Equity Gap? There’s no such thing
Doug Richard believes the frequently referenced ‘equity gap’ is nothing more than a myth– and that the real problem is simply a lack of investment-ready small businesses
Earlier this month, the research firm of which I am chairman, Library House, published a report that examined the capital history of every currently trading company in the UK that has ever received venture capital. Every single one.
Our goal was to understand the current state of affairs regarding venture investment – a subject clouded in mystery, mostly because no one has ever studied it comprehensively. This is particularly troubling given how much of our country’s economic wellbeing may depend on this small class of investors. Fast-growing small businesses drive economic growth. Further, it is high-risk funding, from angels and institutional venture investors, that fuels these companies with the capital they need to grow.
Exploding the myth
In the report, we tested a number of common assumptions. Perhaps the most contentious is the widely held belief that there is an ‘equity funding gap’.
To be precise, the common wisdom is that there is money available for companies at inception from friends and family. There is money following that from angel investors. But at a magic number of £500,000 a chasm appears. So, if you are trying to raise money between £500,000 and £2m, it is apparently diffi cult or impossible to do so because it is too much money for angels and too little for the institutional investors.
As that is a common capital requirement, many early-stage businesses are looking for funding in that range. And every time a start-up fails to get funding between those two magic numbers it is taken as further evidence of the ‘equity gap’. But no one has asked whether those that do get funding receive amounts between £500,000 and £2m.
Our study showed that nearly half of all institutional deals are made in that range. In fact, more deals are made below £2m than in any other size range. So there simply is no gap.
What concerns me is the fact that massive time and money has been poured into dealing with an issue that doesn’t exist. If too many companies are not receiving funding – something that’s merely an hypothesis itself – then it cannot be explained by a gap in the capital cycle.
The readiness gap
Anecdotally, it has always been diffi cult for me to reconcile the fact that the investors are fi nding it diffi cult to invest their capital at the same time people are decrying the lack of it. This strongly suggests we have a completely different issue to contend with: a readiness gap – a lack of companies that are ready for investment.
A lot of small businesses desire funding, but are not in a position to be invested in. Whether they are unrealistic about how much they are worth, or have not developed a strong enough team, or their core proposition is simply not scaleable, they have fallen short on some basic criteria. There is a great deal that we can do to help entrepreneurs help themselves.
There is a great deal we can do to help small businesses up their game. But we cannot blame it on an absence of capital, or a failure of nerve by the investors. Because they are investing and they are doing so in the heart of the so-called ‘gap’.