Executive Summary

What is SME Finance and why does it matter for LGPS investors?

SME Finance refers to debt and equity investment provided to small and medium-sized enterprises to support growth, working capital and innovation. For LGPS and institutional investors, SME finance offers a way to achieve competitive risk-adjusted returns while supporting regional economic growth, job creation and place-based impact across the UK.

How can LGPS invest in SME Finance?

LGPS can invest in SME Finance through:

1. SME private credit and secured lending funds
2. Asset-backed and trade receivables strategies
3. Lower mid-market private equity funds
4. Growth equity and venture capital
5. Blended public–private regional investment funds

These approaches provide diversified, intermediated access without direct lending to individual SMEs.

Background

Small and medium-sized enterprises (SMEs) are the engine of the UK economy. They account for 99.9% of all businesses and more than 60% of private sector employment. They drive innovation, create jobs and anchor local supply chains.

Yet despite their economic importance, access to long-term growth capital remains uneven – particularly in the UK’s regions.

Our recently published SME Finance Deep Dive, following on from our 2025 white paper Scaling-Up Local Investing for Place-Based Impact, explores how the Local Government Pension Scheme (LGPS) and other institutional investors can scale investment in SME Finance to deliver competitive returns alongside measurable place-based impact.

Why SME Finance Matters to the UK Economy

The UK’s SME funding environment has changed significantly in recent decades. The retreat of high-street banks from relationship-based lending, combined with tighter capital requirements, has reduced the availability of long-term and growth-oriented finance for many smaller businesses.

This has created a persistent funding gap – especially for lower mid-market and asset-light businesses outside London and the South East.

SMEs are critical to both:

• The Government’s priority growth sectors, including advanced manufacturing, clean energy and life sciences.
• The foundational economy – sectors such as health and social care, construction, retail and hospitality – where the majority of local jobs are created.

Without access to patient, long-term capital, regional productivity and inclusive economic growth will remain constrained.

SME Finance as an Institutional Investment Opportunity

SME Finance is increasingly recognised as part of the UK’s productive finance agenda. According to UK Private Capital, nearly 13,000 UK businesses were backed by private capital in 2025, supporting 2.5 million jobs and contributing 7% of GDP.

For institutional investors, SME Finance offers diversified exposure across debt and equity strategies, including:

• Senior secured SME loans
• Asset-backed and trade receivables finance
• Cashflow-based lending and mezzanine debt
• Growth equity and lower mid-market private equity
• Venture capital

Expected return profiles vary by instrument. Indicative gross IRRs range from 4 – 7% for senior secured lending to 20 – 30% for early-stage venture capital.

For LGPS funds targeting 6 – 8% net returns in debt strategies, SME private credit and asset-backed lending can align well with income objectives.

Importantly, SME Finance does not require direct lending to individual businesses. Institutional investors typically access the market through established private capital funds with specialist origination, underwriting and portfolio management capabilities.

Place-Based Investment and Regional Growth

The regional imbalance in UK private capital is well documented. London attracts significantly higher levels of private equity investment per job compared to regions such as Wales, the North East and the East Midlands. At the same time, many of these undercapitalised regions face weaker inclusive job growth outcomes.

Scaling SME investment through regionally embedded fund managers offers a practical way for LGPS and institutional investors to support:

• Local entrepreneurship
• Job creation and skills development
• Supply chain resilience
• Net zero innovation
• Broader regional economic productivity

Blended finance vehicles such as the Northern Powerhouse Investment Fund and Midlands Engine Investment Fund demonstrate how public capital can anchor regional ecosystems and crowd in private investment.

University spin-out funds – including Northern Gritstone and Midlands Mindforge – further show how targeted SME Finance can unlock regional research and innovation capacity.

Digitally Enabled SME Lending at Scale

One of the historical barriers to institutional investment in SME Finance has been fragmentation and operational intensity.

Today, fintech-enabled origination platforms and specialist asset managers have made short-dated trade receivables and working capital finance increasingly institutional-grade.

These strategies typically offer:

• Short duration exposure
• Strong diversification
• Transparent reporting
• Low correlation to public markets

For LGPS Pools, such models provide scalable exposure to SME lending while remaining compatible with governance, risk management and fiduciary requirements.

Managing Risk in SME Investment

SME Finance carries familiar private market risks – including credit risk, liquidity constraints and macroeconomic sensitivity. However, there are established mitigation strategies, including:

• Senior secured lending structures
• Portfolio diversification
• Active monitoring and covenant protections
• Conservative leverage
• Robust governance and reporting frameworks

Accessing SME Finance through experienced intermediated fund managers is therefore critical.

Strategic Fit for LGPS Local Investing

SME Finance aligns closely with LGPS local investment objectives, including:

• Regional growth and productivity
• Innovation and net zero transition
• Resilience of local economies
• Skills development and employment pathways

As pooling arrangements evolve, ensuring sufficient flexibility to allocate to smaller, specialist and regionally focused SME funds will be essential.

A Timely Opportunity for Institutional Capital

With increasing policy emphasis on mobilising institutional capital into productive UK assets, SME Finance represents a credible and scalable opportunity for LGPS and other long-term investors.

Strengthening the flow of long-term capital to SMEs – across both high-growth sectors and the foundational economy – can help drive balanced regional development, create high-quality jobs and deliver competitive, risk-adjusted returns.

For institutional investors seeking both financial performance and place-based impact, SME Finance is no longer peripheral. It is central to building a more resilient and inclusive UK economy.

Take a look at our FAQs and find out more about Place-Based Impact Investing.