Prevailing winds: UK seed-stage investments

By Neil Dillon, Equity Manager, Swoop 

What’s really going on with early-stage equity investing?

There have been so many narratives and data sets surrounding early-stage investing activity globally, it’s hard to get a handle on what’s going on.  I want to talk specifically about seed-stage investments in the UK. In my role as Equity Manager for Swoop Funding, I am constantly being asked which way the wind is blowing and whether it’s a “good time to raise”. The answer of course varies according to the sector, funding stage, timeline – and region. And in this time of flux, it’s harder than ever to read the anemometer. Ok, I’ll stop with the wind metaphor… 

The British Business Bank published their Small Business Equity Tracker for 2020 (which covers 2019) a few weeks ago and there are some interesting callouts relating to seed stage. I’ll try to unpack them: 

• Overall volume of money invested has increased, up 24% on 2018, and we see larger deal sizes, up 21%, driven by growth stage. Seed-stage deal sizes are only up 1%. What does this mean? It means later stage equity deals are getting more love. 

• Seed-stage investment was down for the first time since 2011, a reduction of 1%. Remember, this data precedes COVID-19 so this is notable. 

• The number of follow-on deals outweighed investment in brand new companies for the first time, 964 vs 868. Not a good omen for businesses looking to get up and running. 

Yes yes, this is all very interesting but that was 2019, so what’s happening now? 

The decline in seed-stage investment is likely to be further exacerbated by COVID-19 because venture capital is naturally looking for safer bets, e.g. growth stage companies with a proven track record. At Swoop we are seeing VCs and angels favouring further investments in their existing portfolios.

VCs placed their bets on several companies in 2018 and they don’t want COVID-19 to wipe out their book in one fell swoop. It’s noble of them to support their portfolio companies through these hard times but it will no doubt come at a cost to their seed-stage strategy –and to early-stage startups more broadly. My clients (i.e. businesses looking for investment) have been patient throughout COVID-19 but in many cases it won’t be long before they stop growing – or stop existing. 

As always founders need to be resourceful and I’m on the journey with them. It’s not easy but if you look hard enough, you might find angels in the most unexpected places. Think laterally. Perhaps you can introduce individual investors to each other? They might be able to create an investment team that’s more than the sum of its parts. Remember to explore all your funding options.

The top crowdfunding players in the UK are reporting a good number of deals closing during COVID-19, with many overfunding. These platforms can be a great source of funding if you can catch people’s attention. Small-time investors don’t have large portfolios to tend to. 

It’s worth noting the sectors that saw the most overall investment in 2019. Software-as-a-Service (SaaS) remains in pole position with fintech trailing in second. Technological adoption has increased during the pandemic and I predict that investment in tech sectors will only increase and that quantum is only beginning to take off. COVID-19 has seen many in the market try to capitalise on the situation. Investors are making guesses as to which companies will thrive in the ‘new normal’. Are you about to launch an invisible facemask? If so, you’ll probably find people are banging down your door to give you cash.

Similarly, to 2008, this crisis has seen seed-stage investment hit hardest, which is not surprising given the higher levels of risk involved. Startups raising for the first time have seen an 81% drop in investment between 23 March to 7 July, according to Plexal. This is an alarming figure. We risk losing a generation of superstar founders. Switching to sporting metaphors… imagine losing United’s Class of ’92 or the golden age of American tennis – think Agassi and Sampras…

It’s not all doom and gloom though. I’m hopeful that I’ll see, first-hand, several great startups get the investment they deserve but they’ll have to work harder for it. As my friend from school used to say in the depths of exam time, ‘chin up, head down’. 

Access to finance has been a perennial problem for seed-stage businesses. From the investors’ standpoint it’s risky and the due diligence required is similar regardless of deal size – so of course it’s more attractive to raise larger funds and chase bigger deal sizes. But I’d urge investors not to understate the importance of this stage of funding. Without new businesses sprouting up we could see an era when whole countries – or at least regions – fall behind, with no one to challenge the industry giants!

To end on a more positive note, UK VCs have lots of dry powder for the next 12-16 months – approximately £9.5bn according to Preqin. To quote Samwise Gamgee (or was it Leo Varadkar – watch the funny clip here) “But in the end, it’s only a passing thing, this shadow. Even darkness must pass. A new day will come. And when the sun shines it will shine out all the clearer.” 

Let’s hope they’re right.