Assessing and measuring the equity gap and the equity requirements for innovative SMEs

Purpose – This paper sets out to critically review the different approaches developed for the assessment and measurement of the equity gap for firms, mainly innovative SMEs, extending the quantitative approaches for equity gap developing a demand-side model that allows to predict the future demand for equity in precise terms.Design/methodology/approach – The first part of the paper deals with financial constraints for innovative SMEs and the possible existence of an equity gap, due to market failures. We analyse the different approaches developed for the assessment and measurement of the equity gap, their limits and level of significance. The next step in our analysis is focused on the computation of the additional amount of equity needed in order to finance the expected growth in sales, through the development of an original model that enable the estimation of the equity requirement under the hypothesis of maintaining a constant ratio between financial debt and equity. Findings – As far as the approaches developed to estimate the scale of the equity gap from the documentary review, our main finding is that demand-side analysis is the least well developed, especially as the quantitative approach is concerned. Through the application of the model to a sample of Italian firms, we find that, irrespective of the degree of innovation, the amount of equity needed is on average tiny (147.3 K euro). Moreover, the size of the additional equity requirement is clearly influenced by the role of the current debt.Research limitations/implications – The empirical data covered in this paper are from a large database that does not allow for pre-sale situation; moreover, the estimation of the amount of equity needed cannot be considered explicit evidence of an equity gap problem, since the gap itself require the rejection of a demand for additional financing tools that can be measured only in qualitative terms. Nonetheless, the threshold identified in our study could point to the existence of an equity gap, since the figure is in line with the findings emerging from international studies centred on the financing obstacles to SMEs’ growth. Practical implications – The research will be of interest to policy makers and practitioners in defining appropriate mechanism for bridging the equity gap for innovative SMEs. The relevance of the topic is due to contribution of these firms to economic growth. Originality/value – The attempts to quantify the scale of the equity gap at the international level have been limited by availability data. As a result, they have tended to be largely qualitative pointing to anecdotal conclusions. The model presented here allows predicting the future demand for equity in a precise way: the results could indirectly confirm the problem of a gap in the availability of risk capital for innovative SMEs.