Europe is geared up for banks. If a company needs capital, its Directors go and talk to a bank. And most SMEs have a trusted bank with which they do most of their business. With banks struggling to fulfill this role, Europe needs to think long and hard about equity financing. Equity investment for companies is precious. But the bad news is: there’s not enough available in Europe. The good news: this can be changed.
Equity is like a shy animal that is extremely cautious about coming closer. It is demanding: equity requires special treatment and likes to be fed by lots of information. After all, if things go wrong, then equity is lost. However, once an equity investor has bought into an idea, he or she becomes the most faithful companion you could wish for.
Equity has many benefits. It makes a firm more stable if times get tough. Indeed, the better a firm’s equity position, the better its credit risk, a condition that encourages banks to offer more favourable terms and conditions.
Equity is willing to take risks. You have a great new business idea? You want to take your company to new markets? This is where equity financing comes in. It comes in different forms and sizes: public equity for listed companies or private equity for privately-held companies. And within private equity, there is venture capital for young start-ups, and growth capital and private equity for more mature companies.
While we have public and private equity in Europe, we do not have enough of it. According to a recent study by think tank New Financial, the IPO markets in Europe are only half of the size as the ones in the US, even when adjusted for GDP. The same goes for private equity, with the European market less than half the size of the US. The difference for venture capital is even more marked: the US market is about 7 to 8 times bigger than the European one.
Contrast that with the credit market. Reliance on bank loans is particularly clear from company balance sheets. In aggregate terms, bank loans to companies amount to €5.4 trillion, while other forms of debt, such as high-yield bonds, add up to €1.7 trillion.
Times have changed from the lending heyday and banks are struggling to do what they need to do: lend to companies. Reforming Europe’s capital markets so that companies can access alternative sources of finance including equity is at the heart of the job for Britain’s new Commissioner in Europe, Lord Hill.
But why is there so little equity in Europe? One important reason is that providing equity means taking a risk. If the company fails, the equity is fully liable and stands to be lost. Risk-taking doesn’t really fit with the European profile. We are more on the cautious side, aren’t we? We tend to seek the security of a job at a big corporation or, better still, in government rather than striking out on our own.
Even more problematic is the fact that risk-taking is not rewarded in our society. Starting your own business is high risk because if you fail, you will lose out badly. You’ll lose your credit rating and your personal reputation.
We need a change of mindset here. We need to encourage each other to take risks and celebrate the entrepreneurial spirit. Yes, you might fail. But if you do, you will have learned a lot. And the next time you will do better. We have great success stories that we should showcase: Spotify and Skype are two examples of European start-ups where the founders and backers took enormous risks to succeed.
We need to educate our children to become risk-takers. We need to welcome those willing to provide equity and take risks into our economies. Europe definitely needs an equity culture!