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The Supply of Equity Finance to SMES: Revisiting the "Equity ...

  1. 1. THE SUPPLY OF EQUITY FINANCE TO SMES: REVISITING THE “EQUITY GAP” A report to the Department for Business, Innovation and Skills SQW CONSULTING URN 09/1573
  2. 2. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Acknowledgements SQW Consulting would like to acknowledge the substantial contributions to this study made by Professor Colin Mason, University of Strathclyde, for his advice and guidance, and by Oxford Innovation, for help in engaging business angels. However, the views expressed here are those of the authors alone. The authors would also like to thank all those who made data available to the study; those informants in the public and private sectors who participated in interviews; and the business angels who participated in a group discussion. Special thanks are due to staff in the British Venture Capital Association for advice on the use of data sources. www.sqw.co.uk
  3. 3. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Contents Executive Summary................................................................................................................1 1Introduction.........................................................................................................................10 Methodology and definitions...............................................................................................13 2Analysis of the supply of equity finance - venture capital .............................................16 3Venture capital funding – characteristics and processes...............................................32 4Analysis of the supply of equity finance – informal equity (from business angels).....36 Publicly-backed funds in UK................................................................................................42 5Other public sector interventions in the equity finance market in the UK.....................50 6Equity investment and institutional investors..................................................................53 7Corporate venturing in the UK...........................................................................................57 8International comparisons.................................................................................................60 9Implications of the current economic climate..................................................................72 Assessing the Equity Gap....................................................................................................75 10Bibliography......................................................................................................................82 Annex A: Data sources and definitions............................................................................A-1 Annex B: Additional data on investment activity.............................................................B-1 Annex C: List of consultees...............................................................................................C-1 www.sqw.co.uk
  4. 4. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Executive Summary Introduction 1. This study into the supply of equity finance1 for SMEs was conducted on behalf of BIS2 (then BERR3 and DIUS4) by SQW Consulting with contributions from Oxford Innovation and Professor Colin Mason, University of Strathclyde. It was conducted during the period September 2008 to January 2009. Research objectives 2. The research was commissioned to refresh the evidence base on equity finance and, specifically, to establish whether the existence and boundaries of the equity gap have changed since the initial ‘Bridging the Finance Gap’ research was undertaken in 2003 by HM Treasury and the Small Business Service. The latter research identified the shortage of modest amounts of risk capital – the “equity gap” – to be most acute for businesses seeking investments of between £250k and £1m, but extending up to £2m, and for some businesses it may be higher. 3. The prime objective of the current study has been to determine within which segment(s) of the SME equity supply market the structural equity gap is most acute and whether there are any differences across sectors (especially high technology), stages in business development and regional geographies. The study also provides an assessment of more recent factors affecting the supply of equity capital to SMEs including the economic downturn and Credit Crunch. Methodology 4. The study deployed a mix of research methods, including: • desk research on:  published reports and data  data provided by public sector bodies • consultations with individuals active in the equity supply-side market • facilitated workshops with business angels. 1 Equity finance is defined as capital invested in a business for the medium to long term in return for a share of the ownership and sometimes an element of control of the businesses. Unlike debt finance, equity finance investors do not normally have a legal right to charge interest or to be paid at a particular date. Instead their return is usually paid in dividend payments and depends on the growth and profitability of the business. Equity finance is often referred to risk capital as it shares the risk of the business and equity is the last source of finance to be repaid out of any residual assets in the event that the business fails. 2 Department for Business, Innovation and Skills 3 Department for Business, Enterprise and Regulatory Reform 4 Department for Innovation, Universities and Skills 1
  5. 5. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills 5. The primary research involved consultations with key private and public sector stakeholders. Consultees included finance experts, sector/industry experts, fund mangers, investors and representatives from British Venture Capital Association (BVCA), European Venture Capital Association (EVCA), British Business Angel Association (BBAA), National Endowment for Science, Technology and the Arts (NESTA), Technology Strategy Board (TSB) and Regional Development Agency (RDA) finance leads. Key findings Supply of venture capital 6. Out of a total of £12bn invested in unquoted equity in 2007, early stage equity accounted for 4% by value (£434m in 502 companies). Expansion capital accounted for 9% of investment by value (£1.1bn in 595 companies). Therefore, private equity (early stage and expansion stage combined) accounts for 13% of total private equity, with the remainder mainly comprising finance for Management Buy Out (MBO) and Management Buy In (MBI). Over the period 1998-2007, the level of early stage equity remained relatively constant, with peaks in 2000 (the height of the dotcom boom) and again in 2006. The supply of expansion investment has been more variable throughout the period, with prominent peaks in 2000 and 2006. Figure 1 Investment in early stage and expansion in the UK by BVCA members, 1998-2007 (£m) 3,000 2003 2007 2,500 Investment (£m) 2,000 1,500 1,000 500 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Total early stage Expansion Total early stage and expansion Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007; Expansion excludes refinancing bank debt and secondary purchase. 7. The bubble caused by the dotcom boom was not just a case of arguably reckless investment by VCs but also a function of their ability to raise funds from institutional investors who took an interest in the ICT sector. Many VC funds were raised just before the dotcom bubble burst and given their ten year lifespan, these funds have been suffering ever since in reported performance returns due to the aftermath of dotcom failures. The dotcom crash therefore meant not only that VCs withdrew from the sector on risk rounds, but also that they found it 2
