Business growth, innovation and state funding

Ask an audience of new business owners to identify the most crucial driver of growth and you are likely to receive an array of responses. The list might include talent, determination, vision, strong leadership, competitive advantage and product differentiation. In the final reckoning, though, one answer should clearly feature above all others: money.

The truth, after all, is that every company starts out small and needs funding to become bigger. Some entrepreneurs might use their own finances to fuel expansion; some might secure backing from their family or friends, and some might be left with no choice but to seek external funding.

The entrepreneurs who make up the last of these groups have almost invariably faced the toughest challenge. Historically, their businesses have lived or died by the caprices of financial institutions. Naturally, banks are still wary in lending decisions in the wake of the global financial crisis. The situation is further complicated by the emergence of a qualitatively different set of lending opportunities.

Rapid and accelerating developments in technology and communications provide the perfect conditions for a much faster exchange of information and experience, and the development of new business ideas and innovations. Many of the nascent entrepreneurs generating this new wave will require external finance, but their lack of experience and asset-backed security will prohibit access under conventional criteria.

The fact is that loans are increasingly conspicuous by their absence for many of the young originators of radically new business concepts. As a result, a wave of innovation is at grave risk of either going to waste or being lost to other economies which have more modern and sophisticated financial services.

There is a measure of comfort in the knowledge that novel means of financing are taking up some of the slack. Crowdfunding is one obvious example of these new approaches. With so much at stake, however, it may be high time to reconsider the fundamental role of the state in bankrolling the country’s brightest new businesses.

Redefining the role of the state

It has long been widely assumed that the most effective contribution the state can make to business growth is to ensure that markets are “innovation-ready”. In other words, rather than investing directly in new companies, it should intervene to encourage the efficient operation of markets whenever appropriate. This view has dominated in the UK since the 1970s.

Yet the reality is somewhat different. Research has shown that the state is eminently capable of doing much more. Despite the romantic image of a swashbuckling entrepreneur single-handedly prevailing against all odds, the state has often served as principal risk-taker in supporting breakthrough concepts.

What is urgently required now, particularly when the economy in general is liable to suffer if innovative enterprises are denied the backing they need to flourish, is a much more wide-ranging application of this philosophy. Radical innovation demands radical finance, and there is a good case for nominating the state as the ultimate provider.

Imagine, for example, a state-controlled Innovation Fund. Rather than standing alongside traditional and alternative sources of funding, this could act as a “lender of last resort” for businesses and entrepreneurs whose ideas, despite their genuine promise, have failed to convince other would-be sources of funding.

Unlike these other sources, such a fund would be designed to accommodate the ways in which many modern-day innovators operate. It would be constructed with an eye on the radical and the future, however uncertain these might be, rather than with an eye on the conventional and the past. It would strive to meet needs that at present are too often unmet.

How might such a scheme work? Crucially, it would have to employ criteria very different to those with which new business owners have become wearily familiar. Previous experience and performance would count for comparatively little, with much more weight given to prospects and potential. As ever, it would be a question of risk and reward – but one approached in an entirely unconventional way that would better reflect the proven importance of radical innovation.

Plus ça change... 

While entrepreneurs would no doubt welcome such an initiative with open arms, admittedly, it is difficult to imagine too many policymakers warmly embracing the notion of an Innovation Fund. The irony of such official disinclination should not be lost on us.

Perhaps the naysayers might usefully revisit Joseph Schumpeter’s The Theory of Economic Development, which was published in 1911. Schumpeter argued that it is the radical, not the incremental, that spurs progress. What was true more than a century ago is still true today, and policymakers would do well to recognise as much.

Another insight that still holds true, and which may have even more serious implications now, confirms what many businesses have known for decades. It emerged very clearly to me during my work more than 40 years ago for the Committee to Review the Functioning of Financial Institutions, and it was encapsulated as follows:

The smaller the firm, the larger the proportionate increase in capital base required to respond to an increase in demand – but the lower its ability to command loan and equity finance.

To this should now be added the following:

The more rapid the flow and exchange of radical new ideas, the larger the opportunity for innovation-led growth and economic development – but the greater the need for a radically different, alternative source of external finance if it is to be realised in practice.

We may never understand the scale of negligence by the state in the absence of an Innovation Fund, because we cannot observe how many “birds” never flew. Casual observation of some of our better-placed competitors, however, may provide us with the sad and belated advantage of hindsight.

Martin Binks is the former dean of Nottingham University Business School and a Professor of Entrepreneurial Development at its Haydn Green Institute for Innovation and Entrepreneurship.