Key Findings/ results

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 factorin 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.

Executive Summary

• This report contributes to policy efforts to transform Northern growth, rebalance the UK economy and establish the North as a global powerhouse.
• We utilise a unique corporate level database covering the period 1998-present to analyse the characteristics of the corporate sector in the North of England with a view to identifying the size and nature of the potential target market for growth finance through mid-market private equity (PE) investments. For this purpose we focus on companies within the size band of £5-£15m in assets and/or turnovers in the £5m plus range across all industry sectors.
• For purposes of this report, the North is defined as comprising the North East, North West, Yorkshire and Humberside, East and West Midlands government standard regions. The North consistently has around a third (32.5%) of the total number of active companies throughout the whole period 1998-2013.
• Recent analysis by the Centre for Management Buyout Research (Imperial College Business School) shows an increase in the number of private equity backed buyout deals in the period since 2012 with the Northern regions showing most activity outside London and the South East. We estimate that the Northern regions have 44% of the stock of PE invested firms in 2013. In 2015 81 deals worth £5.5bn were completed in the Northern regions representing 38.0% by number of deals and 27.1% by value of total private equity portfolio investment last year.
• Our data set is utilised to profile the characteristics of private equity targets and identify potential targets in the Northern regions. The profiling of private equity targets, using a multivariate technique that assesses all firm level characteristics simultaneously, generates a range of significant characteristics. Private equity targets tend to be established companies in terms of age and size and are more likely to have a higher proportion of tangible assets. The targets are in stable industry sectors with a lower than average failure rate and are less likely to be diversified (single product). Amongst the riskier sectors private equity investors have a preference for advanced manufacturing technologies and the high technology end of the services sector. The firms that private equity investors target are generally cash generative, profitable and have high interest coverage ratios on existing debt. The target firms are likely to have borrowed and have charges on assets. These firms have lower levels of equity and lower than average productivity thus providing opportunities for investors to realise performance improvement, and growth, post investment.
• The model identifies a total of around 1187 potential prime private equity targets in the Northern Regions that represents 36% of the total identified targets.
• Depending on whether analyses include full accounts with or without the productivity determinant, or are based on the full sample estimation and the 2009-2013 sub-samples, we find that the number of medium sized PE targets in the Northern regions ranges from 689 to 293, and the number of large PE targets ranges from 1399 to 794.
• We model firm level productivity using a multivariate technique that isolates the efficiency differences in firms attributed to technological progress, knowledge and know-how, management practices and other factors that increase efficiency (i.e. total factor productivity (TFP)). We find a positive productivity differential of PE backed firms over the control group of companies of around 5.1% throughout the whole period, which is stronger in the pre-recession period (around 6.4%). The differential is around 4.1% above the control sample, in the recession and post-recession period. The models are re-estimated on the subsample of firms in the northern regions and reveal a stronger relative performance of private equity portfolio companies relative to the control sample (7.5% to 9.1%) with a particularly strong performance in the more recent period.
• We find a positive profitability differential for PE over other company types of between 2.0% and 3.5%. The differential is higher in the recession period and strongly significant. The results hold for the models estimated using the northern region subsample of firms only.
• We find a rolling three-year compound annual growth rate (CAGR) in employment of around 3%, showing that achieved productivity improvements are not at the expense of employment. Private equity portfolio companies appear to be particularly resilient in the recession period. We find no significant differences of growth rates for firms in the Northern region compared to the PE invested population.

There are two major strands of debate on the issue of diversity in the corporate sector. The first concerns diversity (ethnicity, gender) within the boards of directors of UK companies and the second concerns the incidence and contribution of migrant ‘entrepreneurs’ or ethnic businesses across the UK corporate business population. However, the evidence base on diversity within the population of UK companies is scant. Taking a snapshot of all directors and companies in a unique data-base at the beginning of 2014 provided details of 8,870,881 directors. The individual directors could be matched with 7,404,463 individual company registration numbers and associated company characteristics. The Cultural-Ethnic-Linguistic (CEL) classifications of directorships in the study uses both the recorded nationality of the director and the ONOMAP classification algorithm based on given and surname. Around 87% of the directorships analysed were individuals of UK/European roots or nationality and white. Between 4-5% were Asian (Indian, Pakistani, Bangladeshi) and around 1% Black African or Black Caribbean and just over 1% of Chinese origin. Around 5% were of Central or Southern European origin. These figures are in line with population demographics based on Census 2011. The picture that is revealed of directorships is more one of ethnic concentration in ethnic businesses focused on industrial sectors and location than ethnic diversity within company boards. Female directorships account for around 33% of the total and the proportion of female directorships declines with size of company (around 12% in listed companies, on average over the time period.). A large proportion of the directors who record a non-UK nationality are associated with UK subsidiaries of (large) foreign parent companies and these should not be classified as ‘migrant entrepreneurs’.

http://realbusiness.co.uk/article/19873-family-businesses-are-more-stable-due-to-diverse-boards

http://www.publicserviceeurope.com/article/3514/family-firms-more-likely-to-survive-than-others

http://www.cps.org.uk/blog/q/date/2014/02/11/why-family-firms-should-be-encouraged/

Over the past few years, there has been growing momentum in Europe pushing mandatory quotas for women in the public arena but also on the boards of private companies

USA Today

Research by

CMRC and Imperial College Reported in Private Equity News and Fortune

Link

http://finance.fortune.cnn.com/2012/11/27/private-equity-debt/

and on CNBC

http://www.cnbc.com/id/49928721

“The arguments for alternative sources of finance are strong. More diverse financing gives businesses greater choice, promotes competition amongst finance providers, potentially reducing cost,

and leads to greater resilience in the financial system. Some other countries, particularly the US, have a wider range of bank and non- bank finance options for businesses creating a more diverse and efficient market” .

Breedon Recommendations 2012

Guerrilla Guide to Finding Working Capital

Professor Wilson presented a paper at the Theories of Family Enterprise Conference, University of Alberta, Canada (May 2012). The paper is a result of collaborative research with Imperial College and the University of Nottingham

Nick Wilson and Mike Wright presented at the Private Equity Forum in Paris 4-5th June, “Private Equity Portfolio

Company Performance through

the Economic Cycle”