  6. 6. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills harder to raise funds for any type of investment. This led to venture capital suffering from a bad reputation with institutional investors. 8. By 2005, the worst of this problem had begun to dissipate and VCs were able to raise a good level of funds. This meant they had plenty of money to invest in 2006. By this time, new types of investor had taken an interest in the VC market, including banks and hedge funds. The decline of VC activity in 2007 may now be seen as an early warning of the current economic problems: the Initial Public Offering (IPO) market began to dry up, cutting off an important exit route for private equity. 9. Sub-£2m investments have accounted for between 70% and 80% of all venture capital investments for the period 2001 and 20075. However, investments below £2m accounted for 12% of all investments in 2001 falling 6% in 2007. The most common amount received by companies during the period 2001 and 2007 appears to have between £200k and £500k. However, the extent to which sub-£2m investments are elements in larger syndicated deals is uncertain from examination of published sources. 10. In recent years, the key sectors for VC funding (of all types) by value have been consumer- related and communications. In terms of number of deals, computer-related, medical health/biotech and consumer-related have been the highest. In terms of technology-related transactions, the key areas for early stage investment have been software, biotech and communications. 11. Since 1998, London and the South East regions dominate in terms of early stage equity provision, both absolutely and when compared to the number of VAT registered businesses in the each of the English regions. Venture capital characteristics 12. The investment criteria of early stage funds are designed to meet the initial needs of the target client base. However, these criteria, if rigidly applied, may prevent the funds providing follow on finance, thus requiring them to pass on the deal to other providers with deeper pockets. 13. Good management is by far the most important attribute in making a company attractive to potential VC investors (more important even than the initial product or service proposition), as VCs consider it is this which will help ensure good returns. Investment readiness schemes need to take this into account as there is a perception by some fund managers that those delivering schemes are not tough enough on entrepreneurs about the need to bring in professional management. 14. The early stage VC due diligence and deal process is time consuming and expensive when compared with the potential returns and the risk that those returns will not be realised. This has contributed to the withdrawal from the market of former key players and to the syndication of deals. However, the early stage market, where the investment sizes (for non- capital intensive businesses) are relatively small, can act as a first step for new VC fund 5 Pierrakis & Mason (2008) Shifting Sands: The Changing Nature of the Early Stage Venture Capital Market in the UK. NESTA research report. 3
  7. 7. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills managers with only limited resources to invest. So, whilst there are only a few VC funds at this end of the market, it is not true to say there are none. Supply and characteristics of business angel finance 15. Business angels are playing an increasingly important role in providing early stage finance (business angels’ share of private sector investment rose from 15% in 2001 to 30% in 2007). However, the total value of recorded deals done has fallen over the period from 2005 (£47.8m) to 2007 (£29.5m). However, data on business angel investment are incomplete and hence these figures could understate the real scale of transactions. What the figures are likely to be reflecting, however, is the anecdotal evidence that a lack of market ‘exits’(e.g. IPOs, trade sales) means that business angels are having to stay involved with investees for longer, constraining their ability to invest in new deals. 16. One important investment route for business angels is through acting as co-investors for publicly backed funds, as business angels are willing to operate at the smaller end of the market. VCs are seen as less willing to be co-investors as the deals are too small to be viable (given that they would still want to undertake their own due diligence). Business angels tend to invest only in sectors in which they have direct previous experience and hence they do not need to undertake such extensive due diligence as VCs. 17. A key trend is the increasing use of angel syndicates to invest. These allow angels to share the risk and take part in larger deals (i.e. £250k to £500k). The syndication approach also allows angels to appoint a ‘lead angel’ with both financial experience and knowledge of the sector in which the investee company operates. VCs confirm that the presence of an experienced lead angel at the early stage makes the deal much more attractive to later stage investors because they take comfort from the expertise that has been involved. 18. Although business angels rate the satisfaction of their direct involvement in an investee highly, they are of course looking to generate a commercial return from their investment. Publicly backed funds 19. There are a large number of publicly funded VC funds: Table 1 provides a summary of these by fund type. Table 1 Summary of publicly backed VC funds Fund type Total funds Investment size End of investment Geographical available (during range period scope investment period)6 Regional Venture £241m Up to £660k 2007 - 2008 Regional Capital Funds (RVCFs) RDA VC funds £220m £50k - £2.5m 2008 - 2012 Regional Early Growth Funds £36.5m Up to £200k 2014 – 2016 Regional (EGFs) 6 Investment period was defined as last two years i.e. 2007 and 2008. Variations in the way the data from different sources are recorded may lead to slight differences in the time period covered. 4
  8. 8. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Fund type Total funds Investment size End of investment Geographical available (during range period scope investment period) University Challenge £60m £25k - £250k Evergreen National Seed Funds (UCSFs) UK High Technology £126m Up to £2m 2006 National Fund (UKHTF) Community £40m £100k - £2m May 2009 National Development Venture Fund (Also known as Bridges Fund) Enterprise Capital £185m £500k - £2m 2011 – 2013 National Funds (ECFs) Carbon Trust Funds £27m £250k - £3m Still open to National investments NESTA fund £50m £250k - £1m Evergreen National Source: BERR/DIUS/RDAs/Carbon Trust/NESTA 20. It is clear from discussions with market stakeholders that publicly backed VC funds are vital for providing early stage equity capital to SMEs. Business angels do not have enough capacity by themselves to meet the financing needs of businesses seeking equity finance. Therefore, publicly backed funds help fill the gap at the early stage of the market that would otherwise exist. 21. However, there were concerns expressed by some consultees that individual publicly backed funds were too small both in terms of overall capacity (it is suggested that they need to be £30-50m to be commercially viable) and in terms of the maximum amount they could invest in any one company (initially £250k, then increased to £500k, and then increased again to £660k for an RVCF or £2m for an ECF). An example of the former would be one of the RVCFs which had total funds of only £12m. This means that they may not be able to provide all the funding the company needs and they often do not have sufficient capacity to provide follow-on funding. Hence their investees may need to find other investors to avoid growth being constrained. 