Economist warns of a ‘hole’ in the middle of Wales’ economy
WALES needs a new approach to financing firms looking to scale up through the provision of patient capital, says leading economist Gerry Holtham.
Aberdare-born Mr Holtham, in giving the annual Julian Hodge Institute of Applied Macroeconomics Lecture, said that in terms of Wales’ population of more than 250,000 companies, there was a lack of socalled middle-market firms.
And he said that his research, through Cardiff Metropolitan University, shows that many firms in this category have the ambition to scale up, providing they are able to raise not too onerous growth capital, including not having to give up too much equity. However, he said that often the terms offered on debt and equity deterred such firms from expanding.
And he said he hoped that the successor to Finance Wales, the Welsh Government-owned Development Bank for Wales, would – unlike its predecessor – back the growth plans of Welsh firms to scale up with finance on favourable terms over the long term.
And he said whether those backing strategies to improve the economic standing of Wales – which on the GVA per head measure is 71% of the UK average – favoured an exportorientated growth approach or the development of the so-called foundational economy by effectively intervening to get more indigenous firms to win contracts in areas like healthcare, transport and housing, there was a hole in the middle of the Welsh business population.
While both philosophies were at variance with each other, he said: “They both observe that Welsh firms are either branches of large international companies or they are very small. We don’t have many homegrown middle-sized businesses. And when we have one, it tends to disappear as they get to a certain size and sell out. We have not been able to develop any kind of Mittelstand [a reference to the strength of small to medium-sized firms in Germanspeaking countries] in Wales.
“So whether you want to see export-orientated led growth or you just want to improve domestic services and conditions to improve people’s everyday lives, you could argue that the missing link in either case is grounded companies that are able to develop from being small to being successful medium-sized companies.”
And he added that a small number of large companies, employing more than 250, drive a significant level of the overall turnover generated by the private sector in Wales
He added; “Employment also shows the hole the Welsh economy – everybody is mostly either employed by micro-businesses or in large businesses. We don’t have enough companies in this [mid-sized] sector and that is one of the abiding weaknesses of the Welsh economy.”
In his Hodge Foundation-funded research with Professor Brian Morgan of Cardiff Metropolitan University, they analysed companies in the mid-market sector in the Welsh economy.
He said: “We talked to a lot of companies and asked why they were not bigger. And some 80% said they planned to grow in the next five years in Wales, while most of them were selling far more than half of their output outside of Wales. These are the kinds of companies that you want and a third of them were collaborating on R&D, although not necessarily within Wales.”
However, he said that in terms of issues faced in realising growth plans, 18% cited (access to) finance, while 62% said they couldn’t secure the right sort of staff locally.
He added: “If they wanted technical, sales and managerial people, they said it was very difficult.
“I was talking to a fintech company and they were looking for a strategist and they found one, but he lives in Edinburgh and he is going to fly down and commute to Cardiff on a weekly basis. That is the number-one hole that [the companies surveyed] did tell us about.”
He also said that the vast majority of the firms interviewed, some 93%, had applied for some form of support or subsidy from the Welsh Government. Mr Holtham said that 51% had found the experience satisfactory, but 42% not so satisfactory,
He added: “But when we interrogated that, we found that the ones that found it satisfactory were on the whole firms from outside Wales coming in because there were grants available.
“But most of the companies that said it was unsatisfactory were ones here. And they often described the experience as painful. There seems to be in the bureaucracy a tendency that if you get someone in, that has to be good, but ‘what do freeloaders want money for?’.
“So if you have this bias in favour of attracting people in rather than helping the businesses that are here already, although I am overstating that somewhat, that affects the 18% who said they were having trouble in raising growth capital and are based here [so higher than 18% in the indigenous business category].
“And the problem here is that there a lot of schemes to get companies started and there are venture capitalists around to fund start-ups, but then they want the money back after three to five years. But what happens when you need the capital to continue to grow?
“We now have got the Development Bank of Wales and perhaps this is going to help to plug the gap, but certainly its antecedent organisation in Finance Wales didn’t succeed in plugging this gap.
“I have met a quite a few entrepreneurs that have told me [Finance Wales] only looked for three years and then took the money out. And as their second round of finance was going to come from London and their customers were in London too, they would ask, ‘What am I doing here?’. It’s the sort of question you don’t want to hear.
“So there is an issue, and it is not just a Welsh one, but an issue in UK finance, in that long-term, more patient capital is hard to come by.
“And what tends to happen is that [when firms cannot secure funding, or on good terms] they say, ‘This is okay – I cannot grow, but I am happy with my turnover of £5m to £6m. I am making £500,000 a year and I have a nice house in Cyncoed and can eat out and enjoy myself at the weekend... and I am not going to take on a lot of debt and risk my business’.
“They say that people that want to give them equity want to take an arm and a leg and even a right eye, so forget it. So, they say they will just settle into a low-level equilibrium.
“But I believe that if we had a different financial sector that could support these businesses, we could push some of them to grow to a big level, which they have the capability to do.”
The Development Bank of Wales said in a statement: “We recognise the growing demand for patient capital [a minimum of five years] to support businesses through their growth stages. The Development Bank of Wales has launched additional funds in recent years to address the need for longer-term investment.
“Our newest funds, the Wales Business Fund, invests up to seven years and the Wales Flexible Investment Fund up to 10 years. Between these funds, over £271m is available.
“We currently have 27 equity investments which have been in the portfolio longer than five years. Our average time to exit to date has been just over five years from initial investment.”
■ The Julian Hodge Lecture was sponsored by Hodge Bank, Cardiff University and Cardiff Metropolitan University.