FOR BUSINESSES seeking scale, the process of funding growth is often characterised as an escalator - with founders initially staking personal capital, then finding angel support, then venture capital, and ultimately accessing public markets. While arguably simplistic (the academic Paul Gompers, for example, has argued that different funding sources are more suited to some business models than others), the escalator is a useful concept for understanding how companies can successfully fund growth. Between 2001 and 2007, for example, 8 per cent of firms that achieved a Nasdaq listing had raised money from angels and venture capital in succession. This escalator may now be broken. Colin Mason and Tiago Botelho of the Adam Smith Business School in Glasgow and Richard Harrison of Queen's University Management School in Belfast have just published research with stark potential implications for startups. First, they say, classic venture capital has given way to private equity on a market level. Venture capital hasn't dried up and there are signs of renewed vigour, but the authors say that a restriction in supply has hampered the "relay race" of angels passing on the baton to venture capitalists as firms grow. Further, since 2001, there has been a blockage at the top of the escalator, with a decline in small-cap IPOs. This heightens the importance of angels for longer in a company's lifecycle. As Gompers wrote in 1994, however, a flaw in angel investing is that the market can suffer from poor information sharing and the "amount of invested capital can be small." But Mason, Botelho, and Harrison think more recent research has ignored a change in the market. Angel investment has shifted from being "fragmented, and largely invisible" to being characterised by "highly visible angel groups which consolidate and channel finance from individual investors to entrepreneurial ventures." As a 2012 study by the Centre for Strategy and Evaluation Services found, most of the angel investment that we know about still does not flow through either the syndicate model (which predominates in Scotland ) or the network model more common to the rest of the UK . But the market could be shifting radically. In the case of Scotland , the number of syndicates (groups who regularly invest together) rose from two to over 20 between 2000 and 2012. The trend is likely to intensify. This could be beneficial, with implications for how startups plan their fundraising strategies. Syndicates are easier to approach than individual angels. They allow for more efficient screening of investment enquiries. They make it simpler for individuals to invest in smaller companies. They can also reduce risk, and allow for specialised investment strategies by the angels. The pooling of smaller angel stakes may also plug the structural equity gap for SME funding - stretching between £250,000 and £2m - identified by a 2012 BIS report. There may be a further complication, however. As angel groups could be unwilling to invest less than £50,000 collectively per venture, another hole may open up at the bottom of the market. Let's hope crowdfunding can fill it. Tom Welsh is business features editor at City A.M.
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