22. The issue of follow-on funding highlights other concerns, including whether the fund manager of the publicly backed fund has been sufficiently tough with the investee and ensured that it is ready for the next round of investment. Also, having a public sector fund and a group of angels involved might not be attractive to some later stage investors who may only be willing to invest if they can take over the whole transaction. 23. Another problem identified with publicly backed funds was their limited time spans for investment. RVCFs and some RDA VC funds have come and gone leaving perceived gaps behind them in regional markets. However, ECFs are being made available in tranches and hence at present their geographical coverage is varied7. There have been a number of new VC schemes recently introduced including the Capital for Enterprise Fund and Aspire Fund. 7 It is understood that ECFs are not restricted from investing outside of their immediate geographic area and so in theory are able to invest throughout the UK. In practice, fund managers often choose to make investments closer to their geographic location to minimise costs. 5
  9. 9. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills (Since completion of the research for this report, the Government announced on 29 th June 2009 the new UK Innovation Investment Fund which will focus on providing equity finance to growing small businesses, start-ups and spin outs in digital, life sciences, clean technology and advanced manufacturing.) 24. Publicly backed funds are not generally viewed as crowding out the private sector as the private sector has commercial reasons for not being more involved in the early stage market. Co-investment arrangements were cited by stakeholders as a way of encouraging the private sector (in the form of business angels) to invest alongside the public sector. Likewise, the ECFs are seen as a way of the public sector making use of private sector fund management skills to do deals that the private sector might not otherwise consider. Other public sector equity interventions 25. Although not a focus of this report, there are a number of tax based initiatives designed to increase the supply of equity finance to SMEs. These include Venture Capital Trusts (VCTs) and Enterprise Investment Scheme (EIS). Venture Capital Trusts (VCTs) 26. VCTs came into existence in 1995 as a tax efficient way for High Net Worth Individuals (HNWIs) to invest (passively) in early stage companies. Funds raised/invested reached a peak in 2006 when changes in the Finance Act (FA) tightened the rules and reduced the range of companies in which VCT funds could be invested. 27. Whilst VCTs have been structured to ensure that only small companies are supported, the structure does impose constraints on the use of the vehicle. VCTs are limited to £1m on any one investment. Enterprise Investment Scheme (EIS) 28. The EIS allows HNWIs to invest more actively in early stage companies (as business angels). The key benefits of the EIS include: • 20% of the cost of the investment can be offset against income tax • Capital Gains Tax relief on any gains made on the investment if held for at least three years prior to disposal • loss relief whereby any losses made on investments disposed of after three years can be offset against income tax. 29. These reliefs make investing a tax efficient arrangement for HNWIs as well as cushioning any losses incurred. Institutional investors in venture capital funds 30. Over the period 1987-2000, unquoted equity outperformed other asset classes in terms of returns. Its reputation was however, tarnished by the dotcom crash which depressed returns for a number of subsequent years. By 2006, institutional investors were back in the market 6
  10. 10. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills only to ease off funding again in 2007 as the early effects of the economic downturn began to cause concern. The European Venture Capital Association is stepping up promotion of VC as an asset class to try and improve its image with institutional investors. 31. In terms of funds raised in 2007, only 10% were earmarked for early stage and expansion deals (down from 15% in 2006). Also, 75% of funding came from overseas sources. Pension funds remained the largest single class of investor but their share has declined as the importance of fund of funds and banks has grown. This is a concern given that the present credit crunch has also left banks capital constrained. International comparisons 32. Trends in VC investment in Europe between 1998 and 2007 were broadly similar to those in the UK. However, Europe recovered far more quickly from the dotcom crash than the UK. The reason may be that the UK, being by far the largest source of VC funding in Europe (40% of deals) was much more seriously affected by the market collapse than other countries. 33. The UK is also the largest angel investor in Europe (31% of volume and 44% in number of deals). The average deal size in the UK has fallen below the average for Europe between 2005-2007. It therefore appears that the UK is doing many more deals than other EU countries but the deals are smaller in size. 34. The UK is the second largest VC market in the world after the US. In terms of VC deals the UK transacted a total volume of £12bn, 56% of the volume transacted in the US (£21.5bn equivalent). It also lagged the US with regard to the percentage of deals that were early stage (on like for like definitions - 13% vs 21%). However, given the higher GDP in the US, the penetration rate in the UK was higher. 35. In volume terms, US angel investment is an order of magnitude larger than in the UK. In 2007, US angels invested US$26bn (£18.7bn) compared with UK business angels investing the equivalent of US$4m (£29.5m). Average deal size in the US in 2007 was US$455,182 (£327,527) compared with US$91,332 (£65,705) in the UK. Implications of the current Credit Crunch 36. Fund managers state it is currently ‘too early to tell’ when the market will pick up, but recent experience from the dotcom crash suggests that downturn in the equity markets could be prolonged. The early stage end of the equity market will only pick up again when VCs can raise funds themselves. However, institutional fund raising, new early stage deals and exits are all adversely affected by current uncertainties over company valuation. 37. Most of the usual exit routes from private equity are currently restricted and hence early stage investors are staying involved in investments for longer, tying up funds that would otherwise be invested in new deals. In many areas business angels are less active in new deals because they need to concentrate on existing investments or have less income available for investment. 7
