By Professor Nick Wilson
About the author
Nick Wilson is a Professor of Credit Management at Leeds University Business School. His research with Professor Mike Wright, Imperial College Business School, on how venture capital firms invest in small knowledge-intensive businesses in the UK has contributed to the development of a new Government policy initiative.
Our research looked at how small knowledge-intensive firms grow and how this is affected by the so-called ‘equity gap’ - the difference between the external funding that these businesses require to develop and the amount that is actually available.
The ‘equity gap’, when the market fails to provide sufficient equity capital, is seen as a major impediment to the UK’s economy as it limits how quickly knowledge-intensive businesses – which are seen as critical for future economic growth – can expand.
Evidence of the existence of a market failure is used to justify government intervention to stimulate investment in the knowledge intensive and high technology sectors without contravening European Commission regulations on state aid for industry. Venture capitalist firms have traditionally been reluctant to invest in knowledge-intensive firms because they have had difficulty in valuing these companies and assessing the timing of future revenue flows.
Our report, ‘The equity gap and knowledge-based firms’, analysed data on over 15 million sets of accounts and annual returns of UK limited companies and, using sophisticated econometric methods, estimated the demand for venture capital investments and the scale of the equity gap. The study calculated that the current ‘equity gap’ for knowledge intensive businesses is between £10bn and £15bn. The report also found that knowledge intensive firms typically take longer and require more funding to reach financial stability than traditional businesses.
The research utilised a unique UK corporate database covering all limited companies from 1997 to 2014. I constructed and updated the database (initially through the University of Leeds spin-out company Creditscorer Ltd) over the past 15 years. The core data has been continually enhanced, through collaboration with Professor Wright, to include details of Private Equity and Venture Capital backed enterprises during the time period. A current project is looking at the composition, characteristics and growth of the corporate sector in the North of England, the role of venture capital, private equity and the availability growth finance.
A considerable amount of work has sought to identify detailed ownership and governance characteristics of the individual firms through analysis of over 50 million records of director and shareholder data dating back to the mid 1990’s as well as tracking individual company performance and exits (insolvencies, dissolutions, acquisitions).
The equity gap study builds on my previous published work on private equity, venture capital, business angel investment and small firm financing which has informed policy debates on corporate finance and taxation policy (eg through HM Treasury, Her Majesty’s Revenues and Customs, National Audit Office, Bank of England, and the Department for Business and Innovation Services).
The same database has been utilised to analyse the performance of family businesses, SME’s, board level diversity (gender, ethnicity), ethnic businesses, the audit market, and financial distress and failure, resulting in a number of 4-rated publications. The work has been cited in other high profile reports as detailed in the Research Excellence Framework (REF) Impact Case produced by the Credit Management Research Centre (CMRC). The research also feeds in to the Big Data initiatives and the Consumer Data Research Centre (CDRC), which is funded by the Economic and Social Research Council (ESRC).
The Government has sought to encourage investors, including venture capital businesses, to fund knowledge-intensive businesses by offering tax incentives as a reward for the increased risk. In July 2014, the Treasury launched a consultation on these tax-advantage schemes in the wake of new rules on state funding. I contributed to the consultation and met officials from the Treasury, HMRC and the European Commission.
‘The equity gap and knowledge-based firms’ report was used by the Government in the development of a new tax-advantage venture capital policy that was announced in the Summer Budget on 8 July 2015.