Can the mid-market learn any lessons from the growth of the early stage investment market?

Falling-pennies.png

Way back in 2002, when only just over half of the UK population had internet access and Girls Aloud released their debut single Sound of the Underground, it was fairly common to hear a litany of woes about the funding gap for early stage companies.

Fast forward to today, and although there are certainly still plenty of complaints, the gap has lessened considerably, as we continue to see a boom in early stage investment activity with UK growth capital investment reaching nearly £1.7 billion last year.

What in the world happened?

  • Attractive tax reliefs - building on the risk capital tax reliefs launched in the mid-90s, designed to encourage investments in small unquoted companies, subsequent governments rolled out Entrepreneur’s Relief in 2008, the Seed Enterprise Investment Scheme (SEIS) in 2012 and Social Investment Tax Relief (SITR) in 2014. Peter Cowley, renowned serial entrepreneur and former UK Business Angel of the Year, remarked that the various reliefs had instigated investment in some questionable start-ups which probably should not have been funded.
  • Response to the 2008 financial crisis -- there is little doubt that the crisis was the petri dish in which new funding mechanisms were cultured. Businesses not otherwise able to secure finance turned to higher-risk innovative funding sources created by entrepreneurs, who were in turn backed by investors willing to do so in order to take advantage of very attractive tax reliefs. That might not have happened with an inflexible watchdog. But at the time, the Financial Services Authority, now replaced by the Financial Conduct Authority (FCA), took an arguably riskier but supportive incremental and retrospective approach. This was best illustrated in the case of crowdfunding, allowing the alternative finance market to develop while new regulation was still under consultation.
  • Increased collaboration - there has been a significant increase in entrepreneurship programmes (particularly within universities and at the local community level), incubators and accelerators, as well as an increase in collaborations between these and early stage investors, such as angel clubs and VC funds. This has resulted in growing funds for university start-ups and spinouts, and investors switched on to the type of capital required.
  • Innovation in technology - From Web 2.0 in 2006 to electronic signature platforms there are various applications which made online funding activity viable on a larger scale. Technological innovations and the birth of Fintech have also played a significant role in increasing access for early-stage companies  to investors, creating new funding products, and seeking to simplify the investment process.
  • New funding structures – over the last 15 years many new funding structures have appeared, including Enterprise Investment Scheme (EIS), SEIS and SITR funds, university collaborative funds, and of course the alternative finance market, which has more or less doubled in size most years from 2012.

What can the mid-market learn from all of this?

Our new Defying Gravity research, that shone a light into the boardrooms of mid-market businesses all across the UK, revealed that the only ask of Government from eight out of ten business leaders was “a stable economy and decent tax conditions”.

The former may seem out of reach with the uncertainty of Brexit and there doesn’t seem much promise for the mid-market on the tax front. Tax incentives for early stage investment  continue to prove incredibly popular. For example in 2015/16, 3,285 companies raised around £1.6 billion under EIS and 2,225 companies raised around £170 million under SEIS.

While some are pressing for similar tax reliefs to be offered in the mid-market, that seems increasingly unlikely. Current whispers from Government suggest that EIS may soon be “re-focussed” to even earlier stage businesses, and HM Treasury are clear that tax reliefs are not on offer to subsidise investment into larger more mature businesses where the risk profile can be very different.

However, our research also unveiled a defiant ambition in the mid-market, with leaders remaining confident in their own abilities to succeed against the odds. Innovations in technology and new funding structures in the early stage market developed because entrepreneurs identified a gap and were willing to take risks in providing creative solutions. And it would not have worked had the FCA not taken a supportive approach, no doubt driven by government’s need to foster growth within a potentially flailing market.

The conditions may now be rife for innovations in mid-market finance with business leaders prepared to take measured risks around increased collaboration and joint ventures, as well as new investment products. An uncertain market could be the ideal breeding ground for funding innovation.

For more information or a conversation contact Dona Ardeman on +44 (0)1223 222499 or email dona.ardeman@mills-reeve.com