Mad Money #61 - The Answer Dictates the Question


Sometimes when you think you know the answer, it will affect the question you ask. And this can be true of companies asking for funding.

I wrote recently about research published by Josh Lerner and Antoinette Schoar into employment growth of angel-backed companies compared to those funded by other means.

Another interesting finding of the research showed that differences in the angel funding achieved in countries was linked to how established angel investing was within their geography.

In countries where angel investing and risk capital generally had not been operating for long and had not yet gained traction, it appeared that companies who were more established tended to get funded. And furthermore, those companies applying tended to ask for smaller amounts of money than the norm in those countries where the investment model was more developed.

This seems odd as you might expect established companies, typically already with some good revenues, to attract more, not less funding.

The suggested answer was that the companies were self selecting or “self-censoring” as the report puts it. The companies believe the angel investors are more risk averse or less experienced in assessing and investing in very early stage investments. So they ask for less in an effort to match the funding sweet spot as they perceive it.

This of course can reinforce the status quo and actually hold back the development of a more favourable funding ecosystem.

This is a very interesting piece of academic research from some of the most respected experts in this area. However can it be extrapolated to what we see in Northern Ireland?

I think there are good grounds to say yes, it can, although not completely.

Put yourself in the place of a young company seeking funding. Naturally you want to go for the most likely source of funding and hence the one which will cost you the least time and effort.

If you have a product which appeals to consumers, then crowdfunding could be a logical route to pursue. On first glance it may look like the easiest too, although talking to companies who have been successful down this track it turns out that they were better prepared and did a lot more work than it might at first sight appear. The crowdfunding sites are largely based outside NI and so these deals are in effect taken out of the NI funding ecosystem.

And then there are the very technical companies who feel they need very smart investors who have a history of working in the company’s technical field. They are less likely to go the generalist route, instead pursuing specialist funds or individuals they know to have the relevant expertise.

So, in a way, the companies in NI do self-select a more limited range of opportunities than are available to the local angel population.

It is also true that the angels in NI are often seen as being more risk averse and happier viewing companies who are that bit more established. Hence more of these will tend to appear in front of them and therefore the prophesy sustains itself.

What is less clear is whether these effects are reducing the size of the funding NI companies are seeking. Based on what we have seen at Halo over the years, I would suggest not at the angel level. However the 2016 Knowledge Economy Index published by Catalyst Inc shows that for VC and Private Equity investments NI tops the UK regions for number of deals but is near the bottom for the value of those investments. So, it appears that self-selection is taking place in terms of values companies are pitching for, but on the flip side, the activity of deals is increasing which is good news for those looking to invest.

All in all it does look like the expected answer is to some extent dictating the question being asked by early-stage NI companies. Or at least of whom they are asking it.