29th February 2020 by Jason Vincent

Do entrepreneurs need (and deserve) more protection from investors and lenders?

It’s an odd title. Definitely a deviation from recent blog posts on technology and payment systems. But with economic uncertainty in the air (think Brexit and the Coronavirus affecting trade for many small businesses), and following on from a conversation with several customers recently, I’ve spent a lot of time thinking about the ethics of SME angel investors and lenders.

As an entrepreneur myself, and having worked with hundreds of startups and SME’s over the years, this is a topic that is incredibly personal to me, and one that I don’t see many people talking about.

I find it surprising that if you pick up a ‘How to start a business’ book (any of them, really) , even today, there will likely be some reference to going to a bank with a business plan. For anyone that’s actually done this, they’ll know that in all honesty (and sorry to break the news here), it doesn’t really matter what this plan says. You could have the best concept, with a perfect strategy and execution plan and solid financial model, and the answer (after much intentional deliberation) would almost certainly be “Yes! But…” and then comes the personal guarantee.

It seems banks don’t really truly understand SME’s. Is any business manager really qualified – or trusted – to look through a business plan and make a decision on whether the bank should carry the risk for that particularly venture’s success? I’d guess the answer is no. With startup success rates almost in the single digits, I’m not entire surprised.

This isn’t, obviously, limited to startups either. If an SME approaches a bank, having been established and running profitably for several years, there’s a very good chance they’ll be treated in a similar way and the directors expected to provide personal guarantees.

So the question is: are we stifling innovation and entrepreneurship by allowing the cost of failure to be so high?

It’s pretty clear that governments want to incentivise innovation and entrepreneurship. Once upon a time the UK was an industrial and manufacturing power-house, and despite recent shifts favouring the financial sector, there is still a substantial amount of manufacturing and technology companies operating in the UK.

If you look at it from the government’s perspective, there are countless schemes to incentivise entrepreneurship. From tax-based incentives like Entrepreneur’s relief designed to incentivise individual entrepreneurs and reward them in the long term upon exit; Research & Development tax credits to incentivise innovation within SME’s; Substantial grant funding made available through Innovate UK (formerly the TSB) to assist with R&D and innovation; or even Patent Box to reward organisations that innovate and protect their intellectual property appropriately. Then there are obviously the regional and local incentives to drive businesses to incorporate in particular parts of the country.

If we look at the other side of the equation, angel investors have a fair few incentives of their own. SEIS and EIS being two major programmes designed to mitigate risk for investors by providing tax benefits tied to investment performance. If their investments don’t work out, well, at least they get a sizeable amount of their tax back, offsetting their risk.

For a passionate entrepreneur, a business is their life. The belief in their idea’s success dwarfs any thought of risk or failure. Signing a personal guarantee for a loan – be it from a bank, an emerging lender (like Funding Circle), an asset finance provider, or even an investor – is just part and parcel of what they need to do. They don’t question it. But is it ethically right? And does it provide the right incentives to the entrepreneurs?

We live in an age where there have been countless studies published about the need to have a solid base in order to be the most productive and innovative. From the theoretical concept of universal income being trialled in pockets of society around the world to give people the confidence to try and fail, through to Venture Capital (VC) funds recognising the need for founders to be rewarded throughout their journey and enabling them to cash in throughout later rounds, rather than merely working towards a long term goal to exit in full – everyone is talking about the need for individuals to be financially looked after in order to do the best work they can do.

We know entrepreneurs are a crazy bunch. They take risks, pursue their passions blindly, and often succeed in the face of immense adversity. The odds of success for anyone starting out are small – so small in fact that it begs the question whether anyone who sets out on their own is, legitimately, insane.

So what are the ethics of asking them to sign personal guarantees? For an investor, should this even be allowed? We’re essentially allowing investors to profit from risk-free investments. Succeed, and they’ll take a large chunk of equity and the associated payout. Fail, and well – just give me my money back and you’ll be fine.

Similarly with lenders like Funding Circle who are known to pursue anyone who defaults “to the end of the earth”, should SME’s really be paying a substantially higher interest rate due to their “risk profile” if behind the scenes the directors and founders have had to sign away their rights and guarantee their debts, by any means necessary?

I’ve now known several friends and acquaintances who have faced both the situations described above, and personally I find it unethical, immoral, and possibly even abusive.

In my opinion, everyone should have the right to take a chance without fear of losing everything. Angel investors, lenders, and any type of funder, should evaluate their risks based on the proposed venture. Some businesses are more likely to succeed – some are almost certainly destined to fail. And this will appeal to different lenders, different investors, each with their own risk profiles and criteria. If it weren’t possible to make informed decisions on which companies might succeed, then the entire venture capital and private equity industries wouldn’t exist!

I believe there should be regulatory protection to prevent the practice altogether. Yes, it might mean that some ideas never get off the ground – we hear the glorified stories of those who succeeded, far more than those who didn’t. But looking at the individual entrepreneurs, preventing this practice in the industry might be the single biggest decision that saves them from a mistake they live to regret. No one should lose their home because they dared to fail.

Here’s to success, great ideas, and inspiring entrepreneurs pursuing their dreams!