Investment starvation could stall startup innovation

Technology is considered a key way we can address environmental and social challenges. Over the last ten years, tech innovation in this area – known as impact technology – has been supported by growing investment.

Between 2011 and 2021, funding for impact tech companies that support UN sustainable development goals rose from £59 million to £2.8 billion, but there has been some concern regarding a downward trend in the proportion of early-stage funding available for tech startups in general.

Research by Tech Nation and Google for Startups found, in 2011, seed and pre-seed venture capital investment made up over 15% of the total investment mix in UK tech. By 2021, however, this dropped to just 4.8% due to a downward trend over the course of the previous four years.

“If these firms are to grow into the scaling engines of the UK economy, the supply of capital that sustains their early growth must be prioritised,” warns George Windsor, research and data director at Tech Nation. If funding isn’t sustained, the UK runs the risk of stifling future stars on the global tech stage.

Tech startups face drop in early-stage funding

Alongside a reduction in the proportion of startup funding, the research also found an ever-larger proportion of funding is being allocated to later-stage companies. This is because they present less risk to investors, particularly during times of economic uncertainty following Brexit, COVID-19 and now the Russian invasion of Ukraine combined with the UK cost of living crisis.

“The recent stock market recession and high inflation affects early-stage investments because venture capitalists have more concerns regarding future returns, which are less realistic now,” says Yana Mashukova, founder of fitness app Buttn.

Entrepreneurs caution that if things don’t change, the UK pipeline of innovative tech companies could be curtailed, leading to a period of silence in terms of the launch of product and services and growth.

Windsor, meanwhile, points to the UK potentially losing its sense of identity and the renown it’s achieved over recent years. “It’s likely to find itself in limbo between fast moving smaller economies like Sweden, Switzerland and Estonia and the might of India, China and the US,” he says.

Is now the time for entrepreneurs to panic?

Tash Grossman, co-founder and CEO of tech startup Slip, thinks a lot of entrepreneurs may delay pursuing their ideas because of the recent negative conversations around funding and growth. Delaying the launch of new startups, however, is a bad idea, she adds.

“I’ve seen a lot of posts recently on all the great startups that were born in the last recession – Uber, Airbnb, Square, et cetera – so there’s no reason to stop,” she advises.

Investors can, indeed, become more keen to find the ‘next big thing’ in times of uncertainty or crashes. The financial crisis, for example, also gave birth to the idea of cryptocurrency and blockchain-powered systems and platforms, which eventually entered mainstream thinking. Now, there are countless startups and ventures pursuing such technologies.

Furthermore, in absolute terms, investment in tech startups is actually still at an all-time high, with the UK currently fourth in the world for tech investment, having achieved a record year in 2021. Alexej Pikovsky, a former investment banker-turned-CEO of Alphagreen Group, points out that the relative decline in early-stage funding can be explained by a different breed of investors joining the venture capital world.

“Pension funds, asset managers and hedge funds have never invested in early-stage or late-stage private deals. Yet, for the last two years they’ve begun to participate as early as in seed-stage rounds – their capital just hasn’t reached early-stage investing yet.”

Startup investment: Reasons to be cheerful

There’s clearly room for optimism in the UK tech startup market, and data provider Preqin predicts the overall size of the private capital industry will grow from over $10 trillion, last year, to almost $18 trillion by 2026. Investment bank Goldman Sachs, on the other hand, forecasts this could even grow to as much as $30 trillion.

Plus, 2022 has started off very positively in terms of tech startup funding. This June, Dealroom and Tech Nation produced a report that showed the UK ranking second for global startup funding, after a record first quarter in which UK startups raised more investment than India and China, behind only the US.

“We must just be mindful of supporting early-stage tech startups with high potential to ensure this strong trajectory of growth and innovation continues,” Windsor notes.

Many experts predict the tech investment market will remain strong in the year ahead, although valuations could start to drop if market sentiment weakens due to macroeconomic trends such as inflation and higher interest rates.

“If stagflation becomes entrenched we may see more private investors forced to support their existing portfolios,” says Helen Oldham, founding board director at NorthInvest. “However, as long as the UK tax benefits exist in early-stage investment, we believe there will be an appetite.”

There may be a lot of uncertainty in today’s world, but the general consensus is this shouldn’t stop tech entrepreneurs from pushing forward with their business ideas.

It’s important to remember “the UK has the strongest venture and growth capital funding ecosystem in Europe,” says Mark Howard, joint head of technology, media and telecommunications at law firm Charles Russell Speechlys. This is “supported by tax approved investment schemes such as EIS and SEIS, and the VCT market. We also have the AIM market – Europe’s largest growth company public market.”

Where should early-stage startups start looking?

The key advice from both investors and entrepreneurs is that tech startup founders should be proactive and continuously build out their networks.

Marta Krumpinska, head of Google for Startups, recommends they always look for opportunities to meet other founders – even if from a completely different sector – as everyone who’s started their own business has experience to learn from. Tech entrepreneur Indy Gregg, founder and CEO of Wedo, meanwhile, advises shopping far and wide for the right investor for your startup, saying there are investors “literally everywhere”.

“There are some really great networks online like the UK Angel Investment Network and Connectd where you can search and be matched with angel investors. There are a lot of family offices and early-stage venture capitalists out there as well – and there’s always the crowdfunding approach. This can be costly, but also helps drive users.

“Startups can also consider alternative funding approaches such as NFTs, initial coin offerings, startup lending platforms and grants.

“Another way of raising investment is to share some equity with key team players,” she continues. “There are pros and cons to raising capital – you’re giving up a piece of your company in return for either money or human capital. Human capital is what you need to attract in order to achieve goals and be ready for scale. It’s rare to find a startup founder who’s built an empire on their own.”