How policy changes could help start-ups grow faster

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Entrepreneurial Britain

Although the UK is Europe’s most entrepreneurial country, start-ups face myriad challenges. James Sproule explains how policy changes could help them grow faster and benefit the wider economy too

An election campaign invariably accentuates the differences between members of the political establishment across a broad range of issues. The need for Britain to encourage entrepreneurs is that rare exception: an area of near universal agreement. Indeed if there is a danger it is that entrepreneurs can be seen as almost a miracle drug, solving policy conundrum after policy crisis.

But simply asserting that entrepreneurs are an undoubted “good” and that the UK would love to have its own home-grown, world-dominating behemoths like Amazon and Facebook is not enough.

There needs to be much more of a practical focus on what can realistically be done from a policy perspective to encourage entrepreneurs, as well as a concentration on specific actions that are most discouraging or counter-productive to business start-ups.

There is always a danger of conflating “entrepreneurs” with internet or tech start-ups. Worse, when non-tech entrepreneurs are being considered there can be a tendency to slightly dismiss any non-tech entrepreneur as a ‘consultant’ who will take on a full-time job as soon as they can find one.

Such people exist, but people who turn to entrepreneurship out of necessity account for less than 1.5 of the seven per cent of the adult population engaged in such activity¹.

The IoD encourages all sorts of entrepreneurialism, in whatever field or industry people feel they can find opportunities. By its very nature, a new business means someone has spotted what they feel is an unfilled niche, and they are going to survive and thrive by being more responsive to opportunities than larger rivals.

McKinsey estimates that 21 per cent of developed world growth between 2006 and 2011 was due to the internet. Already, in 2009 the internet as an industry was almost 3.5 per cent of global GDP².

The number is much larger in the UK, however, at roughly 12 per cent of GDP, according to Policy Exchange³. UK online retail trade alone makes up a trade surplus of $1bn (£674m), larger than the online markets of the US and Germany combined. The very newness of the industry means much of this economic growth is being driven by entrepreneurs.

But the effect is being felt well beyond the tech sector, with McKinsey gauging that 75 per cent of the impact of the internet arises from traditional industries4.

What entrepreneurs bring above all is a new vitality in many economies, and the economies that embrace entrepreneurialism and the inherent competition are the ones that are going to thrive.

In looking at the factors that encourage entrepreneurs, three seem to be critical from a policy perspective:
   How can entrepreneurs find appropriate financing?
   How can entrepreneurs find the right talent to help them run their businesses?
   How can entrepreneurs cope with the regulatory burden?

The data on the graph above explains a good deal: Europe has been falling woefully behind. It has a huge number of established small businesses: a plethora of pleasant cafés and architects’ offices attests to that.

The problem is that while the levels of entrepreneurism in Europe have roughly doubled in the last 15 years, the rest of the world has really caught the entrepreneurial bug. The average number of people in the global economy engaged in entrepreneurial activity has jumped from 7.9 per cent of the measured workforce to 13.2 per cent.

But a look at the data in 2000, and then again in 2014, shows an even more striking contrast. In 2000, there was far less data, a sign of just how nascent entrepreneurial activity was in large swathes of the world.

Europe’s performance was fairly middling. Since then, the story has been one of explosive growth as more and more people around the world began to see starting their own business as a valid career option.

What is all the more striking is that Europeans generally have a favourable opinion of entrepreneurialism – they just do not see it as something that they would embark on themselves, largely driven by a fear of failure and a perception in a good number of countries that there are few opportunities5.

The benefits of an entrepreneurial culture reach well beyond the new business bringing media or technology to the wider economy. Companies that culturally embrace entrepreneurism see change as a more natural ally. This mindset can pervade the whole business culture, with established firms’ senior management and employees looking for opportunities and embracing new approaches.

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The IoD wants to see greater numbers of people investing in entrepreneurial start-ups

Financing entrepreneurism
There are myriad challenges facing any start-up. Finding the necessary finance consistently rates as one of the most critical keys to success6.

The IoD’s regular Policy Voice survey tells us that the most widespread form of finance for over half of UK small and medium-sized businesses is retained earnings, followed some way behind by “friends and family”7. These UK results closely match the broader dataset of results run by the Global Entrepreneurship Monitor, where the most significant form of funding is personal savings8.

