SMALL companies are increasingly turning to the private equity sector for growth funding in the wake of the banking crisis and continued volatility on financial markets.

Deal makers in Scotland talk of the ending of a previously cosy relationship between corporate Scotland and the nation's banks and the growing willingness of firms in the central belt to adopt expansion strategies long favoured by the offshore oil industry in the north-east.

Figures from the British Venture Capital Association show that in 2011 some £40 million was invested in Scottish companies as expansion capital, up from £31m in 2010 and £19m in 2009.

Simon Munro, regional director for Scotland at the Business Growth Fund, which is backed by five British banks, said: "We are finding there is strong demand out there at the moment.

"While the economy generally is not in great shape there of lots of attractive smaller to medium sized companies that are doing fine."

Equity funding is coming to the fore because the credit crunch restricted access to bank debt. This is despite several Government initiatives, including the £80 billion funding for lending plan set out last week.

Calum Paterson, managing partner at Glasgow-based private equity house Scottish Equity Partners, said: "The availability of bank debt is more difficult for companies than it was historically.

"In that scenario growth equity finance becomes a more relevant consideration."

Paul Mason, director of corporate finance at accountancy firm Mazars in Scotland, said the cosy relationship some firms had enjoyed with the large banks located north of the Border has ended.

He said: "One phone call and they would have provided you with capital that is probably equity capital but at debt prices."

Meanwhile, listing on the stock market, previously an option for larger firms, is less attractive than it was.

Corporate lawyer Andrew Ley said companies worry about volatility and lack of liquidity.

He said: "There are lots of companies choosing not to go anywhere near the markets."

Mr Ley, a partner at HBJ Gateley, added: "It requires them to focus on their relationship with the City rather than driving forward the growth of their business."

However, barriers remain between growing Scottish companies and equity capital, where an investor puts in money for a return for a stake in the company.

Mr Mason said: "In Scotland in particular we do not have much of a private equity mindset compared to places like Leeds, Birmingham, Manchester and, of course London."

Some in the industry think there is a divide between those involved in the oil industry in the north-east who are accustomed to dealing with the private equity industry and firms in the central belt that have more typically favoured bank funding.

The surrendering of equity in the business can be a sticking point.

He said: "They do not want to give up the family jewels."

However, Mr Paterson, whose firm has backed prominent companies including Edinburgh-based comparison website Skyscanner, said: "The owner can end up with 75% of something that is much bigger rather than 100% of a small business."

Graeme Malcolm, chief executive of Glasgow-based laser technology business M Squared, said the company plans to expand its workforce from 32 to 100 within the next three years after a £3.9m investment by the Business Growth Fund.

He said: "There are many guys who run lifestyle-type businesses. You either live that life or, in our case, you are more ambitious."

The Business Growth Fund has so far committed £15.9m to three Scottish firms, including earlier this month investing £4.2m into AFG Media, which makes spandex Morphsuit costumes.

The fund and other private equity firms emphasise that they can contribute more than just money including knowledge and contacts to help firms with potential customers or assistance in areas such as human resources.

Those involved in helping companies raise finance argue it is a good time to seek cash. Mr Ley said: "In many ways there is more growth financing than there ever was."

Meanwhile, attitudes in the private equity industry appear to have changed as the ability to use cheap debt to boost returns has disappeared taking with it the chance of a quick buck.

Mr Paterson, whose firm typically puts £2m to £20m in investee companies, said: "For a lot of private equity investors gearing was a very important part of their model.

"That has changed."

However, this more cautious attitude means that companies have to prove they are a good bet.

Mr Ley said: "There is more pressure than ever in being investor-ready and really having a robust growth plan."