By James Inness
Emerging companies remain under-represented on Europe’s capital markets despite the introduction of measures to make equity financing more accessible. This was the overarching takeaway from a recent one-day summit at which Latham convened with regulators, stock exchanges, financial institutions, corporates and advisors to discuss progress to date in relation to the European Commission’s Capital Markets Union (CMU) proposals.
In the technology sector alone, research shows that only 20 small and medium-sized enterprises (SMEs), collectively raising €600 million, accessed the Euronext markets in 2015 for funding. In comparison, despite 2015 being a record low since 2009, the NYSE and NASDAQ combined were accessed by 79 venture-backed companies, raising US$9.2 billion.
While there have been steps at both the EU and national level to develop the investor ecosystem and improve access to financing for high growth companies, it remains highly under-utilised. The recent CMU proposals, launched in September 2015, outline, among other things, the Commission’s strategy to close the funding gap. Yet Europe’s emerging companies continue to receive more than 75 percent of external finance from bank loans. Whilst progress is being made, it is widely recognised that regulators need to further enable, develop and support financing alternatives for high-growth companies.
Why target high growth companies?
High growth companies emerge from various geographies and span diverse industry sectors. A healthy business case and strong projected financials to support an ambitious vision are the defining characteristics of high growth companies.
By creating highly-skilled employment opportunities which diversify markets, these sustainable businesses are in demand to support and develop economic growth across Europe.
Closing the gap
More than 75 percent of European businesses are dependent on bank lending. Europe is host to 23 million SMEs, but only 11,000 are represented on the European capital markets. Consequently, it is predicted that Europe will be facing a EUR two trillion equity funding gap by 2020 should equity financing not become more accessible to emerging companies.
While equity financing should not strive to offset lending, there are challenges facing high growth companies seeking to access alternative funding, including:
- The retraction of equity allocation in investment portfolios. European policymakers need to ensure retail investors are able to access financial markets and institutional investors are not excluded by regulation which stipulates limits on investments in certain asset classes.
- Lack of knowledge on the process of going public. To go to market, emerging companies, powered by entrepreneurialism, require a cultural shift to become investor-ready. High growth companies are often deterred by the perceived high cost of going public and are reluctant to adhere to the stringent disclosure and market reporting requirements associated with public companies.
- Ecosystem deficit. Currently, there is a lack of mid-market brokers to drive the investor ecosystem. In addition, incentive structures are no longer present to educate and rally high growth companies.
- Regulatory landscape. National capital markets authorities and the European Commission need to address regulation to nurture a financial system that promotes growth and removes barriers to entry by shifting away from a retribution model.
- Tax. Organising tax processes more efficiently may assist high growth companies in managing tax liabilities and thus protect the company valuation. If such processes were more transparent, equity capital markets may become a more attractive funding option. In addition, improving the accessibility of cross-border information to investors would incentivise long-term investment and in emerging companies.
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