Friday Letter: Minding the (funding) gap

The evaporation of funding for very early-stage companies is a problem shared by every country in the world. But it is also a problem for growth capital investors.

Certain governments have been very proactive in their response to a lack of financing for young companies.

The Australian government, for example, launched its Innovation Investment Follow-on Fund in March to provide follow-on funding to start-ups in the biotechnology, biomedical, information communication technology and clean energy sectors. This week, it selected 11 venture capital firms to receive total commitments worth A$64 million (€37 million; $53 million).

This is one step ahead of similar initiatives that have been launched recently in the UK and Canada in direct response to the economic downturn. Both have recently developed or augmented state-backed fund of fund schemes to support investments by domestic venture funds. Such moves go some way toward preventing the “tragedy” that Kim Carr, Australia’s minister of innovation, industry, science and research, said might occur “if these promising companies failed through no fault of their own”.

While Carr’s point is valid, these government-backed initiatives are so focused on certain sectors – with life science, IT, biotech and cleantech most frequently targeted – they naturally leave other promising companies out in the cold. Where is the support for early stage agri-business companies, for example? Or early stage retail companies?

Not only is the oversight bad news for these companies, but, if left unchecked, this funding gap will translate into a supply chain hole for private equity firms looking to invest further along the investment stage spectrum; growth specialists for example.

India is one clear example of a country where, outside of the IT or biotech-related sectors, there is little government or private funding available for very early-stage companies. So bad is the situation that a private equity specialist at a Mumbai-based investment bank recently said India’s lack of growth-stage companies is the biggest challenge faced by the Indian private equity industry – which, of course, is growth-focused.

Funds, he said, all want companies that are growing at 30 percent or 40 percent annually, with a revenue base of INR3 billion (€43 million; $62 million) to INR 5 billion. However, the number of those companies is shrinking, and without anyone investing further down the funding chain, where will more companies come from?

The problem is not exclusive to India. Neither of course is its potential impact limited to private equity deal flow – there is the stagnating effect on the growth of a country’s economy to consider, too. Governments and angel investors must take note – and take greater action.