Economic growth

UK drops to 3rd place in early stage VC investments

Yannis Pierrakis and Liam Collins - 08.12.2011

NESTA welcomes the recently announced seed enterprise investment scheme (SEIS)

According to data from Thomson One Reuters, the UK is now lagging behind both Germany and France in terms of seed and early stage venture capital investments. The number of UK seed and early stage investments has been decreasing since 2006 in absolute terms, reaching their lowest levels in 2010. In contrast, seed and early stage investments in Germany have been increasing since 2005 reaching their highest levels in 2010. In fact, both Germany and France outperformed the UK last year in terms of the number of seed and early stage deals for the first time ever.

Figure 1: Number of seed and early stage deals in the UK, Germany and France

Source: Thomson One

A similar picture emerges when looking at the total amounts invested in seed and early stage companies where again, we see that in 2010 both Germany and France outperformed the UK.

Figure 2: Amounts invested in seed and early stage companies in the UK, Germany and France

Source: Thomson One

The number of UK seed and early stage investments as a proportion of all venture capital investments remained relatively stable until 2008 but has fallen dramatically since - from 37%(2009) to 22%(2010).  Latest figures for 2011 show a slight recovery for the year so far. In contrast, US seed and early stage investments experienced relatively stable growth thought the decade. Similarly in Germany, seed and early stage investment increased dramatically relative to later stage investments, driven by both an increase in smaller deals and a parallel decrease of late and expansion stage investments.

Overall, the amount invested into seed and early stage companies as a proportion of total UK venture capital investments has been falling since 2004 driven by the decreasing value of the average size of seed and early stage deals and by fewer later stage deals. In contrast, in the US the amount invested has again experienced steady growth while the amounts invested in seed and early stage companies in Germany has drastically increased since the financial crisis begun mirroring the increasing number of such deals. As a result, although the UK continues to perform better than any other European country in terms of expansion and replacement investment as proportion of GDP, when it comes to the early stage investments the UK continues to drop in the ranking list.

The previous figures clearly show that the availability of seed and early stage finance in the UK has declined dramatically in the current financial crisis and too little has been done so far to revive it.   In this current crisis, where private investors are becoming more risk averse and leaving the early stage space, and regionally based publicly backed funds are running out of money, it is essential that existing and new sources of finance are mobilised for the benefit of seed and early stage companies. There is a need to encourage more professional VC funds to remain or return to the seed stage since the continuing exodus of institutional investors from this area may create two distinctive layers of funding that are not interlinked. In addition, it is important to expand the number of business angels active in the UK. Evidence suggests there is over three and a half times as much business angel investment per capita in the US[1].

Several industry commentators argue that the equity gap is actually the measurable outcome of information asymmetries, or 'knowledge gap', and that policy has been most effective in countries which have approached the development of a venture capital market through demand rather than supply side measures. [2] Business angels are often able to bridge this knowledge gap because they provide 'smart money'. They are typically 'hands on' investors contributing their experience, knowledge and contacts to the benefit of their investee businesses.

Therefore, NESTA welcomes the recently announced seed enterprise investment scheme (SEIS) which has the potential to further incentivise private individuals to invest in seed and early stage high growth companies. The generosity of the scheme, which allows individuals who invest up to £100,000 per year in a new start-up business to claim back income-tax relief equal to 50% of the amount invested, could spark a large increase of funding to seed companies, similarly to that in France.

Click here to read NESTA's response to the HR Treasury consultation 

[1]  Wiltbank R., (2009), Siding with Angels: Business angel investing - promising outcomes and effective strategies, NESTA & BBAA,  May 2009

[2] Harding R., (2001), Plugging the knowledge gap: An international comparison of the role for policy in the venture capital market, Journal of Venture Capital, Vol (4), Issue 1, 2001