Understanding Regional Variations in Equity and Growth Finance: An Analysis of the Demand and Supply of Equity Finance in the UK Regions
182 Pages Posted: 12 Oct 2018 Last revised: 17 Apr 2019
Date Written: April 2019
Analysis of the regional distribution of equity finance.
Our descriptive analysis of the equity investment activity in the UK from 2011 to 2017 confirms results of previous studies in that London, the South East and East of England regions received in that period 67% of all equity deals and 75% of all invested funds in the UK. The concentration in London has increased over time since it has the highest average annual growth rate in equity investments (in both number of deals and invested amounts).
The three regions (London, South East and East of England) received higher proportions of equity investments in the UK than expected based on the number of high-growth firms (HGFs) and small and medium-sized enterprises (SMEs) in 2011-2017. Scotland received higher than expected number of deals but not invested amounts.
The detailed econometric analysis of firm-level data explaining the determinants of equity funding revealed that, after controlling for a wide range of firm and industry specific variables, the probability of a firm getting funded (any equity funding) is up to 50% lower in nearly all regions outside London. More specifically, in the period 2011-2017, the odds ratios that an identical company in a given region will get equity funding compared to London are the following (in descending order): Scotland (1.24), , East of England (0.80), South East (0.77), South West (0.70), North West (0.65), West Midlands (0.54), Yorkshire and Humberside (0.53), East Midlands (0.51). The results for the North East (1.01), Northern Ireland (0.96), Wales (0.85) are not statistically significant.
Firms able to communicate to outside investors attributes of the entrepreneurial and management team such as commitment, entrepreneurial experience, knowledge and management industry and technical know-how, and relevant networks increase their likelihood of accessing finance. Thus, the experience and composition of the board is important factor in gaining finance and venture success. Firms seeking equity investment are likely to compile larger initial boards aimed at capturing and signaling to potential investors these range of skills, business experience and evidence of networks. Moreover, the analysis showed that directors’ previous experience of equity finance is associated with significantly higher odds of obtaining equity finance after controlling for a wide range of variables related to the financial and non-financial situation of a company (financial ratios, size, age, charges on assets), directors’ characteristics, industry sectors’ failure rate and macroeconomic environment, directors’ previous experience of equity finance is associated with significantly higher odds of obtaining equity finance. By contrast, family firms have on average smaller odds of obtaining equity finance.
The econometric analysis of individual equity deal size (deal value) showed that all else equal, compared to London, in other regions the deal values are lower by up to 41%: East of England (-9% - but not significantly different from London), South East (-14%), Northern Ireland (-16% - but not significant), Scotland (-20%), Wales (-20%), South West (-25%), North West (-27%), East Midlands (-27%), West Midlands (-29%), Yorkshire and Humberside (-35%), North East (-41%). The models controlled for a range of variables related to the financial and non-financial situation of a company (financial ratios, size, age), deal characteristics (announcement, government involvement, stage), industry sector and macroeconomic environment.
In conclusion the differences in the probability of obtaining equity finance provision between London and other regions are magnified by the differences in deal values.
Analysis of equity finance supply in the regions.
An analysis of investor-investee pairs revealed that investors located in Northern Ireland, North West, Wales, North East and London invest most of their funds in their home region. The percentages of funds invested in the head office region (in descending order) are: Northern Ireland (93%), North West (70%), Wales (66%), North East (52%), London (52%), South East (49%), Scotland (45%), East of England (45%), Yorkshire and Humberside (24%), West Midlands (21%), East Midlands (19%), and South West (14%).
Overseas investors invest about 84% of their funds into companies located in London, East of England and South East. The percentages (in descending order) of overseas funds invested into companies with a primary trading address in particular regions are: London (60%), East of England (13%), South East (11%), South West (4%), North West (3%), Scotland (3%), North East (2%), West Midlands (2%), Yorkshire and Humberside (1%), Wales (1%), East Midlands (1%), and Northern Ireland (0.2%).
The proportions of company-investor pairs involving government (local, regional, devolved, or central) are the following (in descending order): North East (53.4%), Wales (39%), North West (34.6%), Yorkshire and Humberside (33.9%), Scotland (33.4%), Northern Ireland (28.4%), West Midlands (27.5%), East Midlands (9.3%), East of England (7.3%), London (5.1%), South East (8.3%) and the South West (5.1%).
Analysing distances between investor and invested company we find support for the spatial proximity hypothesis that the number of equity investments decreases with the distance from the investor. The frequency of equity deals decreases with the distance between the invested company and the nearest investor’s office. The exceptions to this rule are investors headquartered in Yorkshire and Humberside, West Midlands and East Midlands since they fund a relatively large number of deals further from their nearest offices. The pattern persists also after excluding government-backed funds.
Private investors are more likely to fund an equity deal outside their head office or branch office region if government is involved as a syndicated investor or if a director has past experiences with equity finance. In both cases the odds of equity investment from private investors located outside a focal firm’s region increases by about 20%, after controlling for deal value, investor type, announcement, stage and macroeconomic environment.
Analysis of the demand for equity finance in the regions.
Using the propensity score matching methodology we identified companies that share similar characteristics to those that have received equity finance. These firms are potential targets for equity investors. Then for these targeted companies we imputed deal values based on the characteristics of known deals. The sum of the deal values forms the estimate of the potential additional demand for equity finance (i.e. the ‘equity gap’) and is compared with actual stock of equity investments in regions.
The ranking of regions in terms of the potential demand for equity finance in 2011-2017 shows that the highest potential additional demand for equity finance was in Yorkshire and Humberside, followed by East Midlands, West Midlands, Northern Ireland, South West, North West, Wales, Scotland, South East, East of England, London and North East. (The presented order is on the basis of the potentially invested amounts imputed by the regression approach per one million pounds of actual equity investment, but the order remains virtually unchanged if other measures are used).
Using the plausible parameters to account for proportion of companies seeking expansion, willingness to take equity investor and the acceptance rate of equity funders we provide estimates of the aggregate ‘equity gap’ i.e. the total shortfall of equity funding in the economy. Analysis from alternative methods of estimation suggests that the size of the aggregate ‘equity gap’ is of the order of £6.5bn - £12bn.
Breaking this estimate down, the greatest additional demand in absolute terms seems to be in London (£1.9bn - £3.6bn), followed by the South East (£1bn- £1.8bn), the East of England and North West (£0.6bn - £0.86bn), and the South West (£0.5bn - £0.93bn). The West Midlands, Yorkshire and Humberside and East Midlands have a similar situation in that the potential ‘equity gap’ is approximately in the range £0.4bn - £0.7bn. Scotland follows closely after them (£0.3bn - £0.6bn). The lowest volumes of potential additional demand for equity funding seem to be in Wales (£0.16 - £0.3bn), the North East (£0.1bn - £0.17bn) and Northern Ireland (£0.06bn - £0.16bn).
In relative terms, the highest relative demand for additional equity funding in relation to the actual stock is in the East Midlands, followed by Yorkshire and Humberside, the West Midlands and Northern Ireland. At the other end of the spectrum, there is London and the North East.
Keywords: Entrepreneurial Finance, Venture Capital, Private Equity, Market Failure
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