The Second ‘Equity Gap’: Exit Problems for Seed and Early Stage Venture Capitalists and Their Investee Companies

DR. GORDON MURRAY IS WITH THE WARWICK Business School, University of Warwick, England. The availability of venture capital funds for early stage investment (such as seed capital and start-up equity finance) remains limited in the United Kingdom. This paper investigates one element of the relationship between early stage venture capital investors and their larger, development capital counterparts. It is hypothesised that there could be a complementarity of activity between investors in early and later stage activities. Particularly, the later stage, venture (development) capitalists could provide a material source of follow-on funding for investee companies within the portfolios of the financially constrained, early stage funds. A population of fifteen UK venture capital organisations specialising in seed capital, start-up and early stage financing were identified. Twelve of these investors were interviewed using a telephone survey. The findings indicated that both parties rarely shared deal flow activity. While development capitalists were the preferred source of follow-on finance for their investee companies, the early stage respondents did not believe that development capitalists were, or would be in the future, an important means of either refinancing or exiting from their portfolio companies. The lack of provision of follow-on finance from the established venture capital industry suggests that the young, growing and potentially successful firm funded by an early stage investor faces a second equity gap. This gap occurs when the growing firm seeks additional finance for commercial expansion once the available resources from its early stage investor are exhausted.