Since the financial crisis, the level of investments made by VC firms in developed markets has fallen markedly.
This stage is a critical time in a company's life cycle. Rebalancing growth with the additional cost of building infrastructure must be closely managed to ensure market leadership and to stay in business.
Contractions in bank lending growth and VC flows in some G20 countries are making it difficult for companies to grow beyond the start-up stage, but mechanisms are emerging that may help address the funding shortage.
Once an entrepreneur has been able to demonstrate a market for their product or service, the venture enters the emerging growth stage. The company will be earning revenues but is unlikely to be sufficiently profitable to fund its own expansion.
With a track record now behind it and a management team that has demonstrated its competence, it becomes somewhat easier for companies at this stage to access finance, and the range of options broaden. VC firms may start to show an interest, provided the company meets their criteria, and bank finance should be easier to access because collateral can be provided.
But despite this improved access, there are several trends that are hampering the ability of companies at this stage of growth to secure the funding they need.
The financial crisis has made banks and VC firms more risk averse and limited the funds that they have available to lend or invest. This means companies at the emerging growth stage face a highly competitive funding environment, and many will find that their growth prospects are constrained by a failure to secure the financing they need.
Entrepreneurial businesses are heavily dependent on bank finance to fund operations and enable their growth. Bank finance can be very difficult for SMEs to access in any market and at any stage of their development. Key reasons for this include the perceived risk of lending to SMEs, a shortage of suitable collateral, the high administrative costs of serving SMEs relative to the size of the loan, and difficulties obtaining valid credit information on borrowers.
The financial crisis has greatly exacerbated the difficulties that SMEs face in accessing bank finance. In the wake of the crisis, credit conditions tightened dramatically in many countries.
Since 2008, there has been a modest improvement in global bank lending conditions, but despite this positive trend, credit growth rates remain very low.
Credit guarantee schemes fill the gap
One way in which governments are helping to address this shortfall is through the use of credit guarantee schemes. These essentially involve underwriting the risk of lending to SMEs so that banks can be reimbursed, either in whole or in part, in the event of a default on a loan.
Some schemes also offer borrowers advice to help them with securing finance or other aspects of their business.
Publicly funded credit guarantee schemes exist across developed and rapid-growth economies. Although recent data on the number of credit guarantee schemes is scarce, a report from 2003 estimated that there were more than 2,250 schemes in almost 100 countries around the world.
Specialist bank for entrepreneurs and venture capitalists
Founder & EVP,
Chief Credit Officer,
Square 1 Bank
Square 1 Bank is a full-service bank dedicated to serving the financial needs of the venture capital community and entrepreneurs. Founded in August 2005, the firm raised US$105m of initial funding and opened with six offices in the US. This has since expanded to 10 offices and US$1.6b in assets today.
The bank serves companies across all stages of growth and expansion, including pre-revenue start-ups and expansion stage businesses. It aims to build relationships with businesses at the earliest stage of their development and is one of only a handful of banks in the US that will provide debt finance to pre-revenue companies.
Square 1 Bank has a credit philosophy that revolves around knowing its partners. "We're a relationship bank, and this is a very unique industry requiring a hands-on partner at every level," says Susan Casey, founder and chief credit officer. "We spend a lot of time getting to know the equity investor, and we focus on our partnership with them and the relationship they have with individual companies."
Square 1 Bank provides companies with a full suite of banking services, including revolving and term lines of credit, treasury management products such as credit cards and ACH, foreign exchange services and letters of credit. Square 1 Bank does not provide equity financing to its clients but often receives warrants, or rights to purchase equity, in connection with extending lines of credit to clients. Square 1 Bank also aims to be a partner with its clients, and often collaborates with the client on its business plan, and may also facilitate introductions to equity partners.
"We consider ourselves to be our clients' financial partner," says Casey.
Companies at the emerging growth stage often need relatively large injections of finance to consolidate their position and enable a promising idea to be scaled. VC has traditionally been an important means by which these funds can be made available.
The VC industry's focus on later-stage companies can be positive for ventures that have reached the emerging growth stage of their journey. But there has also been a consolidation of VC firms, which has reduced opportunities, and increased competition for available funding.
Since the financial crisis, the level of investments made by VC firms in developed markets has fallen markedly. Overall, entrepreneurs from developed markets including Australia, France, Italy, the UK and the US point to deterioration in the access to VC over the past five years.
In 2011, venture capitalists put US$6.1b into 1,012 deals for European companies, down from US$6.7b into 1,253 deals in 2010. This represents the lowest annual deal count in Europe since 2000.
In rapid-growth markets, however, the picture is very different, with most entrepreneurs reporting an improvement in access to VC.
The Chinese VC market, for example, is growing rapidly. In 2011, US$5.9b was raised in 323 rounds, compared with just US$1.1b in 2005. In India, the growth in VC has also been impressive. Between 2005 and 2011, VC investment in India has increased five-fold from US$300m to US$1.5b.
- At this stage entrepreneurs should have a credible plan to take to banks, should seek out specialist or community banks that may have stronger links with the business and explore the potential for corporate venturing.
- Governments should explore credit guarantees, introduce monitoring and mediation entities, make it easier for VC firms to make cross-border investments and co-invest with the private sector.
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