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Risk capital

Equity financing for high growth SME businesses

Purpose

To reduce the equity gap, in particular, increased levels of:

• private sector investment in the equity gap
• skilled investment professionals operating within the equity gap; and
• high growth business start-ups within the economy.

How will this be achieved?

By improving high growth SME access to private sector finance by levering in public sector capital, where risk is shared.

Why offer public sector support?

The market does not currently provide an efficient level of equity-based finance to smaller businesses seeking only modest amounts of capital. This represents a barrier to successful investment, innovation and growth in SMEs with significant growth potential that hinders improved levels of enterprise and productivity growth in the UK.

An equity gap arises because the costs of making equity investments do not vary proportionately with the size of investment being made, and can be prohibitively high in the case of smaller investments. The relative costs of assessing potential high growth projects can be significant when the costs of identifying potential investees, evaluating the prospects, ensuring suitability for investment, and subsequent performance monitoring are taken into account. There is thus a co-ordination failure until such time as venture capital firms have entered the market and these costs to SMEs are reduced.

Evidence indicates that this “equity gap” is estimated to be particularly acute for investments between £250,000 and £2million.

A partnership approach would provide an opportunity for fund managers to gain expertise and develop innovative methods for assessing applications and managing portfolios of investments where there is currently a funding gap. This should help to reduce the market failure in the longer run by changing market knowledge and behaviour and demonstrating commercial returns.

What will be offered?

Provision of commercially viable equity funds by investing a combination of private and public money in small high-growth businesses that are seeking up to £2million in equity finance.

Who will be eligible?

The specified provision is up to £2m risk capital as this is currently where evidence (see Note 1) indicates that the equity gap has the greatest impact for businesses wishing to attract initial investment. This represents a particular barrier to successful investment, innovation and growth in SMEs, hence the specifications stipulation on SME business size.

Only schemes where there is a mix of public and private partnership should be allowed. Private sector funds to constitute at least 33% of the total fund and be genuinely at risk – subordination should not allow private investors to ignore the need to invest wisely.

Note 1: Bridging the Finance Gap: next steps in improving access to growth capital for small businesses, HM Treasury/Small Business Service, 2003.