The Equity Gap : 83 years old or dead?

It's a rare person these days who does not believe that we are a nation of fantastic entrepreneurs - the 5m odd companies now in existence pay testimony to this. It is also a rare person who does not believe that there is loads of cash lying around in the bank accounts of investors, whether private or corporate, of which increasing amounts are being put to good use in investing in and supporting private UK companies. The range of investor activity extends from crowd funding (in all its guises) to corporate venture capital and from debt to equity. Even the amazing Neil Woodfood, that veteran of defensive quoted company fund management, has suggested he will be investing in private equity in his new independent firm. 

The Macmillan Gap or "Equity Gap" coined in the report of the same name in 1931 to explain the concept that business finds it difficult to access finance and, more importantly, that government should intervene to help, is now, in my view, dead. We need draw a line in the sand and bury the concept not least because in doing so it will remove the ability of government to use it as a justification to spend our taxes on business support schemes to "close the Gap". 

I sit across many parts of British business from the small privately owned company (my own) through the angel world and onto Venture Capital and also the quoted stock markets. What I see is that there is far less difference between them than you think. Broadly, entrepreneurs and business leaders just want to be left to get on with it. They want government to move out of the way, as few barriers to trade as possible, an appropriately educated and trained work force and to pay only the minimum amount of tax they are legally obliged to. The most significant and fairest things that the government could do to help them would be to reduce their taxes so they can keep more of the cash they generate, educate brilliantly the people who are going to come and work with them and help them move around the country more easily by investing in infrastructure such as rail and roads.

When it comes to access to third party finance, there are now so many options that companies, both large and small, are spoilt for choice. It is telling that some of the greatest innovations in finance for decades have come in the last five years precisely during the time when government has engaged in austerity. Just look as the rise and rise of crowd funding and corporate venturing to see how well the private sector works when government gets out of the way.

The work/education divide is the one big challenge for business which the state could help with. It needs to imbue a culture of business as one part of our core primary, secondary and tertiary education systems to the extent that everyone whose choses to can be, or is happy to work with, an entrepreneur when they leave formal education (and has been given the skills to enable them to do a good job). This is now (hurrah!) beginning to happen thanks to initiatives from the Department of Education and independent ones such as Founders4Schools.

The geography gap between London and the South East and the rest of the country is also less than you might imagine. Look at how Bristol and its Silicon Gorge are rising to the challenge of being in its own separate region. The government's commitment to investing in our national infrastructure - H2 and HS3 for example - will make a massive difference to these ambitious regions as transport links improve their ability to trade.

We discussed the Equity Gap issue at an excellent dinner at the London office of Smith & Williamson the other night.  Around my table were representatives from the angel, VC and private equity worlds. They were absolutely clear that the Equity Gap as it was originally envisaged does not really exist anymore. We rather struggled to think of any Gap at all and eventually settled on the fact that there is a dearth of Series B equity (i.e. £30m or more) in London and you really need to pop across to the East and West coasts of the United States to find a plentiful supply. Somehow I don't think the committee who wrote the Macmillan Report would have counted this particular gap as one that the Government should seek to close!

The truth is we are awash with different sources of funding and they are awash with money to invest. The alternative funding market raised £1bn in the first 3 months of this year for businesses (especially SMEs), the VCT market raised £400m in the tax year ending April '14 on top of the cash they funds are already holding on their balance sheets for investment, angel investing is expected to be worth £1bn+ and perhaps even £1.5-£2bn in 2014, and crowd equity investment is being tipped by some commentators to be set to exceed angel investment by autumn 2016-end of 2018. Corporate venture capital is also becoming a major source of funds for the best of class too. So even ignoring the banks, private equity, institutionally backed venture capital and good old friends and family, there is £billions available.

Meanwhile the explosion in incubators and accelerators, the 10,000s of books on entrepreneurship, college and university courses, independent coaches, specialist and general press, let alone enough networking events that you hardly need pay for your own supper again, are all happily servicing the needs of entrepreneurs on how to access funding should they need it.

The reality these days is that if the government does set up a scheme or subsidise business it does not really move the dial on volumes of activity and the impact of the scheme is that two camps form. Firstly there is the camp of the less savvy in the private sector who just have to pay for it without being able to take advantage of it and secondly there is the camp that simply works out a way to grab some of the funding themselves, using it to subsidise activities that would have otherwise have been happily paid for by the private sector or which are not commercially viable and should therefore not be allowed to survive.

