UK late-stage venture boom offsets early-stage lull

Katharine Hidalgo
21 October 2019

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Amid declining buyout dealflow, Brexit, and a stuttering economy, investors in the UK do not have much reason to be cheerful. Late-stage venture investment, however, seems to be bucking the trend. Katharine Hidalgo reports

With 89 deals, the second quarter of 2019 saw a four-and-a-half-year high in the volume of expansion deals (in this context meaning funding rounds for companies that are generating revenues), according to Unquote Data. Furthermore, Q2 aggregate deal value, which reached £2.73bn, was the highest in Unquote recorded history.

The UK and Ireland have seen larger late-stage investments in recent years. The second quarter saw an average value per deal of £30.7m, significantly higher than the 10-year average of £11.8m. Furthermore, Q2 2019 saw six deals with a value of more than £100m, another Unquote Data record.

Max Bautin, a partner at IQ Capital, points to the high level of dry powder in the market due to a fundraising boom in 2017 and 2018. "The capital is there. There is lots of dry powder to the point of surpassing all records," he says. "There is an even bigger capital overhang in the US and Asia. International capital is focused on later-stage investments because it is easier to do that cross-border than at an earlier stage."

Despite political uncertainty, many international investors still view UK venture as more attractive than in other European countries, partly due to the track record of the industry, the infrastructure and the English-speaking factor.

Octopus Ventures CEO Alliott Cole says: "For many, it is our companies' expertise in emerging technologies, along with the size and diversity of the British market, that makes investing here so attractive. The role of our leading universities should not be undervalued either."

Canary in the coal mine
However, this increase in late-stage investment might be a harbinger of economic decline. Bautin says: "We often see larger and fewer rounds before a slowdown." Bautin thinks the significance of this phenomenon is that, when investors think an economic slowdown is approaching, they begin to focus more on their existing portfolio. "Local investors appear to be starting to play it a bit more cautiously," he says.

This is reflected in the volume of early-stage investments, which has seen a dramatic decline since H2 2018. The first half of 2019 saw 33 deals, the lowest level since H2 2005.

However, sentiment among venture capital firms does not seem to reflect this data. Cole says: "On the ground, we have never seen so many early-stage companies with the capability and vision to grow world-changing businesses."

Bautin agrees: "I do not see any reduction in appetite for early-stage investing." The Cambridge-based technology investor has done 15 early-stage and series-A investments in 2019. "The market looks like it is continuing to be red hot," Bautin says.

Nevertheless, difficulties for venture in the UK may be looming, with a marked drop in venture fundraising activity in 2019. While there are 18 closed 2018-vintage venture funds, the second largest volume in Unquote Data history, the total value of those funds is £1.2bn, the lowest level since 2013. The picture looks even more bleak in 2019, with only seven closed 2019-vintage funds, with a total value of £207m at the time of publication.

In the case that Brexit occurs, the European Investment Fund (EIF) would dramatically slow its investment in the UK. Octopus Ventures' Cole makes the point that EIF has focused less on the UK for several years now. While the fund made investments in a number of UK-based venture and lower-mid-market funds with a pan-European focus, it invested in no UK-focused funds in 2018. IQ's Bautin says: "Disappearance of investment from EIF and other EU-only investors can have a very material impact, as the British Business Bank does not have the same level of resources."

The British Business Bank is dedicated to compensating for this loss of funding, having supported 89,000 businesses with £6.6bn in financing since its inception in 2013. Bautin says: "So far, we have seen a significant increase in private investment, from family offices and institutional investors; however, in a slowdown, government sources are incredibly important to sustain investment activity."