Is small still beautiful?

David Quysner, chairman of the Capital For Enterprise board, an independent body that helps the Government implement the ECF scheme, clearly feels there’s an equity gap to be filled, saying, ‘ECFs will fulfil a genuine need by addressing a market gap in the availability of equity finance.’

Throughout England, small amounts of equity are available from Regional Venture Capital Funds (RVCFs), which aim to provide risk capital finance of up to £500,000 for small firms with good growth prospects in any sectors. The government has endowed nine RVCFs with funding through the DTI and the European Investment Fund, while the rest comes from private sector investors. The Government has also taken other steps to compensate for the disproportionate costs of making small-scale investments, including tax breaks for Enterprise Investment Scheme investors.

Gap, what gap?
Now that these schemes have been set up to plug a supposed void in funding, many investors and industry experts argue there is no longer an equity gap because businesses with relatively small equity needs can access finance easily. On this subject the debate gets heated.

A study by research firm Library House entitled Beyond the Chasm found that of the 1,511 current venture capital investments made by private funds, more than half (899) are for £2 million or less. In that band, the vast majority (706) were between £250,000 and £2 million, which is the zone the Government identified as experiencing a market failure that created an equity gap. Library House findings conclude, ‘there is no gap in the range of funding deal sizes available to growing companies in the UK’.

On releasing the research, Library House chairman Doug Richard, of Dragons’ Den fame, was quoted as saying, ‘It calls into question a number of very large schemes. The whole venture capital trust industry has no reason to exist if there is no gap.’

David Quysner responded to the Library House findings by pointing out there is good evidence that without Government intervention viable businesses would not get financed. He added, ‘I would be delighted if there was no equity gap, but I have spent most of my working life aware of its existence.’

Boyd Mulvey, co-founder and chief executive of Create Partners, which manages the regional venture fund for the East of England, says, ‘I work with Doug Richard from Library House on a number of projects but I question his conclusions that there is no equity gap.’

Mulvey argues the issue of follow-on funding could be responsible for skewing the statistics. The availability of funding at low levels is often tied to the future investment needs of the business in question. Most private equity backers will, therefore, only back companies with very small initial investments if it constitutes the first tranche of a series of subsequent fundings.

He says, ‘It’s good that Doug has stimulated debate, but where his research shows the vast majority of VC deals were between £250,000 and £2 million, those deals could’ve been the first round of a series that ultimately amount to an investment of ten times that. So, small companies seeking an investment total below that level and above angel funding still need help.’

Create took the prize for ‘Equity Gap Fund of the Year’ at the 2006 Investor AllStars awards, the annual giving of gongs in the investment sphere, so he’s on the frontline of equity gap funding. Mulvey contests that, ‘rare and occasional deals private equity backers conduct in the £250,000 to £2 million space do not constitute equity gap funding.’

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