  11. 11. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Conclusions – assessing the equity gap 38. Most consultees consider that even in normal market conditions a structural equity gap remains. However, it is clear that the boundaries of the equity gap are more complex than a single set of parameters. The parameters of the gap are believed to stretch from £250k to at least £2m (with some putting the ceiling at £5m). In the case of sectors requiring complex R&D or large capital expenditure the gap may extend up to £15m. This is generally consistent with the previous assessment presented in Bridging the Finance Gap (2003) which concluded that ‘the gap appears most acute for investments between £250k and £1m, but is also severe for businesses seeking up to £2m, and for some businesses it may be higher. 39. These equity gap parameters define the first round funding gap, but there are additional concerns relating to the possible underfunding of UK companies at each stage of the venture capital process relative to the US. This could constrain the growth of early stage companies which then do not fulfil their potential. 40. The early stage market has been changing in recent years with the growing importance of business angels, both as individuals and as members of syndicates. Business angels also constitute the most frequent source of private sector match funding in co-investment deals. 41. Whilst there is concern that VCs have abandoned the early stage market, this is not entirely true. Some new VCs have entered this market. Early stage funding can provide a stepping stone for new VC funds on the way to larger deals. The ECF structure encourages this approach. Areas for further research 42. First and foremost, in considering the ‘equity gap’, this report has only investigated the existence of a gap in supply-side provision. When considering the overall ‘equity gap’, it will be important to consider the demand-side and the ability of firms to obtain the equity finance they need. 43. However, the report has shown that even in terms of the supply-side, there are areas where further research would be useful. These include: • investigation of the true extent of business angel funding in the UK. This would require use of the combination of techniques suggested in the recent report by Mason and Harrison.8 • further examination of the funding available within each region. This would include the additional data on business angel investment and more detailed input from the RDAs (not all of which were able to provide data for the current research). This could then be used, in combination with demand-side research, to ascertain more fully how acute the equity gap is in regions outside London and the South East. • further in-depth investigation of US VC investment data to arrive at a breakdown of average deal size by funding stage. This would enable a comparison with UK 8 Mason and Harrison (May 2008) Developing Time Series Data on the Size and Scope if the UK Business Angel Market, 8
  12. 12. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills average deal sizes to see if the anecdotal concerns about UK underfunding of early stage companies relative to competitor countries are justified. 9
  13. 13. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills 1Introduction 1.1 This research project was conducted on behalf of BIS9 (then BERR10 and DIUS11) into the supply of equity finance12 for SMEs. The research was undertaken by SQW Consulting in collaboration with Oxford Innovation and Professor Colin Mason, University of Strathclyde during the period September 2008 to January 2009. Background 1.2 Access to finance is essential in enabling some businesses to start up and expand. Although only a small proportion13 of businesses actually use or consider using equity finance, it is an important source of finance for SMEs, particularly those that have strong and rapid growth prospects. In addition, certain businesses are unable to obtain debt finance because they may not have sufficient cash flow to service repayments, and so equity finance is suitable for the early, pre-revenue stages of company development. SMEs can also benefit from involvement by investors in the running of the business through their expertise and personal contacts. 1.3 This research has been commissioned to refresh the evidence base on equity finance and, specifically, to establish whether the existence and boundaries of the “equity gap” for SMEs seeking modest amounts of equity finance have changed since the ‘Bridging the Finance Gap’ research undertaken by HM Treasury and Small Business Service in 2003. 1.4 The latter investigation identified the shortage of risk capital – the “equity gap” – to be most acute for businesses seeking investments of between £250k and £1m, but extending up to £2m, and for some businesses it may be higher. 1.5 Since this earlier research was conducted there have been a number of new public sector initiatives to address the issue: the introduction of Enterprise Capital Funds (ECFs) and the provision of additional venture capital funds by Regional Development Agencies (RDAs) co- financed by the European Regional Development Fund (ERDF). 1.6 The present study is being conducted against a background of mixed views. For example, research by Library House (2006) questioned whether a funding gap currently exists at all. However, the weight of other evidence appears to indicate that venture capital deals have been continually increasing in size in recent years, contributing to a gap in the supply of equity 9 Business, Innovation and Skills 10 Business, Enterprise and Regulatory Reform 11 Department for Innovation, Universities and Skills 12 Equity finance is defined as capital invested in a business for the medium to long term in return for a share of the ownership and sometimes an element of control of the businesses. Unlike debt finance, equity finance investors do not normally have a legal right to charge interest or to be paid at a particular date. Instead their return is usually paid in dividends payments and depends on the growth and profitability of the business. Equity finance is often referred to risk capital as it shares the risk of the business and equity is the last source of finance to be repaid out of any residual assets in the event that the business fails. 13 The BIS Annual Small Business Survey 2007/08 shows of SMEs seeking finance in the last 12 months (23%), only 3% sought equity finance. Similarly, the CBR Financing UK SMEs Survey for 2007 shows that of those SMEs seeking finance in the last three years (36%), only 2% sought equity finance. 10
  14. 14. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills finance for smaller deals required by early stage businesses. The present study has the objective of testing and resolving the disparate views. Scope 1.7 Building on earlier evidence, this study examines the status of supply in terms of the scale of overall supply, supply by stage of business development, regional distribution of supply and supply by industry/technology sector. 1.8 In addition to providing a snapshot of the current supply of equity in the UK to SMEs, the study also examines trends in volume, deal sizes and coverage over time. 1.9 It assesses the supply of equity from three relevant sources – from formal investment activity through venture capital institutions; from informal equity investments by business angels; and also from publicly-backed funds. 1.10 It is important to note that the current research has not revisited the underlying market failure arguments for the existence of an equity gap, as these are already evidenced in ‘Bridging the Finance Gap’ report. Objectives 1.11 The original objective of the research was to look at structural issues affecting the existence and scale of the equity gap. Whilst this is still the case, the study also provides an initial assessment of more recent factors affecting the supply of equity capital to SMEs including the ‘Credit Crunch’ and recession. 1.12 The study has sought to determine within which segment(s) of the SME equity market is an equity gap most acute in terms of lack of supply and whether there any differences across sectors (especially high technology) and across stages in business development. The study also assess what factors cause differences in the availability of private sector finance. 1.13 The specific study objectives are to examine: • changes in VC investment over time to determine the recent and current pattern of venture capital provision to SMEs, examining data from 1998 onwards • changes in informal investment over time to determine the recent and current pattern of informal investment made through individual business angels and angel groups/syndicates • public sector backed funds to determine the pattern of investment by public sector backed venture capital funds14, including targeting of funds in relation to patterns of private sector supply and also an assessment of the strategic “fit” - the complementarity of public backed interventions in terms of rationale, objectives and investment activities 14 Including Regional Venture Capital Funds (RVCF) and Enterprise Capital Funds (ECF). 11
