Ongoing innovation and a transition to a greener economy are integral to a more sustainable future, and a healthy pipeline of small and medium-sized enterprises (SMEs) remains an important driver of both.
We see enabling SMEs as both a vital structural growth trend and an anchor of a sustainable economy, with these companies making up 99% of all US businesses and accounting for 44% of the country’s GDP and two-thirds of net job creation (according to US Small Business Administration).
Defining an SME is jurisdiction dependent; they are considered to have a maximum of 500 employees in the US but fewer than 250 in the European Union. Whatever the definition, however, the basis of our investment theme lies in identifying companies offering products and services that give these businesses the best chance to succeed and grow. Even many high-growth companies start from sole proprietorship and, historically, there have been major barriers to developing a business idea, with SMEs needing capital, talent and knowledge to achieve scale against entrenched incumbents.
Highlighting the recent spate of business growth in the US, 2021 had the highest number of IPOs in 20 years and the figure was more than twice that seen in 2020, which had already doubled 2019’s tally.
Recent work by the OECD highlights the benefits of strong SMEs in an economy: to quote, ‘new and small firms are often the driving force behind the sort of radical innovations that are important for economic growth, since they can work outside of dominant paradigms, exploit technological or commercial opportunities that have been neglected by more established companies, or enable the commercialisation of knowledge that would otherwise remain uncommercialised in universities and research organisations’. Their strength lies in greater agility to pivot quickly towards new technology or take advantage of gaps where larger businesses cannot.
Enabling SMEs also improves the overall resilience and diversification of an economy, which is particularly important for resource-rich countries with heavy dependence on commodities, and we see these businesses contributing to the following four Sustainable Development Goals:
SMEs encourage a more inclusive form of growth, reducing inequality across regions and demographics as well as providing opportunities for skill development. They are considered an important channel for inclusion and poverty reduction, as they contribute both to achieving economic growth and social objectives like improving the quality of jobs for low-skilled workers or marginalised groups.
Some of the traditional barriers faced by smaller businesses have disappeared over recent years with developing technology and the rise of the internet, but more focused support is needed to remove remaining hurdles. Further digitalisation and technological innovation, for example, should allow more dynamic businesses to achieve scale without mass and at lower cost. An example is using an online e-commerce marketplace, which lowers barriers to entry. SMEs will also gain from digital access to skills and talent, through better HR recruitment and knowledge sharing.
Where are we finding these SME enablers across the market? While the environment for these businesses has improved, there remain issues in areas such as high costs of tax compliance, lack of access to credit finance and training opportunities, and barriers to digitalisation. On the latter, the divide between incumbents and SMEs tends to be narrow in web presence or connectivity, but substantially larger in more niche and potentially business-enhancing areas such as cloud computing, big data or enterprise resource planning software.
Cloud computing is a good example of where innovation could potentially have large benefits for SMEs but the knowledge and costs involved are prohibitive. This tech allows delivery and use of computing infrastructure – servers, storage, databases and analytics – over the internet rather than relying on costly physical infrastructure. Access to such technology can eliminate costs of maintaining expensive hardware or software and allow SMEs to take advantage of big data without significant investment in technology or manpower. There are also major energy/carbon emission savings inherent in moving to a cloud offering.
Another area is tax compliance, which is region dependent and has a high fixed cost component. Again, lack of knowledge and resources in this area can heavily impact small firms and companies able to provide support are vital. In our funds, we own US firm Intuit, for example, which helps the self-employed and small businesses by providing financial management, compliance products and tax products.
Several holdings in our funds offer different areas of expertise to SMEs, including UK business Softcat and Learning Technologies Group (LGT). Softcat is the UK’s leading value added reseller of IT software and equipment, serving the fragmented SME market, while LTG, held under our Providing education theme, offers a collection of e-learning, compliance, training and Human Resources software and content brands.
With a thriving SME space so integral to general economic health and a more sustainable future, we believe companies helping to create this growth should continue to thrive and offer a range of investment opportunities for our portfolios.
About the authors
Chris Foster, Co-manager of the Liontrust SF Global Growth Fund, GF SF Global Growth Fund and SF Managed Growth Fund
Chris joined Liontrust in April 2017 following the acquisition of Alliance Trust Investments. Prior to this, Chris joined ATI through the management training programme after graduating with a First Class Honours degree in Economics and Mathematics from the University of Edinburgh. Chris is a CFA Charterholder.
Sarah Nottle, Trainee Sustainable Investment Associate, Liontrust
Sarah joined Liontrust in September 2021 on the Sustainable Investment Equities team. Prior to this, she worked within the asset management industry in an operations role. Sarah graduated from the University of Sydney in Australia in 2017 with a Bachelor of Commerce and a Bachelor of Arts, majoring in Finance, Commercial Law, International Relations, and minoring in Ancient History. Sarah holds the Investment Management Certificate (IMC) and is a CFA Level II candidate.
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