The importance of self-financing in funding the establishment of entrepreneurial businesses points to the need to allow savings and capital to build up within an economy and society. If high marginal tax rates are imposed, serial entrepreneurship and self-financing become harder and the initiative passes from the individual entrepreneur to the government as to how the money is spent.

It may well be that the government chooses to have state-funded entrepreneurial-style funds, but these become subject to the malaises that made the state such a poor investor in the past – from politically motivated channelling of funds to sectors deemed desirable (green energy, for instance) to geographical funds where the desire to regenerate is seen as more important than running a sustainable business and making a profit.

What entrepreneurs need, above all, are committed investors. Such investors scrutinise business plans and will often make recommendations on how the enterprise might be improved.

The IoD would like to see greater numbers of people investing in entrepreneurial start-ups, and we will be conducting a Policy Voice survey in the coming months seeking views on how the tax system could best be tailored to incentivise investment.

For any entrepreneur, personally knowing your investors prompts a greater sense of responsibility. Defaulting is not merely informing a bureaucracy that plans have not turned out as one might have wished, it is giving friends the news that their trust in your project was misplaced – a far more powerful motivator.

Moreover the reality is that most projects will fail, a few will make some money and only a very few will become stunning successes. This pattern of risk and reward is well suited to investors with a complex understanding of risk; it is not the sort of risk where taxpayers’ funds are appropriate.

Policy recommendation: To maximise the amount of capital that can be made available to an entrepreneurial start-up, we propose that all investments in early stage start-ups of most trading businesses9 ought to qualify for tax relief at the investors’ marginal rate – up to a generous cap of, say, £250,000 per annum. These funds would be in addition to any lifetime pensions cap. This becomes particularly apposite in light of the likely limiting of pensions tax relief for higher earners in the coming parliament.

Finding the right talent
High-growth enterprises account for a small number of firms but a relatively high proportion of employment. In 2011, for instance, France’s approximately 15,000 high-growth enterprises employed more than one million employees. In most countries, such enterprises account for between two per cent and four per cent of the total number10.

One interesting observation from the Global Entrepreneurship Monitor is that starting one’s own business is generally held in high esteem, even in countries where very few people ever manage to do this.

The question for much of Europe is, why then do entrepreneurs still find it difficult to recruit? The answer, in part, lies in Europe’s sclerotic labour markets, where those in work are protected at the expense of those who do not have full-time contracts.

Our belief is that productivity, entrepreneurism and flexible labour markets are closely tied. Where labour markets are flexible, new job openings tend to be more plentiful. In such circumstances, the pervading mood among jobseekers and employees is one of optimism.

For an entrepreneur seeking to find staff for his or her company, this is critical. The idea of joining a start-up can be exciting for an employee if the worst thing that can happen is that you have to find a new job in a year or two.

If the potential cost of taking a job in what is by its very nature a risky venture is to shut oneself out of the employment market for a prolonged period, it is understandable that fewer people will take such risks. However, where there is a dynamic job market, allowing people to move from one post to another with a minimum of career disruption results in entrepreneurs being able to readily hire staff from established firms.

Our belief is that the benefits of a dynamic labour market also benefit a firm’s productivity and, ultimately, economies’ productivity. A dynamic workforce, where people move through a range of careers in their life, allows for new procedures and practices to spread through businesses as new employees will bring fresh perspectives.

This way of thinking can be critical in preventing a company from becoming stale, and it is even more critical for smaller firms where management teams and the internal range of experiences is more limited. While the UK does not, thankfully, have the chronic problems facing the EU, there are several further improvements that could be made to help entrepreneurs find talent.

Policy recommendation: For new businesses fixed costs are particularly hard to bear, whether they are in the form of rates, taxes or other charges. A general reduction across all businesses of these costs would be welcomed and exemptions for newer companies should be considered. A cut in employer NICs remains a high priority for IoD members and any reduction in the wedge between the cost of employment and the benefit received by the employee is welcome.

