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

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. 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. Through the application of the model to a sample of Italian firms, we find that the amount of equity needed is on average tiny (147.3 K euro). One important new finding to emerge from the application of the estimation model is the direct, statistically significant relationship between additional equity requirement per unit of sales and the firm’s size category and age; on the other hand, no significant differences were found with regard to firms’ degrees of innovation. This paper sets out to investigate the problem of assessing and measuring the equity gap for innovative SMEs. The contribution to the current debate is the development of an original demand-side model that allows to predict the future demand for equity (so-called equity requirement) in precise terms. Various authors (Berger and Udell, 1998) have reported that, due to market failures, equity is the form of finance best suited to providing the entrepreneur with the additional resources needed for the development of the innovative project. In continental Europe, the relative backwardness of financial systems (Rajan and Zingales, 2001; European Commission, 1998 and 2003b) aggravates the structural difficulties faced by SMEs in obtaining access to finance amplifying the problems related to the availability of equity. This contributes to create a lack of resources available for equity investments, known as the equity gap. During the last few years there have been various attempts, at the international level, to estimate whether an equity gap exists, and if so to assess its significance. However, there is still a great deal of uncertainty with regard to the method to be used for estimating the phenomenon. Most of the approaches developed focus on the equity supply side, although the demand-side analysis which is currently the least used, it is the most interesting from the methodological point of view.The paper is the outcome of research into “Equity Financing”, performed as a part of the FIRB project “Nuove dinamiche di sviluppo competitivo nella società della conoscenza" [New competitive growth mechanisms in the knowledged society], co-financed by the Italian University and Research Ministry.Our intention here is to pursue the demand-side quantitative approach, with the main aim of measuring the future demand for equity on the part of firms, with a particular focus on firms in innovative sectors.The paper consists of 4 sections. The first surveys the theoretical literature on the financial constraints limiting SMEs’ growth and the main methods used and the thresholds identified in international studies on the equity gap. In the second part, we show the methodology used in order to compute the additional equity requirements. In section three, we study firms in Italy’s Emilia Romagna region to identify the causes which generate financial needs to be covered by equity, and estimate the absolute and relative size of the investment required. Finally, the main conclusions of the study are presented.