Delay now, pay later – why SMEs must not put off investing in innovation and greening

In the last three years, small and medium-sized enterprises (SMEs) and entrepreneurs have been bounced from crisis to crisis. They had barely begun a fragile recovery from the COVID-19 pandemic in 2021 when Russia’s war in Ukraine sent a new shockwave rippling around the globe. High inflation, skyrocketing energy prices, rising interest rates and supply chain disruptions are now falling hard on SMEs, setting them up for a challenging year.

The green shoots of 2021

Throughout this turbulence, finance has been a lifeline for SMEs and entrepreneurs. After a surge in government-backed finance in 2020, lending began to return to pre-pandemic levels in 2021. Encouragingly, that year also saw a revival in alternative forms of finance such as venture capital (VC) – so critical to SME investment and growth.

According to a new OECD report covering close to 50 countries world-wide, growth in VC reached record highs in 2021 (growing 60% year on year), and factoring, a form of asset-based finance which enables SMEs to obtain finance through the sale of invoices, grew 6% in 2021, reversing its decline of 14% in 2020.

SME lending normalised, while alternative finance bounced back in 2021

Trends in SME lending, factoring and venture capital, 2008 – 2021

Higher rates, fewer loans

However, the nascent recovery was short-lived, as interest rate hikes to combat inflation are now raising the cost of finance and reducing its accessibility for SMEs around the world. We are already seeing the consequences – for example, in the United Kingdom, in 2022 only a third of smaller businesses were using any external finance, the lowest percentage since 2011.

In the United States, 45% of banks reported a weakening in SME demand for loans as a result of tighter lending conditions. VC markets also took a hit, falling 32% year on year in 2022. These developments contributed to the recent collapse of Silicon Valley Bank, with potential additional impacts on the lending environment for SMEs.

As bank lending becomes less attractive for SMEs, many are turning inwards and relying on savings to meet their cash flow needs, and putting important investments on hold. According to a recent survey, business confidence in the European Union is at its lowest level in 30 years, with high energy and raw material costs dominating their concerns. In light of these developments, many SMEs are planning to prioritise the need for savings in the coming year.

Businesses expect to put investments on hold

Trend of expected investment index
Source: 2023 Eurochambres Economic Survey

Delaying critical investments would come at a high cost for SMEs

Yet delaying critical investments, particularly those in energy efficiency, greening, innovation and digitalisation, would come at a high price for SMEs in terms of future competitiveness, and would also slow the overall pace of transition to more sustainable economies. Governments, financial institutions and businesses must find solutions to boost investment in a context where SMEs may have less recourse to their preferred form of external financing – bank lending.

The keys to unlocking SME investments

To do so, governments must first seek to diversify financing instruments and sources, to enable SMEs to bolster their resilience to volatile credit markets and help them manage their debt. The 2022 Updated G20/OECD High-Level Principles on SME Financing provide important guidance in this regard. Here, Fintech has an important role to play – in enhancing the efficiency of allocation of finance, reaching underserved segments and regions and strengthening the ecosystem for SME finance.

Second, we must better leverage the opportunities offered by equity and quasi-equity to finance SME investments in eco-innovation and greening. According to a recent study, in the United Kingdom, the share of VC deals related to net zero grew 33% in the first three quarters of 2022 compared to the same period in 2021, outpacing overall VC market performance.

Tapping into this growing pool of finance will enable innovative SMEs to bring new solutions to market and accelerate the net zero transition throughout the economy and society, without piling on additional debt.

Third, continued liquidity support to SMEs facing high energy costs should increasingly target firms and sectors most in need, and go hand in hand with incentives and financing support for green investments. Such support can be channeled through traditional instruments, including guarantees or direct debt or non-debt financing, or through dedicated green and sustainability-linked instruments that tie financing conditions to sustainability performance.

By steering support towards investments in sustainability, governments can better align short-term and long-term objectives.

To meet their latest set of challenges, SMEs need to accelerate investment, not delay it. Working together, governments, financial institutions and businesses can overcome the short-term obstacles and keep finance flowing to ensure a more sustainable and more resilient tomorrow.

Read more on the OECD work:

OECD Financing SMEs and Entrepreneurs Scoreboard: 2023 Highlights

2022 Updated G20/OECD High-Level Principles on SME Financing

OECD Platform on Financing SMEs for Sustainability

OECD SME and Entrepreneurship Ministerial

Senior Counsellor on SMEs and Head of the SME and Entrepreneurship Finance Unit at | + posts

Ms. Miriam Koreen is the Senior Counsellor on SMEs and Head of the SME and Entrepreneurship Finance Unit at the Centre for Entrepreneurship, SMEs, Regions and Cities of the Organisation for Economic Co‑operation and Development (OECD). She leads the OECD Platform on Financing SMEs for Sustainability. From 2011 to 2018, she was Deputy Director of the Centre and Head of the SME and Entrepreneurship Division. Ms. Koreen has worked at the OECD since 2000, when she joined the OECD as an analyst on entrepreneurship and SME policies. She has served as Counsellor to the Trade Directorate, Advisor in the Office of the Secretary-General and Senior Project Manager for the OECD Innovation Strategy. She also chaired the OECD Procurement Board from 2011 to 2015. Ms. Koreen holds a M.Sc. in Development Studies from the London School of Economics and Political Science.