  15. 15. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills • market drivers to identify the factors that have driven recent trends and determine how these will impact on future investment behavior and supply, including specifically attitudes and likely supply of early stage high tech investments • views of institutional investors to ascertain the attitudes of institutional investors to venture capital as an asset class • corporate venturing to ascertain the current state of corporate venturing and the current attitude of larger corporates to investing in early stage third party companies. 1.14 The study also provides an insight into the following issues: • total supply of equity capital in the UK and by region for formal and informal investments by total size and number of businesses helped • the investment appraisal process which Venture Capitalists go through including due diligence before the decision to invest is given • other supply side barriers which could restrict the provision of equity finance to SMEs. 12
  16. 16. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Methodology and definitions 1.15 The study has been conducted using a mix of research methods including: • desk research on:  published reports and data  data provided by public sector bodies • consultations with individuals active in the equity supply-side market • facilitated workshops with business angels. 1.16 The primary research has involved consultations with key private and public sector stakeholders into the existence of an equity gap across: (a) sectors, including high technology sectors, (b) funding stages and (c) regions. Consultees included: finance experts, sector/industry experts, fund mangers, investors and others such as representatives from British Venture Capital Association (BVCA), European Venture Capital Association (EVCA), British Business Angel Association (BBAA), National Endowment for Science, Technology and the Arts (NESTA), Technology Strategy Board (TSB) and Regional Development Agency (RDA) finance leads. A list of all informants is provided in Annex C. Data sources and definitions 1.17 The various UK and international data sources relevant to this project have important differences in the methods of data collation and analysis, and also in the definition of key terms and coverage. Full details on methodology and definitions by data source can be found in Annex A. UK Venture capital Data sources 1.18 The British Private Venture Capital Association (BVCA) represents over 400 full and associate members, constituting the vast majority of UK-based private equity and venture capital providers and their advisors. In analysing the supply of venture capital finance in the UK, this research relies heavily on the BVCA’s annual reporting of investment activity 15 as it is the most robust and comprehensive source of data for the UK. The data are compiled from a survey of full members16 of BVCA and attracts a very high response rate. In some years this has been 100% including the 2007 survey used in this research. 15 BVCA and PricewaterhouseCoopers (PwC) (2008), BVCA Private Equity and Venture Capital Report on Investment Activity 2007. 16 According to BVCA, there are five main categories under which BVCA full members fall into, these include: private firms; partially public backed funds; captive funds; angel syndicates and listed funds. Captive funds invest their own money and/or manage or invest funds on behalf of a parent organisation. 13
  17. 17. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Definitions 1.19 There are a number of specific methodological and definitional points that need to be considered when interpreting the BVCA data. These are outlined in Annex A (see 10 and 10). UK Business angels Data sources 1.20 To measure the level of business angel activity in the UK between 1998 and 2007, the British Business Angel Association (BBAA) was contacted for data in the UK. However, no time- series data on the number and value of investments since 1998 was available. 1.21 As an alternative source, the European Business Angel Network (EBAN) survey of national and regional business angel networks (2008)17 was used to provide figures for number of deals/ investments, amount invested and the average deal size but for the period 2005-2007 only. In the UK, BBAA and LINC Scotland18 were surveyed by EBAN. 1.22 Evidence was also based on data reported by Mason19. 1.23 There are two key points to note in relation to business angel data. Firstly, any BBAA data may only be the ‘tip of the iceberg’ of angel investing because the majority of business angel investment is unrecorded20. Secondly, the data that is recorded may not be representative of the remaining angel investment activity. Definitional issues 1.24 EBAN does not provide explicit definitions for the number of deals/ investments, amount invested and the average deal size. We have assumed the common understanding of these terms. However, it is important to highlight the difference in the definitions for ‘number of deals’ used in relation to venture capital funding (see Annex A) with that implied by EBAN. Deals for venture capital funding were counted as being equivalent to the number of companies, whereas EBAN refers to the number of investments. Consequently, the estimates for the average deal size would be measured differently. European business angels 1.25 European Business Angel Network (EBAN) is the main source of data for European business angel investment activity, in particular its publications: • EBAN Statistics Compendium 2008 and 2007 17 EBAN (2008) Statistics Compendium, based on the information provided by business angel networks having responded to the survey conducted in 2008. 18 LINC Scotland is the national association for business angels in Scotland – www.lincscot.co.uk 19 Mason (2006) The Informal Venture Capital Market in the United Kingdom – Adding to the Time Dimension, Venture Capital and the Changing World of Entrepreneurship 20 Mason & Harrison (2008) identify the gap in data relating to business angel investment activity and advocate that all developed countries should produce time-series data on business angel activity, suggesting a variety of ways in which this could be achieved. This is reported in: Measuring Business Investment Activity in the United Kingdom: A Review of Potential Data Sources, Venture Capital – International Journal of Entrepreneurial Finance. 14
