Small and medium sized enterprises (SMEs) are the backbone of the British economy, and they can also provide opportunities for investors looking to diversify their portfolio while benefiting from inheritance tax relief.

Below, we explain how the SME lending sector works and how investors can access investments in this sector through the ProVen Estate Planning Service (PEPS).  

What are SMEs and why do they matter to the UK?

SMEs, as defined by the UK Government, are companies that employ less than 250 people and have an annual turnover of over less than £50m.

These businesses generate over £2.4 trillion in revenue and are the powerhouse of the nation’s economic growth.

As at the start of 2023, in total there were estimated to be around 5.6 million UK private sector businesses. The vast majority (74%) are sole traders, leaving around 1.4 million firms actively employing workers.

Of these 1.4 million companies, around c.260,000 are defined as a medium-sized business. These typically have an annual turnover of between £10m and £50m, employ between 10-250 employees and generate total revenues of around £1.4 trillion*.

Given their scale and importance to the UK economy, these medium-sized businesses are a focus for many investors looking for returns.

Beringea, which manages both the ProVen Venture Capital Trusts (ProVen VCTs) and PEPS, has a longstanding track record of investing in, and lending to, SMEs.

Why do SMEs require funding?

There are many reasons why businesses raise money. For example, they may want to:

- fund growth opportunities;

- invest in new equipment or staff;

- boost marketing spend; or

- expand overseas.

For a company to consider borrowing money, they should be generating reliable cashflows and have a clear plan for growth.

Since the financial crisis of 2007-8, medium-sized businesses have found it harder to access finance from the banks, which have traditionally been the primary source of funding for SMEs, and they have therefore turned to alternative financing sources to fuel their growth.

How does PEPS’ lending strategy work for investors?

The ProVen Estate Planning Service (PEPS) is a discretionary management service managed by Beringea.

One of the two strategies of PEPS focuses on lending. This strategy aims to offer access to a trading company that provides funding to SMEs in sectors that are able to provide core assets or reliable income streams as collateral.

For example, a recipient of funding from the trading company that PEPS invests in is a food business whose revenue is mostly made up from fixed-term and volume contracts, meaning there is a reliable income stream coming into the company. They also have tangible assets in the form of machinery and equipment, which helps provide collateral against the loan.

Loans can be tailored to meet a company’s specific needs. These can be in single or multiple drawdowns and are repayable with regular payments over periods which can be as long as five years.

Why would a company borrow money, rather than give away equity?

The main advantage of debt financing is that company shareholders do not have to give up ownership over part of their business. Once the loan is fully repaid, with interest, the relationship ends.

In contrast, equity financing means you sell a stake of your business in return for a cash investment. The money doesn’t have to be repaid, unlike a loan.

The lending strategy of PEPS only offers debt financing, as this strategy seeks to provide a steadier level of returns for investors.

What are the risks of lending to smaller companies?

There is always an element of risk in lending money. The biggest risk is that the company enters financial difficulties and the money will not be repaid.

The trading companies backed by PEPS take various steps to mitigate this risk as much as possible. The strategy is kept simple by only lending to UK companies that generate regular cashflows and have assets that can provide collateral.

Because PEPS is solely focused on the UK, we are also not exposed to the volatility of foreign currency that can have a major impact on investor returns.  

These steps are taken to target the security of a regular income for investors and PEPS’ returns are currently targeted to be 4%-5% per annum over the medium term after fees and costs.

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Beringea, as manager of the ProVen VCTs and PEPS, is one of the UK’s leading providers of tax-efficient investment opportunities - managing more than £330m on behalf of around 10,000 investors. Find out more about the ProVen Estate Planning Service (PEPS) here.

This article is for UK residents interested in finding out more about Business Relief and lending strategies. It is not our intention to offer legal, tax or investment advice, and we always recommend that investors seek professional advice that can take account of their personal circumstances before making any investment or estate planning decisions. An investment in the ProVen Estate Planning Service should be considered high risk and past performance is not a good indicator of future results.

Important notice: issued by Beringea LLP of Charter House, 55 Drury Lane, London, England WC2B 5SQ, registered in England & Wales number OC342919 and authorised and regulated by the Financial Conduct Authority, number 496358.

* Source: Federation of Small Businesses (FSB)