Select Committee on European Union Minutes of Evidence


Examination of Witnesses (Questions 100-119)

MONDAY 12 MAY 2003

MR ANDREW MARRATT AND MR STEVE BATEMAN

  100. It is obviously high risk.
  (Mr Marratt) Yes, very high risk. We are always being approached "I have this great idea". I have actually had it put to me by one public sector adviser that if the Queen is putting her money in—but I think they meant the taxpayer—to a SMART award or whatever, the bank should automatically match that with funding. If it is a good idea, we should do that. Our experience and the experience of other countries has been that once we start going down the line of putting loan finance or debt finance into an idea, when it is possibly years away from generating enough cash to meet the repayments and may not ever generate that cash, it is not a place that the commercial retail banks can go. It is just not our market. There is a need for us to be able to assess the idea and pick out a good idea or company which has a good idea, which is then one which is worth working with and sticking with, and trying to help them find sources of suitable funding. If we just load them with debt finance, which they cannot afford to pay, they end up with a bust company and we end up with a bad debt. We are keen to identify the companies with the good ideas, then work with them through various means we have to try to help them get funding from elsewhere. There is a lot we can do for them in the meantime.

Chairman

  101. You partly implied that in the SMART scheme the numbers of people receiving grants was getting to the point where the failure rate was starting to go up. That was the implication, though you put it slightly differently.
  (Mr Bateman) Yes; we were talking about this before we came in. That the SMART award has been very successful in driving up numbers is now creating a problem because the follow-on scenario is that there are more projects which require funding and only so many funders in the marketplace ready to invest at the current time. It has been a victim of its own success to some extent and that is why we have come across these second round funding problems in progressing things.

  102. That is a different problem; that is a different proposition. You are saying that the scheme is in fact successful, despite being expanded.
  (Mr Bateman) It is a very successful scheme but there is a slight risk that if there is a drive to get numbers up, or whatever, if the management potential of the people putting the proposal forward is not addressed at the early stage, then you could see more failures later on because they will not get the funding from the venture capital funds because they will not have the management in place to get suitable funding.

Baroness Cohen of Pimlico

  103. I think I should declare, if not an interest, at least a warning. I am an ex member of HSBC Investment Bank. I came in with the furniture from Charterhouse Bank and I have a great deal of experience of funding small start-up companies. I think what you are saying about the trouble with the SMART scheme is that if you are not very careful you get everything funded to stage one, complete with bank debt, then it falls flat on its face, complete with bank debt, when you try to get to stage two.
  (Mr Marratt) Yes.

  104. Which is, of course, important. In a way you are being slightly bludgeoned: if the chap has a SMART award and some equity it is difficult not to lend to him, but it may not go through the next hoop.
  (Mr Marratt) Yes, and with the current state of the venture capital market, at the moment is not exactly the best time to be going for follow-on funding. If it is a technically feasible idea, but without the management ability to take it forward, then, as we know, venture capitalists look at management, management, management and an idea with it. If ones are getting through which do not have the management skill, in a sense they are just delaying the issue they are going to have to face later on.

  105. How many of these do you have roughly?
  (Mr Marratt) I would have to come back to you with that. Of our network of Technology Banking Managers, which is about 18 in the country, I would say each one probably has about ten SMART winners on its books, but that is only a sample of 18 managers. If you multiply that over the bank as a whole . . .

  106. HSBC is one of the banks with the biggest coverage, so if we had an answer to this we would probably know the answer about the Royal Bank and HBOS.
  (Mr Marratt) Yes. It may not be a very easy number to collect as SMART winners are not a box we have ticked in the past, but it would be useful information for us to have. We can certainly do a sampling amongst our managers and see.

  Chairman: The DTI should be able to tell us.

