Return of equity investment in past five years must not be allowed to falter

Whoever wins on Thursday, let us hope we see further progress on what has been one of the success stories of the past five years: the rediscovery of the power of equity investment in young companies.

Equity investment went out of fashion in the run-up to the credit crisis. Entrepreneurs didn’t feel the need to dilute their ownership when the banks were prepared to fund them through credit, while many providers of equity found themselves unable to compete with the appeal of debt. But as credit dried up – and to this day it remains largely unavailable to many businesses – equity funding has returned to the fore. Research suggests there has been a sixfold increase in investment in fast-growing privately owned companies over the past five years.

The data, published by Beauhurst, reveals that just 73 private companies attracted equity funding totalling only £145m in the three months after the Coalition came to power in 2010. By contrast, funding hit £916m during the first three months of this year, with 276 companies attracting an injection of equity capital.

Some of this increase will have been driven by the changing fortunes of the UK over the period. Fast-growing companies face a more favourable trading climate today than in 2010, which is helping them to attract funding (and encouraging them to seek it).

Equally, however, specific policies have boosted equity funding. Beauhurst points to the introduction of the Seed Enterprise Investment Scheme in 2012, as well as modifications to the existing Enterprise Investment Scheme. The Business Growth Fund, the brainchild of the previous administration, has also been a major equity investor in many companies.

Other Coalition initiatives, such as the launch of Local Enterprise Partnerships and the British Business Bank, came late on in the administration, and have yet to make much impact, though they may in time.

The challenge now is to build on what has been achieved. However, none of the three main political parties offered much detail on how they might do that in their manifestos. The Conservatives’ plans for a “Help to Grow” scheme are aimed at plugging a £1bn funding gap that prevents many small businesses fulfilling their potential, but there is not much clarity on what form this initiative will take. Similarly it is not clear what Labour’s pledge to launch a British Investment Bank will bring to the party, other than reorganising a number of existing projects under a new roof. The Liberal Democrats appear to be offering even less.

This paucity of ideas is disappointing. Businesses with supportive shareholders prepared to take long-term stakes in growing companies stand a much better chance of sustainable success than those built on leverage provided by banks that impose restrictive covenants and inflexible repayment programmes.

Beauhurst predicts that the immediate impact of the election will be a dip in equity investment, as businesses and investors take time to assess the outcome – all the more so in the event of a hung parliament and protracted negotiations over who forms the government.

However, while a temporary lull in equity investment may be inevitable, the next government needs to work hard to ensure that it does not prove permanent. The challenge will be to provide further structures to support investors offering growth capital of this kind – and to encourage more growing businesses to take advantage of it.

In countries that have a good record of helping start-up businesses to develop into profitable medium-sized companies employing large numbers of staff – notably the US and Germany – the role of equity capital is well-established. Now is the time to ensure that it also becomes the norm for Britain’s most promising businesses.

The Alternative Investment Market is likely to be one of the big losers in this week’s election, research suggests. The accountancy firm UHY Hacker Young points out that in each of the last three elections, both the month running up to the vote and the month of the election itself saw major drop-offs in the amount raised on London’s junior market.

In April and May 2001, for example, Aim IPOs raised 15 per cent less than during the average month over the rest of the year. In 2005, the drop-off was 22 per cent, rising to 53 per cent in 2010.

“The closer the election result, the bigger the dip in money raised on Aim,” said Laurence Sacker, a partner at UHY Hacker Young. “The potential for volatility doesn’t help pricing, and many issuers and their advisers simply avoid the months leading up to the election.”