  18. 18. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills • EBAN European directory of Business Angel Networks in Europe 2008 and 2007. European venture capital Data sources 1.26 European venture capital statistics are available from the European Venture Capital Association21 (EVCA) Yearbook 200822. These statistics are compiled using a survey of European countries for the industry’s new database, the Private Equity Research Exchange Platform (PEREP Analytics). This represents the most authoritative source of data on European venture capital. 1.27 Some important points in relation to the methodology and definitions used in the ECVA Yearbook need to be highlighted when interpreting the EVCA data (see 10 and 10 for details). US venture capital Data sources 1.28 The only available and comparable source of data for venture capital activity in the USA is the National Venture Capital Association Yearbook 200823 (NYCA). The data come from a survey of the Association’s 741 members active in the last eight years. 1.29 Definitions used in the context of the US venture capital investment are presented in 10. 21 EVCA has been established since 1983 and is based in Brussels. It represents the European private equity sector and has a membership of over 1,250 in Europe. ECVA’s activities include venture capital (from seed and start-up to development capital). www.evca.com 22 EVCA Yearbook (2008) Pan-European Private Equity & Venture Capital Activity Report. 23 The Yearbook includes statistics from the PwC/National Venture Capital Association MoneyTree Report based on data from Thomson Financial. 15
  19. 19. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills 2Analysis of the supply of equity finance - venture capital Key findings 1.30 The findings on the supply of formal venture capital by BVCA members are summarised below: • In 2007, venture capital comprised 13% of all private equity with total early stage funding accounting for 4% of total private equity investment and expansion stage 9% of all private equity. This led to the financing of around 1,000 companies in the UK. • Over the period 1998-2007, the level of early stage equity remained relatively constant, but with peaks in 2000 and 2006. The supply of expansion investment has been more variable throughout the period, with prominent peaks in 2000 and 2006. • The main sectors in receipt of funding (all stages) by value were consumer-related and communications. In terms of number of deals, computer-related, medical health/ biotech and consumer related were the highest. • The main technology-related sectors in receipt of early stage VC funding were software, biotech and communications. • The figures for the period since 1998 demonstrate the dominance of London and the South East in terms of early stage equity provision, both in absolute terms and when adjusted for the number of VAT registered businesses by area. Introduction 1.31 The analysis of formal venture capital investment has been subdivided into two main parts: • current supply of equity finance in 2007 – this provides a brief overview of the position of equity finance in the UK • recent investment trends between 1998 and 2007 - this is to observe the trends before and after the last global finance shock (the bursting of the “dotcom bubble” in 2001) and to refresh the evidence since 2003 and the Bridging the Finance Gap report 1.32 The key results are set out in this section with further data presented in Annex A being referenced where relevant. Supply of venture capital investment in 2007 1.33 A total of nearly £12bn in private equity capital was invested in the UK in 2007 by BVCA members in companies at total early, total expansion24 and MBO/MBI stages. Of this, £1.6bn 24 Total expansion includes: “refinancing bank debt” and “secondary purchase”. BVCA report these as separate financing stages within the expansion phase. However, the BVCA suggests these should be treated as private 16
  20. 20. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills (13%) is accounted for by investment in total early and expansion stages, in 976 companies in the UK. The total investment made overseas was nearly £19.7bn, of which investment in total early and expansion stages represented £1.9bn (10%) in 186 companies. 1.34 An overview of the position in 2007 of the venture capital market in early and expansion stages in the UK and overseas is provided in Table 3-2. Table 3-2 Investment in the UK and overseas by BVCA members, 2007 UK investment Number of Overseas Number of (£m) companies investment (£m) companies financed in UK financed overseas Start-up 190 207 134 23 Other early stage 244 295 115 59 Total early stage 434 502 249 82 Expansion* 1,137 474 1,645 104 VC (Total early stage 1,571 976 1,894 186 & expansion*) Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007. * Expansion excludes refinancing bank debt and secondary purchase. Investment activity trends over time, 1998-2007 1.35 In nominal (i.e. non-adjusted) terms, the total investment in private equity 25 in the UK by BVCA members has more than doubled (an increase of 217%), from £3,775m in 1998 to £11,972m in 2007. In real terms (removing the effects of inflation) there has been a 155% increase in supply over the same time period. The total amount invested over the period 1998-2007 was nearly £63,970m, for all financing stages. 1.36 Of this, the total amount of venture capital invested during 1998-2007 in early and expansion stages only was £15,852m (see Table 3-3), consisting of : • 11% start-up investment • 16% other early stage investment • 73% expansion investment. 1.37 Since 2003, the total amount of investment in the UK by BVCA members was £38,422m, for all financing stages26. The total investment during 2003-2007 in early and expansion stages was £7,692m. This total was made up of almost the same split between start-up, other early stage and expansion as found during 1998-2007 (see Table 3-3). equity and not venture capital. Unless otherwise stated, the figures reported relating to BVCA data excludes refinancing bank debt and secondary purchase within the expansion stage. 25 Total investment in total early stage, total expansion (i.e. expansion, refinancing bank debt and secondary purchase) and MBO/MBI. 26 This includes: start-up; other early stage; expansion; refinancing bank debt; secondary purchase; and MBO/MBI. 17
  21. 21. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Table 3-3 Investment in the UK by BVCA members, 1998-2007 Start- Other Total Expansion Total Total early Total Total up early early (£m) expansion* stage and MBO/MB investment (£m) stage stage (£m) expansion** (£m)I (£m) (£m) (£m) (£m) 1998 111 177 288 688 822 976 2,665 3,775 1999 128 219 347 980 1,156 1,327 4,666 6,169 2000 175 528 703 2,012 2,122 2,715 3,546 6,371 2001 163 227 390 1,339 1,636 1,729 2,726 4,752 2002 99 196 295 1,118 1,374 1,413 2,811 4,480 2003 73 190 263 477 867 740 2,944 4,074 2004 96 188 284 789 954 1,073 4,098 5,336 2005 160 222 382 1,144 1,951 1,526 4,480 6,813 2006 531 415 946 1,836 2,994 2,782 6,287 10,227 2007 190 244 434 1,137 3,817 1,571 7,721 11,972 Total 1,726 2,606 4,332 11,520 17,693 £15,852 41,944 63,969 Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007. *Total expansion figures include secondary purchase and refinancing bank debt. **Excludes secondary purchase and refinancing bank debt. 1.38 The data on the amount invested in early and expansion stages since 1998 (Figure 3-2) show that early stage investment has been relatively flat for much of the period, with highs in 2000 and, notably, in 2006. The supply of expansion investment has been more variable throughout the period, with prominent peaks in 2000 and 2006. Figure 3-2 Investment in early stage and expansion in the UK by BVCA members, 1998-2007 (£m) 3,000 2003 2007 2,500 Investment (£m) 2,000 1,500 1,000 500 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Total early stage Expansion Total early stage and expansion Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007. NB: Expansion excludes refinancing bank debt and secondary purchase. 1.39 Although the value of investments varies over time, investment has been relatively stable in start-up, other early and expansion stages since 1998 when measured as a proportion of the 18