Baroness Cohen of Pimlico

  107. Yes, the DTI should know the answer to the question, but do they know the failure rate? I suppose they might. What do you understand to be the objectives of the Small Firms Loan Guarantee Scheme? If the scheme is well understood—and it has been around a long time—why do you say in your note ". . . many potential customers fail to take account of the restrictions"? Which restrictions are they falling over?
  (Mr Marratt) It is an interesting point because at every seminar we run I can almost open a book on the point at which the SFLGS will become the point of contention amongst managers or customers or whomever. There does not seem to be an easy answer to it. We understand the official objective is to provide debt funding where the proposition is, that if absolutely suitable for debt funding in everything except one item, that is the lack of availability or suitable security, the government guarantee kicks in to replace the security which would otherwise have been taken over land or assets or machinery or whatever. What the scheme effectively becomes, partly through the slight spin which is put on it and also the understanding of some advisers and some individual firms, is an offering of start-up finance for those companies which are not suitable for debt finance, for traditional bank loan finance, and the aspect of "simply because they do not have the security available" somehow gets lost in the telling. An awful lot of professional advisers, private sector advisers, accountancy firms and so on, do understand exactly how the scheme operates and what the requirements of DTI are for the guarantee. The understanding amongst—to put it in broad terms—the public sector, business link type advisers, is less heightened than it is with the accountancy firms. I would not say they do not understand it, but there is more than an expectation that this is a loan which people are somehow guaranteed to get rather than that it is a government guarantee. We have had people say to us that they are entitled to one of these loans, are they not, because the government is guaranteeing 100 per cent of it, therefore what has the bank got to lose? It is the old thing of the more change something has to go through, the more the tale gets altered a little bit inevitably and sometimes, by the time it finishes with the end user, the customer or the start-up firm, they are slightly of the impression that this is a government subsidised loan, almost grant. We have to have a constant education process both internally and externally to say no, you have to be able to demonstrate that you have a reasonable chance of meeting the repayments as they fall due, because if we lend money where those criteria are not met, the guarantee could be invalid and then we end up with 100 per cent of the debt and no security at all.

  108. I am sure that is not well understood. Nonetheless the SFLGS is very widely used, is it not? Could you suggest any ways of improving it or a better way of achieving its apparent objectives? What would you like to see?
  (Mr Marratt) One issue, particularly in relation to technology firms, which we face and why the SFLGS becomes quite popular for technology firms is that they tend to have a lack of tangible assets, because they are all tied up in intellectual property and they are new companies and so on. Just looking at the technology sector particularly, one comment which has been made to us is that, particularly now that under any circumstance the guarantee only covers 75 per cent, that does leave 25 per cent unguaranteed and totally unsecured with no comeback at all. You do not need many 25 per cents of £250,000 loans to build up quite a portfolio of bad debts and possible losses. One issue we have is that, a little bit because of the perception of it as an entitlement, there is a feeling that the directors of a limited company who have an SFLGS feel it is guaranteed by the government. There is a risk, shall we say, that they feel if things go wrong they can walk away from that loan and the bank is fearful, because they might feel they can walk away from that loan with no liability at all attaching to the directors of the company because the debt lies with the company and the bank and we have no direct call on the directors. Of course if we were able to take a guarantee from the directors of the company for the remaining 25 per cent, okay, there might not be big assets available to support that guarantee, almost by definition, because if the assets were available they would not have qualified for the SFLGS. At least they would feel they had bought into the project and would know that they could not just walk away from it without at least that guarantee being invoked and that would then have to go through due process and they would at least owe that much.

  109. Were you thinking of a personal guarantee, secured on a personal asset?
  (Mr Marratt) If it were secured on personal assets it might then invalidate the loan guarantee scheme.

  110. It is not meant to do that, is it?
  (Mr Marratt) If those assets were really there, then we should not be using the SFLGS. Even if those assets were not there, or were not of the value, I am not saying that is something we would always want to do, but at least if it were feasible, if it were something which would not invalidate the guarantee. The other improvement would be if the publicity were a little clearer for it, that simply qualifying under the criteria for the guarantee, that is being in the industry sector you qualify for, not being a hotel or whatever the excluded sector and being within the loan amounts and being a company running for so many years and whatever . . . We do sometimes get cases where people think that because they are within those criteria, they therefore qualify automatically for the loan. If it were made clearer in some of the government information on the DTI website and so on, that you must be able to demonstrate the ability to meet the payments as they fall due in order to qualify, then that would be a step forward.
  (Mr Bateman) That loan capital is not to be seen as a substitute for equity capital since equity must be the first source of funding for the companies.

