We have run 5 innovation loans competitions since we launched our pilot in November 2017. Through these, we have learned a great deal about this approach to stimulating and supporting later stage innovation for growth-oriented SMEs.
This week we launched our new loans competition.
What did we want to learn?
In this pilot, we wanted to find out:
- Whether businesses would apply for loans?
- What they would use the loans for?
- Whether we could manage an effective and efficient process that provided a good customer experience and?
- Whether we could gather evidence of progress towards economic impact and suitable credit risk (the most difficult part in a short period of time)?
What projects and businesses have we funded?
We are developing a portfolio of businesses that covers a wide range of technologies, sectors and markets right across the UK.
Common theme 1 – manufacturing processes
One common theme is scaling up manufacturing processes. From feminine care products to portable X-ray and asbestos detectors, from 3D printers to industrial robotics and innovative materials for coatings, these innovations all need R&D work to be delivered repeatably, reliably, at scale and cost-effectively.
Common theme 2 - the use of data analytics
We are funding businesses that collect, analyse and report critical information to allow our borrowers’ customers – in advanced manufacturing, education, healthcare, clean energy, marketing and advertising – to operate more effectively.
The businesses we are supporting are typically quite young and small – 7 years old, with net assets of about £500k – but they are rarely brand new start-ups. In most cases they have been developing their technology (often with grants and usually with equity investment) for some time before reaching the point of seeking scale.
While we are supporting risky technology projects, we have taken care to try to manage the credit risk in our portfolio, with a projected default risk that is considerably lower than set out in the original business case. We have focused on the capitalisation of borrowers during their projects, frequently making additional capital-raising a condition of our loans. Borrowers have already raised over £21m in new equity investment.
Offering further innovation loans in 2019
There is more that we want to learn, though, so we will be extending the pilot. With £25m of additional funding available, we plan to run two more competitions in 2019, to continue what we believe has been an initial success and to build on what we’ve learned so far.
July and September innovation loans competitions
These competitions, that we expect to open in July and September, will continue to gather evidence about innovation loans and to test changes in two key areas – the rate of interest that we charge and the way we capture information about the suitability of businesses who apply for loans.
Understanding demand for innovation loans
With nearly 400 applications, seeking over £200m in loans, we believe that there really is demand for innovation loans.
The level of applications increased once we moved from the initial sector-based competitions to ‘open’ competitions and has continued at a strong level. We have committed the full £50m available in the initial pilot. Loans close to the maximum size of £1m have been most popular and the average loan size has turned out to be about £700k, with an average loan term of 7 years.
As result we have made only 70 loans, rather than the 100 we were initially aiming for. Extending the pilot will allow us to reach the 100 loan target that is important for our independent interim evaluation.
Improving process by testing interest rates
Feedback from businesses has been that the availability of these loans for risky innovation projects carried out by businesses that struggle to obtain bank finance is the most important feature of innovation loans. Applicants have told us that the interest rate of these loans, at a very low rate of 3.7%, was not a major factor. But we need to understand if cost really is an issue influencing demand, so in our extension competitions we are testing a higher rate of interest.
Is demand related to price?
We will charge 7.4%, which we believe is still below the rate that commercial lenders would charge – if indeed they would make a loan offer. But, because we recognise that revenues from the innovations won’t come for several years, we will only charge 3.7% during the project period, with 3.7% accrued and deferred to the repayment period, when the full rate of 7.4% will be payable. This will let us see whether demand really isn’t about price.
A new approach to assessing quality
Many applicants are used to the 10 questions that Innovate UK use to assess the quality of an innovation project. These questions broadly cover technology, market, project delivery, value for money and the need for public sector support. And, with an average innovation score of 78%, we are supporting the best innovations in our successful applicants. Many businesses have struggled with the detailed financial information and forecasts that we need to evaluate their suitability to take on a long term loan commitment.
In the pilot extension, we will test a different way to capture this information. The spreadsheets and open-ended questions about the business and management team will be replaced by a structured survey and analytics from start up specialists Early Metrics, to give a better user experience. We still need forecast financial information, of course, as these are very risky loans, but this approach will let us see if there is an easier way for customers to give us what we need.
It is to be expected that a large number of businesses in our portfolio are based in and around London, but we have also seen clusters of successes in Exeter and Belfast. In the extension to the pilot, we will aim to attract more demand in the Midlands and North East, which were relatively under-represented in the first competitions.
Are we seeing evidence of progress towards impact?
It’s too early to see anything other than preliminary hints of whether innovation loans will deliver the expected outputs, outcomes and impact. So far we haven’t seen any businesses encounter financial difficulty – although there are a couple that our credit team are keeping a close eye on as things aren’t developing in the way they anticipated (which isn’t necessarily a bad thing, of course).
Speed, jobs and the future
Our interim evaluation is providing some suggestions of the value of the programme, with most successful applicants reporting that their projects are progressing more quickly and better than they would have done without the loan, while many unsuccessful applicants have told our evaluation consultants that they have not been able to access finance to progress their projects.
Dozens of jobs have been created in R&D roles as borrowers have started on their projects – but the real impact of jobs in production, sales and marketing will only come through in a few years when (or if) projects reach full commercialisation and the businesses scale and grow.
The quality of the business leadership
For me, though, the strongest indicator of the likely success of innovation loans isn’t easily captured in the metrics of loan applications, financial covenant tests and project monitoring scores or indeed in the typical case studies of shiny new technologies.
What gives me confidence that we will see economic impact and the desire to extend this pilot towards a full scale programme is the quality of many of the business leaders in our borrowers.
We gathered about 50 CEOs from our portfolio at a workshop earlier this year, where they displayed a level of growth ambition, commercial capability and professionalism that convinced me that we will succeed in our aim of using loans to help highly innovative micro, small and medium sized businesses to scale and grow.
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