For years, one of the most contentious debates among technology investors in the UK was whether British start-ups were finding it too easy to raise initial funding, only to find themselves starved of investment as they grew larger.
Privately, many investors worried that the proliferation of investment at the so-called “seed” stage which funds brand new businesses was too high and risked forcing businesses to turn to American investors in search of late-stage funding.
Now, some investors are asking if we’ve swung too far the other way.
New research shows that the number of investments in British technology start-ups is dropping while total investment continues to rise.
Research firm Beauhurst found that the number of investment deals in the UK dropped to 1,751 in 2019, down from 1,789 in 2018, which was a drop from the peak of 1,818 deals in 2017.
The number of early seed deals dropped from 739 in 2018 to 689 last year. And investment into university spinouts, the bleeding edge of start-ups where companies bring technologies like quantum computing and artificial intelligence chips out of the labs, is also dropping.
Investment in spinouts fell from £1.38bn in 2018 to £1.24bn in 2019, while the number of deals dropped from 358 to 334.
Meanwhile, the average investment into UK technology start-ups rose 61pc to £6.8m in 2019, skewed by a series of large deals worth hundreds of millions for mature businesses.
There’s no indication that the total amount of technology investment is dropping, however. Beauhurst says there was a 58pc leap in the total funding amount for 2019 to £12bn.
But does the UK’s maturing tech sector risk squeezing out eager start-ups just beginning their life as investors increasingly look for less risky, later stage deals?
Reece Chowdhry, the chief executive of seed investor RLC Ventures, says he has seen signs that it’s becoming more difficult for young start-ups to raise their first round of funding.
“In the media it looks like everyone’s got loads of money to give to founders, but on the ground at seed stage it doesn’t look like that as much as people think it does,” he says.
“There are very few funds doing £25,000 to £500,000 cheques, which is where people are starting up and we’re investing.”
One of his recent investments is Hub 85, which helps businesses examine how spreadsheets are used inside their organisation.
Omar Quraishi, Hub 85’s chief executive, says venture capitalists are increasingly focused on writing larger cheques for more mature businesses.
“Earlier stage companies are finding it takes them longer to fill them rounds. It took us a little bit longer than we had originally planned,” he says.
The journey from founding a business to striding into the plush offices of investors in search of millions of pounds of funding can take years.
Often, founders will attempt to “bootstrap” companies, funding the business themselves with almost no outside investment. It’s a life of borrowing desks from relatives rather than expensive monthly WeWork charges and company hoodies with the logo embroidered on them.
Eventually, those start-ups might turn to angel investors, wealthy individual investors who splash the cash making risky bets on young businesses. They might be successful entrepreneurs who built their own companies and retired or technology executives with some spare cash.
Some investors think angel funding might be drying up as they wait for returns from their existing bets.
Rob Kniaz, a partner at Hoxton Ventures which made early investments into Deliveroo, Babylon Health and Darktrace, says: “I think a lot of angels are tapped out now because they’ve allocated their capital and they haven’t gotten it back as quick as they may have in the past.”
“If you talk to angels, anecdotally they’re saying ‘look, until I get liquidity, I’m not doing too much more. As soon as I sell my shares in Monzo, then I’m going to put half of that back in the market.’”
So what we might need to breathe more life into early stage investing is a series of exits where established companies sell up, returning capital to their earliest backers.
“Until it’s liquid, they’re constrained, they can’t deploy,” Kniaz says.
Angel investment has historically been risky: Make a series of bets on tiny businesses in the hope that one becomes a technology giant somewhere down the line. Failed investments are common and considered part of the game.
Some investors see Beauhurst’s data as proof that British investors are getting better at picking winners.
A continued drop in the number of deals being made each year could signal that early stage investors are making fewer bets as they zero in on the companies most likely to be future “unicorns” with a valuation above $1bn (£771m).
Ed Lascelles, a partner at start-up backer Albion Ventures, says “the quality [of deals] is just much better. People have a better understanding of what it takes to succeed and what the acceptable risks are.”
“You’re seeing an increase in sophistication in the market … and a fairly good understanding now of what a good opportunity looks like.”
An alternative explanation is that start-ups are still raising seed funding but simply aren’t talking about it anymore.
“New founders are less excited to go and do press around a seed round. In some cases they don’t even bother announcing anymore,” Kniaz says.
Either way, investors are quick to dispel any suggestion that the new research should prompt a move away from late stage funding.
For investors hoping to spot the next British tech unicorn, or even a $10bn “decacorn,” the biggest problem isn’t a decline in early stage funding, but the persistent problem that the UK doesn’t have enough late stage backers of its own.
“The UK is still undercapitalised,” Kniaz says, “our company valuations are still probably lower than companies in the US at the same stages, with the exception of some of the fintechs. There haven’t been very many $10bn valuations here.”
The debate around start-up funding in the UK isn’t showing signs of being resolved any time soon, although investors are at least unified in their demand for enough local investment to keep unicorns like Deliveroo and Monzo firmly on British shores.