  22. 22. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills total early and expansion stage investment. Between 1998-2007 the average investment at each financing stage as a proportion of the total early stage and expansion investment was (Figure 3-3): • 10% for start-ups • 17% for other early stage • 27% for total early stage (including start-up and other early stage) • 73% for expansion. 1.40 The data for 2003-2007 show that the average investment supplied at each financing stage as a proportion of the total early stage and expansion investment was relatively consistent for start-ups but fell slightly for other early stage companies (Figure 3-3). Figure 3-3 Investment by financing stage as a proportion of total early stage and expansion investment, 1998-2007 2003 2007 90% 80% 70% 60% 50% Percentage 40% 30% 20% 10% 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Start-up Other early stage Total early stage Expansion Source: Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007; SQW; NB: Expansion excludes refinancing bank debt and secondary purchase. 1.41 The number of companies at start-up, other early stage and expansion that received investment during 1998-2007 was 9,292 (see 10), and of this population: • 19% were start-ups • 25% were other early stage companies • 56% were companies undergoing expansion 1.42 The average amount invested (average deal size) in early stage and expansion during 1998-2007 was £1,706m (see 10). The average investment in early stage and expansion since 2003 has been £1,552m. Figure 3-6 demonstrates that: 19
  23. 23. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills • following the decline in average deal size between 2000 and 2003, the average expansion investment in 2003 nearly matched that of the average investment in all early stage companies in that year. • during the rising trend in average investment from 2004 onwards, the difference between the average expansion investment and the average investment in all early stage companies has been re-established. Figure 3-4: Average amount invested (deal size) in the UK by BVCA members, 1998-2007 (£m) 2003 2007 4,500 4,000 3,500 3,000 Investment (£m) 2,500 2,000 1,500 1,000 500 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Start-up Other early stage Total early stage Expansion Total early stage and expansion Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007; SQW; NB: Expansion excludes refinancing bank debt and secondary purchase. 1.43 The number of companies receiving VC funding per year has remained relatively constant since 2001 at approximately 1,000 companies a year. There has been some change in the composition with the number of expansion stage companies declining since 2003, which is off set by an increase in total early stage funding. In 2007, the number of early stage companies exceeded the number of expansion stage companies for the first time in the decade. 20
  24. 24. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Figure 3-5: Investment in early stage and expansion in the UK by BVCA members, 1998-2007 (number of companies) 1,200 1,000 800 Number of companies invested in 600 400 200 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Total early stage Expansion VC (early stage and expansion combined) Size of investments 1.44 Pierrakis and Mason27 have compiled and analysed figures based on BVCA data for the period 2000 and 2007, investigating the number of companies and amount invested within sub-£2m investments (see Table 3-4 and Table 3-5). According to these authors, this sub-£2m category is the scale typical of early stage investments. Unfortunately, BVCA data for sub- £2m investments are not broken down by financing stage and it is not possible to distinguish between initial and follow-on investments. Table 3-4 Number of investee companies by investment size - sub £2 m investments, 2000-2007 200 200 200 Total (SQW Investment size (£000s) 2003 2004 2005 2006 2007 0 1 2 calculation) 0-4.9 6 19 19 18 16 38 92 53 261 5-9.9 14 8 13 14 9 11 11 19 99 10-19.9 16 23 18 14 27 19 21 28 166 20-49.9 61 40 47 80 95 100 80 110 613 50-99.9 79 84 87 105 114 98 109 138 814 100-199.9 128 135 145 171 167 172 198 161 1,277 200-499.9 230 225 216 296 283 291 258 279 2,078 500-999.9 172 195 180 165 169 146 125 141 1,293 1,000-1,999 176 204 181 152 152 156 115 120 1,256 Total 0-£499.9 534 534 545 698 711 729 769 788 5,308 Total 0-£2m 880 933 906 1,015 1,032 1,031 1,009 1,049 6,847 Investments of less than £500k as a percentage of 61% 57% 60% 68% 69% 71% 76% 67% Not applicable investments of under £2m 27 Pierrakis & Mason (2008) Shifting Sands – The changing nature of the early stage venture capital market in the UK, NESTA 21
  25. 25. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Source: BVCA & PwC (2008), Private Equity and Venture Capital Report on Investment Activity 2007; Pierrakis & Mason (2008) Shifting Sands – The changing nature of the early stage venture capital market in the UK, NESTA. Table 3-5 Amount invested by investment size by BVCA members, 2000-2007 (£m) 200 200 200 200 200 200 200 200 Total (SQW Investment size (£000s) 0 1 2 3 4 5 6 7 calculation) 0-49 - - - - - - - - Not available 5-9.9 - - - - - - - - Not available 10-19.9 - - - - - - - - Not available 20-49.9 2 2 5 2 3 3 3 8 28 50-99.9 6 8 13 6 8 7 8 22 78 100-199.9 19 28 35 21 23 23 29 54 232 200-499.9 87 88 117 79 86 86 88 171 802 500-999.9 145 153 156 100 115 98 95 206 1,068 1,000-1,999 337 301 307 186 215 215 174 278 2,013 Total 0-£499.9 114 126 171 108 120 119 128 256 1,142 Total 0-£2m 596 580 634 394 450 432 397 740 4,223 Investments of less than £500k as a percentage of investments 19% 22% 27% 27% 27% 28% 32% 35% Not applicable of under £2m Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007; Pierrakis & Mason (2008), Shifting Sands – The changing nature of the early stage venture capital market in the UK, NESTA. Note: - denotes value between 0 and 0.5. 1.45 The following observations can be made on this analysis of data on sub-£2m investments made during 2000-2007: • the most common amount invested measured on the basis of the number of investee companies was £200k-499k, followed by £500k- £999k and £100k-£199k • the most common investment amount in value terms was between £1.0m- £1.9m followed by £500k-£999k and £200k-£499k 1.46 During 2003-2007, the total value of investments under £2m increased by 88%, while the number of companies receiving sub-£2m investment over the same period only rose by 2%. This suggests that average deal sizes below £2m have also increased. 1.47 Research by SBS28 finds that 79% of private sector venture capital funds in England invest on a co-investment basis and that “co-investment is the norm for most funds”. Two thirds of funds co-invest on more than half of investments and more than half co-invest on more than 75%. Co-investment in syndicates allows funds to invest in larger deals and diversify their investments more effectively. Aggregate figures may overstate the true level of smaller deals. Investment by sector 1.48 From the 2007 BVCA data it is not possible to separate investment in industry sectors by financing stage. Thus the findings presented are for all investments, including MBO/MBI and this limit the conclusions that can be drawn. Taking this into consideration, the aggregate 28 SBS (2005) A Mapping Study of Venture Capital Provision to SMEs in England. 22
