SFC Capital calls for reform as UK first-time funding rounds down 36 per cent from 2018 peak

The number of first-time funding rounds into UK seed-stage startups declined for a second consecutive year in 2020, to 36 per cent below the 2018 peak for such deals, according to new research commissioned by SFC Capital. 

The data also points to reductions both to the amount of money available for first-time rounds and the number of funds equipped to make such investments. SFC Capital is therefore calling for urgent action to reinvigorate seed-stage investment and secure the future of the next generation of companies that will drive the UK Government’s “levelling up” and “science superpower” economic agendas.
 
There were 1,427 first-time seed-stage deals completed in 2020, down 17 per cent from 2019’s 1,715, and a 36 per cent drop from the 2,055 completed in 2018, the high water mark for such deals. This analysis is based on Beauhurst's data which includes every UK announced and unannounced deal.
 
Commenting on the decline - which SFC Capital has defied in its own performance over the past two years, when it has deployed more funding and completed more deals than ever before - Stephen Page, founder and CEO, says: “Some of this decline can be attributed to the impact of Covid-19 in 2020 - from dented confidence to changes to the investment landscape and founders’ priorities caused by the Government’s introduction of the Future Fund and other financial relief programmes. But only some. The biggest shock is the low number of early-stage businesses seeking SEIS funding. SEIS is one of the best support schemes available to early-stage companies anywhere in the world, and we saw spectacular year-on-year growth in the number of first-time funding rounds into innovative new companies from its introduction in 2012 until the peak in 2018. There should be tens of thousands of companies taking advantage of SEIS every year, not less than 2,000.”
 
Introduced in 2012, the Seed Enterprise Investment Scheme (SEIS) transformed the landscape of seed-stage funding, providing the incentive (through tax relief) and convenience (through funds, launched in 2014) for many more individuals to turn themselves into early-stage investors. SEIS has helped a total of 14,921 businesses raise GBP5.8 billion since its inception, with the volume of first-time seed deals increasing every year from 620 (2011)  to 2,055 (2018). 
 
But the data strongly suggests that changes to SEIS in 2018, introducing stricter requirements for applicants, is responsible for the initial decline in first-time seed-stage deal volume before Covid-19 hit in 2020. It also appears that — while an effective incentive for investors — SEIS has had an unintended limiting effect on the size and timing of first-time seed-stage deals. Since its introduction, both the average size of a first-time seed round and the average time taken to raise it have hovered just below the limits imposed by the scheme: median deal size over the period is GBP140,000, just below the GBP150,000 SEIS cap, while the mean time to raise is 23 months, one month shy of the two-year limit. Additionally, a “sunset clause” requiring SEIS to be wound down from 2025 as part of EU State Aid regulations threatens to make it harder for early-stage businesses to secure funding.
 
Responding to the data, SFC Capital — the UK’s most active seed-stage investor — issued a call to arms to the Government, focused on SEIS reform, increasing the amount of public money allocated to seed-stage funds, and simplifying bureaucracy for early-stage fund managers:
 
SEIS reform — Changes should include: increasing the SEIS funding cap from GBP150,000 to GBP250,000; extending the qualifying period from two years to three; relaxing state aid rules that prevent startups that secure grant funding from raising their full SEIS allowance; speeding up the approval process to prevent companies missing the deadline; increasing the investor-side cap from GBP100,000 to GBP200,000 to unleash capital that is currently going unutilised; abandoning the 2025 sunset clause.

Increase public sector investment — Public sector investment through vehicles such as British Patient Capital and British Business Investments reduces risk for private investors and exposes the Treasury to potentially significant upsides if companies succeed. While these publicly-backed funds are very active, they have comparatively little to invest at the very early stage. Making more public money available to support the growth of innovative startups would back the Government’s rhetoric about “levelling up”, “building back better”, and creating a “science superpower”.

Simplifying bureaucracy for funds — The introduction of an “approved fund” structure — such as exists with SEIS’s sister scheme EIS — would significantly reduce the administrative burden on funds by enabling them to produce a single certificate per investor covering all underlying companies, where currently they are required to produce one certificate per investor per company.
 
Reflecting on the recommendations, Page, says: “More needs to be done to incentivise angels to take the risk of investing in innovative early-stage companies, in greater numbers and at larger volumes. In its obsession with growth funding, the Government is grossly underestimating the importance of seed-stage investment. After all, without it, where will those growth-stage companies come from? Countless companies that are household names today — the likes of Bulb, Deliveroo, and Bloom & Wild — all most likely benefited from SEIS, taking initial rounds of a qualifying size. The Government doesn’t understand SEIS — in fact, many ministers seem completely unaware of it. But if SEIS dies, innovation dies; it really is that simple. The UK currently punches well above its weight on the global innovation stage, but without the required support for early-stage companies, we could tumble down the league table with innovators stifled before they even get going.”