Equity finance policy still in the past

Comment: When Tánaiste Mary Harney formed the Enterprise Strategy Group (ESG), she stated that "we will not guarantee our future by looking to the past".

Yet the past is precisely where the ESG looked to develop policies on the equity financing of Ireland's start-up businesses.

The ESG report, Ahead Of The Curve, and the action plan introduced two weeks ago recommend continuing to implement the equity financing policies of the last decade to promote future Irish enterprise growth.

The ESG failed to create a relevant forward-looking framework for equity financing policy that reflects the tremendous economic growth and success that Ireland and its venture capital (VC) industry have experienced in the last decade, including the increasing rates of equity financing of indigenous start-up businesses, the enormous growth of the domestic VC industry, the nearly €1 billion in venture capital funds raised, and the almost €150 million in equity capital available for new investment.

Instead, the ESG recommends continued investments by Enterprise Ireland (EI) in the venture capital industry to close "gaps" in financing.

In 1992, the Culliton Report introduced the concept of an "equity gap" of early-stage risk capital for Irish small businesses, and, more than a decade later, this idea is still driving the framework for domestic equity financing policy, despite the absence of evidence that such a gap exists.

Since the formation of EI in 1995, it has supported the domestic venture capital industry though investments of more than €300 million in VC funds and Irish small businesses.

EI is now one of the largest equity investors in the country. This targeted support of the venture capital industry has resulted in policy that is blind to other essential parts of the equity financing cycle.

The ESG perpetuates this narrow approach by failing to think beyond the VC industry and critically examine the three key equity financing issues that constrain enterprise development today: the Exit Gap; the limited supply of angel capital in Ireland, and the lack of pension fund investment in private equity.

Closing the Exit Gap is now the most significant equity financing challenge in Ireland. The Exit Gap is evidenced by the very low rate of IPOs, relative to both the US and European averages, among equity-financed small companies in Ireland.

IPO exits generate the highest average returns, which suggests that Ireland's relatively low rate of public flotations directly impacts its ability to realise competitive returns.

Strong returns are critical to attract pension funds, VCs and angel investors to make equity investments in the indigenous start-up companies that are so crucial to Ireland's economic growth.

Closing the Exit Gap by increasing the rate of IPOs is therefore a key component of any long-term equity financing policy.

The relatively poor capital-raising performance of the Irish Stock Exchange for equity-financed Irish small businesses contributes to the Exit Gap.

Demutualisation and alliances are strategic options that could improve the size, liquidity and competitive position of the ISE and increase its attractiveness to indigenous firms.

In the short term, a focus on helping equity-financed companies target and prepare for public flotations and identify the most appropriate foreign or domestic exchange on which to list could also increase the rate of IPOs.

Secondly, Irish small businesses would benefit from an increase in the supply of angel capital. Business angels are wealthy individuals, often ex-entrepreneurs, who make small equity investments (less than €500,000) in early-stage companies.

Angel financing is the most common source of early-stage equity capital in the US and Europe, but is much less prevalent in Ireland.

Yet Irish fiscal policies such as government incentives, tax breaks, schemes and subsidies to individuals disproportionately encourage and reward investments in property assets relative to equity investments in indigenous companies.

These fiscal policies are at odds with Ireland's enterprise policy objectives of fostering the growth of small businesses. "Joining-up" of fiscal and industrial policies to consistently encourage enterprise development through equity investments by individuals would be a logical first step to increase the supply of angel capital to small businesses.

The third key concern is the dearth of pension fund investments in private equity in general, and venture capital funds in particular.

The best equity financing systems in the world are supported by active and substantial participation of pension funds as institutional investors in VC funds.

Ireland's pension funds invest in venture capital at extremely low levels, leaving VCs to primarily rely on banks and the Government as less reliable and attractive sources of capital. Investing the assets of the National Pension Reserve Fund would provide diversification to private equity as an asset class, and contribute a stable source of private sector capital to the venture capital industry.

The ESG fails to address these three critical equity financing challenges that exist in Ireland today.

Instead, the ESG recommendations for the equity financing of Irish small businesses look to the past as a way to drive enterprise growth for the future.

They also ignore the tremendous economic changes that have taken place in Ireland and perpetuate a narrow policy focus limited to the venture capital industry. Getting ahead of the curve requires more.

It demands a creative vision and a bold new framework that goes beyond venture capital to develop comprehensive and sustainable equity financing policies.

It is the only guarantee of a successful future.

Diane Mulcahy is a former visiting fellow at Trinity College Dublin's Policy Institute and is the author of the recently launched book Angels and IPOs: Policies for Sustainable Equity Financing of Irish Small Businesses. She can be reached at diane@mulcahymail.com