United Kingdom. Retrieved from www.nesta.org.uk/wp13-04

Freeman (2013). Finance for Growth – Challenging the Myths about Funding for Small Businesses https://www.demos.co.uk/files/DF_-_Finance_for_Growth_-_web.pdf?1378216438

HM Treasury. (2011). The Plan for Growth. Retrieved from https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/31584/2011budget_growth.pdf

SME Finance Monitor website: http://bdrc-continental.com/products/sme-finance-monitor/

 

 

SME Growth and Public Policy

Entrepreneurship research is characterised by the close collaboration between business, policy, and research. My own research would have been impossible without the help from organisations that foster networking. Two of these organisations, the  Institute for Small Business and Entrepreneurship, and the Enterprise Research Centre, organised a policy round-table event  at Coventry University Techology Park last week to discuss SME growth.

The “Start-Up or Scale-Up” event was to ask whether policies in the UK currently support the development of growth-oriented plans by entrepreneurs. Participants came from a range of universities, and support organisations such as Growth Hubs, LEPs, and Chambers of Commerce. Debate amongst the participants was lively.

Research by the ERC on the impact of high-growth firms and job creation in 2015 showed that, over a three year period, high growth firms represent less than 1% of established businesses, but create over 20% of job growth in all established businesses which grow. High-growth firms make a disproportionately huge impact on job creation. Hence the government interest in supporting high-growth firms. An influential report from NESTA (Brown, Mason, & Mawson, 2014) explores the misalignment between public policy and high-growth firms, particularly given the complex and under-researched nature of what growth involves.

Definitional problems around “high-growth” firms

The policy round table was opened by Professor Stephen Roper with a definitional problem: most policy-makers are using a very specific, even restrictive definition of what a “high growth firm”, or scale-up, actually is.

Start Up Scale Up

The Department for Business Energy and Industrial Strategy is using the OECD definition of a high-growth firm:

“All enterprises with average annualized growth greater than twenty percent per annum, over a three-year period, and with ten or more employees at the beginning of the observation period. Growth is thus measured by the number of employees and by turnover.”  (OECD & Eurostat, 2007)

The problem is that this definition excludes the vast majority of SMEs. 82% of SMEs in the UK have fewer than 10 employees (Department for Business Innovation and Skills, 2016). Of these, 76% had no employees. Start-ups generally have no employees, but have huge growth potential, and often require credit finance, leadership development, and support with exporting to achieve that growth.

A further difficulty is spotting firms at the right time, so that they can be offered help when they most need it. Firms spotted “ex ante” have often come out of a growth cycle and no longer require help. Professor Roper has developed a process whereby high growth firms are spotted through HMRC quarterly tax returns. When HMRC notice an unusual increase in pre-growth indicators, perhaps a change in employee numbers or turnover, they would inform the Growth Hub advisors in the firm’s geographical area. The advisors would then visit the firm to offer support for their growth.

Policy Suggestions for Growth

Professor Roper’s process addresses a key problem: only a small fraction of SMEs have heard of support organisations. Indeed, participants noted the fragmented nature of support for SME growth. In 2015, only 13% of SME employers in England had heard of Growth Hubs, the government-sponsored advisory and training service for SMEs. Growth Hubs are currently provided by the 39 LEPs in England. Wales, Scotland, and Northern Ireland have separate arrangements. Participants in the room noisily discussed the need for a joined-up policy on promoting business growth.

In addition to a lack of joined-up support for growth, a previous post argued that most SMEs are neither willing nor capable of growth. Participants then discussed whether government policy should stop subsidizing all SMEs and focus only on those with growth ambitions. This argument has been made by DEMOS , a non-partisan think-tank. A straw poll of the room showed that about 50% of us thought that government policy support should only go to firms with growth ambitions. The other 50% thought that all SMEs, irrespective of whether they have growth ambitions or not, should be supported.

I would also argue that we must support SMEs who appear to lack growth ambitions. We already know that the majority of entrepreneurs do not have higher education (Department for Business Innovation and Skills, 2016). Research shows that those with higher education can get better-paid jobs, and therefore don’t need to start a business. However, entrepreneurs that want to grow their business may be deterred by their lack of education, including knowledge about support organisations. A lack of growth ambition could therefore simply be a lack of confidence. All entrepreneurs should be given the confidence, skills, and knowledge to grow. Government and local policy should explain the benefits of growth to SMEs, and show them how to grow in a productive and sustainable way. Today’s event was a timely reminder of how much more needs to be done in this area.

 

Further Reading

Brown, R., Mason, C., & Mawson, S. (2014). Increasing “The Vital 6 Percent”: Designing Effective Public Policy to Support High Growth Firms. London. Retrieved from http://www.nesta.org.uk/wp14-01

Department for Business Innovation and Skills. (2016). Longitudinal Small Business Survey Year 1: SME employers. Longitudinal Small Business Survey Year. Retrieved from https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/522364/bis-16-227-sme-employer-report.pdf

OECD, & Eurostat. (2007). Eurostat-OECD Manual on Business Demography Statistics. Retrieved from http://www.sourceoecd.org/industrytrade/9789264041875

 

 

 

Stay private or go public? Firm funding strategies.

Innovative, growth-oriented firms, such as those on the Mercia Centre for Innovation Leadership project, often require additional funding. This could be to finance innovative new projects or to fund employee and capital equipment growth. This post looks at the advantages of going public versus staying private. (A longer version of this article was published in The Conversation)

Control over executive pay

First, founders and bosses get full control over senior executive pay. Because a small group of existing shareholders dictate who buys the shares, it makes it far less likely that activist shareholders will reject controversial pay awards.

Avoiding red tape

Staying private also avoids the onerous disclosure requirements from stock exchanges. Some companies fear that a small failing in due diligence could lead to troublesome interest from regulators, or even expulsion from a stock exchange.

High costs of firm listings

The costs can be significant too. A firm listing on London’s AIM stock exchange for small companies will have to pay in the region of £350,000-£400,000, with a further 6% of any funds raised being paid to brokers.

 

Public vs private.jpg

 

With these incentives to stay private, why go to the markets at all? The public markets are still the ultimate destination for a number of reasons.

Regulatory requirements

Prior to the Jumpstart Our Business Startups (JOBS) Act of 2012, firms in the US had to go public if they had more than 500 shareholders. This is the ruling that forced Facebook to go public in search of more capital. Now that firms can have up to 2000 shareholders, fewer firms need to go to the public markets. Yet growth-oriented companies will still, eventually, have to go public.

 

Promises made to staff and investors

Innovative, growth-oriented firms often extract long hours from staff and patience from investors by promising shares when the firm eventually goes to the markets. Staff and investors cannot be placated indefinitely if they are waiting to cash in their shares.

Recruitment of top talent

Going public can also be a stimulus to recruit top talent. A company preparing for IPO is advised to bring in the best CEO and chief financial officer one to two years before so they can build relationships and galvanise staff.

Companies can also derive a moral benefit from the transparency of public markets. This is particularly true of growing global stars, like Uber and AirBnB, that are changing employment and social practices. A broad base of public ownership is more democratic than ownership by wealthy and invisible individuals. In the increasingly fractured world described in the June training session, companies need to demonstrate they deserve the trust of the public.