  26. 26. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills investment in the UK during 1998-2007 was mainly allocated to consumer-related sectors followed by manufacturing, agriculture & other; and communications (see 10). The line graph for the total investment by sector illustrates the relative success of the consumer-related sectors in attracting investment (see 10). 1.49 The number of companies (deals) by industry sector shows that computer-related, medical health biotechnology, and consumer-related are the main beneficiaries of finance (see 10). However, as mentioned previously, this includes MBO/MBI deals. 1.50 The actual investment by industry sectors as a proportion of the total investment aggregated for the period 1998-2008 (Figure 3-6) shows that consumer-related; manufacturing, agriculture & other; and communications have the largest share of equity finance. Electronics, energy, construction and transport sectors have the smallest proportion of funding. It is important to note that some of these differences may be explained by differences in the size of the industry sector rather than investors willingness to invest. Figure 3-6: Proportion of investment within industry sectors in the UK by BVCA members, 1998-2007 Manufacturing, agriculture & other, 12% Consumer related, 29% Other services, 10% Financial Services, 7% Construction, 4% Computer related, 8% Transport, 4% Energy, 2% Electronics related, 1% Communications , Medical health Industrial related, 5% 10% biotech, 9% Source: BVCA & PwC (2008), Private Equity and Venture Capital Report on Investment Activity 2007; Statistics include MBO/ MBI investments. 1.51 The trend for the average amount invested (average deal size) in each sector during 1998-2007 (Table 3-8) highlights that the average investment in consumer-related sectors has increased. It is worth noting that because these figures include later stage private equity deals, they also cover sums invested in Private Finance Initiative (PFI) transactions, which may account for the peaks in investment observed in transport and construction sectors. 23
  27. 27. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Figure 3-7: Average investment (deal size) by sector, 1998-2007 60 2003 2007 50 Average deal size (£m) 40 30 20 10 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Consumer related Computer related Electronics related Industrial related Medical health biotech Communications Energy Transport Construction Financial Services Other services Manufacturing, agriculture & other Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007. The average investments include MBO/MBI deals. Investment in technology 1.52 Although the BVCA for 2007 do not provide statistics on all industry sector by investment stage, it does provide figures on early stage technology investment deals. The aggregate investment during 1998-2007 in technology-based early stage companies was greatest in those which specialised in software, followed by biotechnology and then communications (see Table 3-6). Table 3-6: Total investment in technology by BVCA members – total early stage, 1998-2007 (£m) 199 199 200 200 200 200 200 200 200 200 Total 8 9 0 1 2 3 4 5 6 7 Communications 13 12 59 61 33 19 15 12 3 14 241 Computer hardware 6 21 5 3 2 3 2 2 - 5 49 Internet 12 49 88 35 4 2 7 5 4 9 215 Semiconductors 1 16 32 24 9 14 12 13 8 16 145 Software 99 55 155 70 30 44 50 52 91 58 704 Other electronics related 10 7 10 17 9 8 15 17 24 13 130 Biotechnology 31 54 49 39 33 62 45 34 14 33 394 Medical instruments 0 6 2 13 6 27 10 25 24 20 133 Pharmaceuticals 14 4 4 26 20 25 22 15 41 31 202 Healthcare 10 4 3 13 7 1 4 63 7 10 122 Other 8 7 86 14 21 18 10 17 11 5 197 Total 204 235 493 315 174 223 192 255 227 214 Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007. 24
  28. 28. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills 1.53 Data on the number of early stage technology deals also highlight the prominence of software companies amongst investees (see 10). 1.54 The trend for the average amount of early stage investment (average deal size) declined during 1998-2007 overall but has been more stable since 2003 (see Figure 3-8). Figure 3-8: Average investment (deal size) in technology – early stage, 1998-2007 (£m) 1.6 1.4 Average investment (£m) 1.2 2003 2007 1.0 0.8 0.6 0.4 0.2 0.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007. 1.55 The total number of early stage technology companies as a proportion of all early stage investees generally increased between 1998 and 2003 but has since declined to the near 1998 level in 2007 (Figure 3-9). Figure 3-9: Proportion of early stage technology companies invested in by BVCA members, 1998-2007 100% 2003 2007 90% Proportion of tech companies 80% 70% 60% 50% 40% 30% 20% 10% 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Total early stage technology companies as a proportion of all early stage companies 25
  29. 29. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007; SQW. 1.56 The value of investment in early stage technology companies as a proportion of all early stage investment demonstrate a fluctuating pattern between 1998 and 2007, with a steep fall between 2003 and 2006 (Figure 3-10). Figure 3-10: Proportion of investment in early stage technology companies, 1998-2007 2003 2007 Proportion of investment in tech companies 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Investment in total early stage technology companies as a proportion of all early stage investment Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007; SQW Investment by region 1.57 The total early stage investment by region29 in the UK aggregated for the period 1998-2007, shows that London, South East, East of England, North West and jointly Yorkshire & Humber and Scotland are regions with the highest level of venture capital funding (Table 3-7)30. Whereas, the highest regions in terms of the number of companies invested in (i.e. number of deals) are London, South East, East of England, North West and Scotland (Table 3-8). 1.58 When aggregating early stage investment from 2003 onwards, the regions with the highest venture capital funding are London and the South. The regions with the highest number of companies receiving investment is the same as for the 1998-2007 time period. Table 3-7 Total investment by region – total early stage, 1998-2007 (£m) 199 199 200 200 200 200 200 200 200 200 8 9 0 1 2 3 4 5 6 7 Total South East 65 99 128 82 72 84 69 80 142 131 952 London 87 119 286 85 99 45 73 106 278 140 1,318 South West 11 14 32 17 11 8 11 26 90 28 248 East of England 25 23 47 88 57 71 40 86 97 45 579 29 The region refers to where the investee company is located. 30 Investment may be more clustered around London and South East than the figures show because the BVCA data includes some public backed funds. 26
  30. 30. The Supply of Equity Finance to SMEs: Revisiting the “Equity Gap” A report to the Department for Business, Innovation and Skills 199 199 200 200 200 200 200 200 200 200 8 9 0 1 2 3 4 5 6 7 Total West Midlands 21 7 29 12 3 2 4 4 18 6 106 East Midlands 10 11 18 10 2 10 17 20 105 19 222 Yorkshire and The Humber 4 15 44 7 1 2 24 12 113 12 234 North West 21 35 34 28 17 9 20 22 56 21 263 North East 3 2 9 2 2 2 3 2 7 7 39 Scotland 37 15 55 45 12 7 14 15 20 14 234 Wales 1 2 7 9 8 14 4 6 16 7 74 Northern Ireland 3 5 14 5 11 9 5 3 4 4 63 Total 288 347 703 390 295 263 284 382 946 434 4,332 Table 3-8 Total number of companies (deals) by region – total early stage, 1998-2007 199 199 200 200 200 200 200 200 200 200 8 9 0 1 2 3 4 5 6 7 Total South East 48 60 82 56 79 98 94 104 90 88 799 London 51 75 126 82 69 66 75 75 104 110 833 South West 8 12 16 19 15 22 29 42 35 29 227 East of England 31 23 53 72 67 66 59 61 50 50 532 West Midlands 9 8 22 23 14 20 21 24 35 32 208 East Midlands 11 9 8 11 5 15 25 22 20 18 144 Yorkshire and The Humber 12 11 14 26 5 13 6 20 10 19 136 North West 21 12 23 34 41 42 61 65 70 77 446 North East 8 6 8 9 16 15 16 16 10 19 123 Scotland 32 33 41 49 30 22 34 36 40 34 351 Wales 5 6 4 16 26 15 14 13 20 17 136 Northern Ireland 5 5 12 11 31 33 20 13 16 9 155 Total 241 260 409 408 398 427 454 491 500 502 4,090 Source: BVCA & PwC (2008) Private Equity and Venture Capital Report on Investment Activity 2007; SQW 27

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