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In recent years Britain has moved to fourth in the global entrepreneurial league table

Regulating entrepreneurism
With a bit of luck, this may sound like an oxymoron. Most entrepreneurs see little purpose with vast swathes of regulation, seeing it as either an unnecessary impediment, or attempts by incumbents in any industry to exclude new entrants. How they cope, at least in some cases, is interesting.

When discussing employment regulation with a collection of young tech start-up entrepreneurs at the Google campus in London (all independent companies using Google’s office space), the question came up whether they find employment regulations onerous? “No” was the immediate and universal response.

If someone was the sort of person who was concerned about employment rights, they were not going to be the right fit to work in a highly entrepreneurial start-up.

The idea that such regulations were not optional seemed to have escaped them. Such an approach has clearly never been tested through any sort of legal dispute, but it does say something about the prevailing attitudes of at least a portion of the hi-tech entrepreneurial world. Moreover, while it is certain that these firms already, or will eventually, obey the law, making these entrepreneurs value that legislation is a much bigger challenge.

The UK government has over the past few years been making considerable efforts to reduce the regulatory burden on all businesses. The current policy that for every new regulation, two old rules are scrapped, is a good start, but it is not enough.

Partly for legal reasons the ‘one in, two out’ only holds across a limited number of policy areas; the expansion of this programme should be seen as a priority for the next parliament. Beyond that, what is needed is a cultural shift and an appreciation that regulation – however well intentioned – invariably has unintended consequences.

Policy recommendation: The policy of ‘one in, two out’ should be continued and expanded in the next parliament.

Political support
Europe has fallen behind in the global entrepreneurial race in recent decades. While the UK remains the most entrepreneurial large economy in Europe, leading the laggards is not good enough.

Britain has made great strides in the recent past, rising from 14th to fourth, trailing only the US, Australia and Canada, according to the Global Entrepreneurship Index, but the scale of opportunity inherent within the information economy continues to expand and running at break-neck speed only just allows the country to keep up¹¹.

Encouragingly, political support for entrepreneurs remains widespread and entrepreneurs seem to be widely respected, indeed more so than mainstream businesses. The challenges in effectively helping entrepreneurs, and business generally, are considerable, but from a policy point of view, assisting with financing, talent and regulation yields benefits to businesses new and old alike.

Policy recommendations at a glance

  • Investments in early stage start-ups of most trading businesses ought to qualify for tax relief at the investors’ marginal rate up to a generous cap of, say, £250,000 per annum.
  • For new businesses fixed costs are particularly hard to bear, whether they are in the form of rates, taxes or other charges. A general reduction across all businesses of these costs would be welcomed and exemptions for newer businesses should be considered.
  • The policy of ‘one in, two out’ for every regulation should be continued and expanded in the next parliament.

For more information about Big Picture, visit iod.com/bigpicture
If you would like to part in Policy Voice surveys, visit iod.com/policyvoice

1. Global Entrepreneurship Monitor, United Kingdom 2014 Monitoring Report, p18; 2. McKinsey Global Institute, The Great Transformer: The impact of the internet on economic growth and prosperity; Oct 2011; 3. Policy Exchange, Technology Manifesto, June 2014; 4. McKinsey Global Institute, Internet matters: The net’s sweeping impact on growth, jobs and prosperity, May 2011. 5. Global Entrepreneurship Database; 6.OECD Entrepreneurship at a Glance 2014, Figs 5.2, 5.3, 5.4; 7. IoD Policy Voice survey Nov 2014; 8. Global Entrepreneurship Monitor, United Kingdom 2014 Monitoring Report, p28; 9. Barring land or property, it is not up to the taxman to encourage the creation of property portfolios. 10. OECD, Entrepreneurship at a Glance 2014; 11. The Global Entrepreneurship and Development Institute, The Global Entrepreneurship Index

About author

James Sproule

James Sproule

James Sproule has been Chief Economist and Director of Policy for the Institute of Directors since January 2014. Prior to joining the IoD James led Accenture’s UK Research and Global Capital Markets Research. He started his financial career as a merchant bank economist working with both Bankers Trust, Deutsche Bank and Dresdner Kleinwort, and eventually helped to found the boutique bank Augusta and Company.

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