Time to get behind the UK's high growth small businesses

Simon Rogerson, Octopus Investments

Published this week, the Octopus High Growth Small Business Report 2015 highlights the impact on our economic value of Britain's fastest-growing smaller companies. It also, for the first time, quantifies the role that such companies are playing in driving regional growth across the UK.

This is the second year we've published the report and the results confirm that the UK economy owes a huge debt of gratitude to the companies we've surveyed.

Last year, one in every three new jobs in the UK was created by a 'high growth small business' (HGSB), and they contributed almost 20 per cent of the UK's economic growth.

Their impact is even more impressive when you consider that HGSBs represent less than 1 per cent of the total number of UK companies.

THE HIGH GROWTH SMALL BUSINESS CRITERIA

To be defined as a HGSB, a company must have achieved average annual turnover growth of more than 20 per cent over a three-year period. It must also have annual turnover between £1 million and £20 million.

It might come as a surprise to learn that HGSBs are not an entirely London-based phenomenon. In fact, three out of every five HGSBs are located outside London and the South East.

What's more, this year's report shows that HGSBs are continuing to have a disproportionately powerful impact on regional economies, including in Northern Ireland and Wales, and in cities such as Newcastle. Without the economic impact of HGSBs, total UK economic growth could be even more heavily skewed towards London and the South East.

Neither is the HGSB sector dominated by technology start-ups, as you might think. Our report shows that almost two thirds of HGSBs are to be found in the service sector, particularly within administration and support, whereas tech companies account for just one out of every 10 HGSBs.

Yet despite their economic contribution, and their clear growth potential, access to funding remains a significant problem for many of the companies we surveyed. HGSBs still attract relatively little attention from an investment community that still clings to the belief that 'bigger is better'.

But there's a very simple reason why smaller companies shouldn't be ignored by investors: they offer the greatest potential for sustained earnings growth, which remains the real driver of long-term returns. To make an obvious point, it's easier for a £100 million company to double in size than for a £100 billion blue chip.

TAPPING INTO THE INVESTMENT OPPORTUNITY

Admittedly, HGSBs are by their nature higher risk, as new companies and unquoted smaller companies have a greater failure rate than those listed on indices such as the Alternative Investment Market (Aim) or the main market of the London Stock Exchange.

But investors willing to accept this risk should note that there are government-approved investment vehicles such as the Enterprise Investment Scheme (EIS) and venture capital trusts (VCTs), which were created in part to provide financial support for smaller companies.

Smaller companies versus all companies performance

20-year performance: smaller companies versus all companies. Source: Lipper, May 2015

To help compensate for the risks there are significant tax benefits, including 30 per cent income tax relief (on any investment up to £200,000 for VCTs and £1,000,000 for EIS per year), and tax exemptions on VCT or EIS capital gains, and on VCT dividends.

Investors can also benefit from being able to invest in actively managed portfolios of smaller companies run by experienced and dedicated investment teams capable of undertaking the necessary due diligence and research to find the very best investment opportunities.

As our 2015 report demonstrates, it makes sense to give support to entrepreneurial small companies that are having a positive economic and social impact on our society. They may be thriving already, but we think there's a lot more to be done for HGSBs.

And from an investor perspective, VCTs and EIS solutions can enable investors to play an active role in supporting this dynamic but little-known section of UK businesses.

Simon Rogerson is chief executive of Octopus Investments, a fast-growing UK fund management business with leading positions in several specialist sectors, including smaller company investing.


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