I wonder though if we will ever see the end to expensive business support schemes? Consecutive governments have adored the Equity Gap as a justification for spending our taxes to interfere in the markets and business for decades. Schemes win prizes if you are a junior minister in BIS and when it comes to cunning projects to stimulate enterprise you get the added fillip that you get to hang out with a groovy load of people and check out some fun new projects on the way through - what is there not to like about that if you are a be-suited politician living in the Westminster bubble? It will be a hard addiction to wean the politicians off.

But what the politicians need to accept is that these schemes in today's world are funded by the taxes paid by the 5 million SMEs in this country and their hard working employees simply to subsidize the competitors to those self-same SMEs. At least 80, and even 40, years ago you could fairly say that government subsidy for SMEs was met by large business taxes, but today you cannot.

Were you aware that the average micro business and its staff are probably paying about £50,000 a year in taxes - VAT, PAYE etc?  A typical small business will be paying around £100,000-£250,000. Imagine what they could do with this money if they could retain it to invest in themselves instead of it being grabbed for business support schemes? Is it right for government to spend it to cross subsidise their competitors? Is it fair, when the government is taking all this money, to expect private investors or banks or alternative funders or whoever to invest similar sums to start taking a business to the next level? And is it fair for the government to allow a "man (or a woman) in a suit" in a secure job in a large high rise office "managing" a government business support project, to earn the sort of sums it takes 5 or 6 or 10 people to work full time for a whole year to generate in terms of taxes owing? Should government really be allowed to steal from people in sheds to fund the salaries of people in suits?

There is a lot of talk about gazelle companies versus the rest, but I just wonder what your average SME would be able to achieve if it suddenly knew that it would be £50-£250,000 better off next year because its taxes were not being grabbed by BIS to fund schemes? (Just in case your mental maths is as bad as mine - it takes 20,000 SMEs and their staff paying £50,000 tax a year to fund just one £1bn BIS scheme. That is probably 100,000 people earning around or less than the average wage!)

Hopefully I have made the case why BIS should not spend our taxes on business support, but some of you might be asking what would be the ramifications of ending the principle of the Equity Gap on other government various policies, and particularly investment tax breaks such as Social Investment Tax Relief, SEIS, EIS and VCTs? 

Well to my mind the ending of the Equity Gap principle liberates these schemes into exactly what they should be - routes to lowering the tax bill of the British tax payer. That is an excellent justification for their existence in its own right and now that the government has established the principle that you can invest in crowd debt through your ISA, it is completely consistent with policy! Even if you do not buy that argument you can cite the fact that these schemes help companies to grow, employ people, advance human knowledge, improve the quality of life and do social good. (And the growth and employment parts of that mix equate to more taxes being generated for the Treasury).

In fact if I was Mr Osborne I would liberate these tax breaks still further - let Friends and Family have the right to use SEIS and EIS when they invest in their children and mates, let VCTs invest in later stage deals and hotels (both of which after all employ large numbers of people and, in the case of the latter, enable many a NEET or immigrant to get on the first rung of the career ladder). 

And of course, the cynical amongst you will note that by not removing these tax break incentives we will never need to face the issue of whether their withdrawal would reopen the Equity Gap!

Nation of Angels Survey

A UKBAA research project 

Every year, the HMRC release statistics on the VCT and EIS market and how much they put into funding new business. However, angels now play a significant role in the UK's entrepreneurial ecosystem, yet we still lack the research that properly maps and evidences their contributions.

Whilst many business angels invest privately, which makes calculating the size of the market relatively difficult, an estimated £850m is invested by angels per annum in the UK. This is around 2.5x the size of the Venture Capital Market, and there are an estimated 18,000 business angels around the country.

Together with the Centre for Entrepreneurs, the UKBAA is leading an ambitious research project which is seeking to identify the scale of angel activity across the UK and the impact of angel investing on growing companies. They are hoping to provide reliable information on the widely uncelebrated role that business angels like you play in providing the funding and expertise to support the growth of entrepreneurs.

The survey has been designed to be quick and east to complete and shouldn't take longer than 10-15 minutes. You can take the survey here: https://www.surveymonkey.com/s/nationofangels

By filling in the survey, you will be helping to create the first set of reliable statistics looking at the Angel Investing market in the UK and to get a sense of the impact that they have on the entrepreneurial ecosystem of the UK. They will also be seeking angel investors that are willing to be contacted by the research team to discuss in more detail their investment portfolio- more details on this at the end of the survey.

Thanks so much for you support, and please follow the link and support this important initiative and also send on to all your investor colleagues please

In line with Market Research Society guidelines, all responses will be treated in complete confidence and held strictly by ERC. No information will be revealed about individual angel investors.