  111. Yes, the point of all this being that if it is not clear to the consumers, then banks get a bit reluctant about it and the scheme does not go as it should.
  (Mr Marratt) Yes and then, to be colloquial, it gets a bit of a bad press sometimes.
  (Mr Bateman) I would say that in 99 per cent of the loan applications I have received nobody has seen that the minimum amount is £5,000 or £10,000—I cannot remember the exact lower threshold. Every application is in at the full amount, that is they have two years of revenue, they want £250,000 tops, or if they are just a start-up business they want £100,000 tops. Very rarely is there ever anything for a lesser figure.
  (Mr Marratt) It is a little bit like looking at it as a grant. Let us put in for the maximum amount we can get and then negotiate down, rather than let us look at the business and see what it actually needs and what it can afford to repay. If you do not get those two right, then you will end up with a bust business.

Lord Faulkner of Worcester

  112. I find your description of the various schemes very helpful and very clear. The one I want to ask you about is the one which quite clearly you are the most critical of, which is the TCS. What do you think are the objectives of the TCS?
  (Mr Marratt) As we understand it, we think it is a cracking scheme. We think it is a very, very good scheme. We are only critical in a way of the way it is not known about enough, it is not marketed enough, it is not well enough known or used throughout the university or business community. As I understand it, it is a scheme where it is a win, win, win. The university proverbial bright young graduate, keen to work on a project with industry, is enabled to transfer his or her knowledge from the university usually into a smaller local company. That company, which has a project, a problem to which it requires a solution, needs its manufacturing system revamped or looked at or whatever it may be but does not have the resources itself to do that, can get the services of the bright young graduate from university working on that project with a large proportion of the cost of that graduate paid for by the government scheme. The university wins because it sees its research and its people transferred over to the company. The company wins because the graduate is still mentored by the university, so they get the transfer of knowledge from the university research department into the graduate and UK PLC wins because a piece of industry gets some innovative work done which it might not otherwise have been able to afford. We have no criticism of the scheme as a scheme. I am sure there is tweaking as to the amounts paid to the individuals and the length of time it runs for or whatever, but our criticism is simply that it is not well known enough.

  113. Whose fault is that though?
  (Mr Marratt) It is partly that there is no clue in the title as to what it is. I was talking to an aerospace engineering student of A N Other university in London at the weekend and he said he was looking for employment fairly soon. I asked whether he had thought about the Teaching Company Scheme, TCS. He said he did not want to be a teacher. There was no clue as to what it was.

  114. So you think the name may be the cause of the problem, do you?
  (Mr Marratt) It is going to be renamed the Knowledge Transfer Scheme, so that will be of benefit. There are not enough local champions of the scheme within each university. Maybe the development of enterprise centres within universities, as we heard about earlier, will help with that. It has been moved a little bit from pillar to post as Teaching Company Scheme, Teaching Company Directorate, where do you find out about it?

  115. Is it a job for your Technology Banking Managers to promote it?
  (Mr Marratt) This is something we do in that we run, in conjunction with Brunel University, regular seminars for all HSBC managers on the issues faced by early stage technology firms and the various ways there are of supporting them. One session will be on it tomorrow morning. We have a whole hour on government support schemes, what universities can do for technology firms, grants and so on, an introduction, and the Teaching Company Scheme is very highly featured in that, the hope being that if our management come across a company which has a need for it, they can at least point the customer in the right direction and suggest they contact their local university, suggest which websites.

  116. What does the government itself say about the effectiveness of it? Do they recognise that it is obviously deficient?
  (Mr Marratt) We have not had a direct response on that. Until this consultation, I am not sure we have been asked the question. Obviously we have made informal representations at seminars and meetings and whatever, but perhaps they have recognised it by the fact that the name is being changed and it is crying out for re-launch and a bit of marketing spend.

Baroness Cohen of Pimlico

  117. I notice that Mr Bateman runs Oxford, so presumably you have experience of this.
  (Mr Bateman) I have to confess, of my three years in this role, I have probably had three instances of TCS being used.

  118. Is that because nobody knows about it?
  (Mr Bateman) Yes.

  119. Not a terribly good scientific investigation.
  (Mr Bateman) It is ironic really, when in the earlier presentation you were talking about the human resource recruitment being an issue and the skills shortage. It should be used a lot more. I would say in Oxford that the type of spin-out or company which establishes itself in Oxford tends to be a bit of a bigger entity, quite reasonably funded on the whole, quite a few university graduates involved in the setting up of the company. I was speaking to a company on the way down here today and ironically they are an Oxford spin-out, but they are using the TCS in the recruitment of an individual from the Aberdeen area.


 
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