Just one quarter of venture capital funding went to early stage “true venture” businesses in 2020, according to an analysis undertaken by Price Bailey, a Top 30 firm of accountants.
Price Bailey says that while at a macro level the venture capital (VC) market is buoyant with GBP11.2 billion invested into UK scale-up businesses in 2020, and GBP5.1 billion already invested in Q1 2021, these numbers do not provide an accurate picture of the volumes and values of “true venture” deals. Price Bailey defined “true venture” deals as businesses with less than GBP1.5 million share capital, raising GBP2 million or more in equity. These are businesses raising their first transformational equity funding round, often referred to as Series A.
According to this definition, there were just 422 “true venture” deals in 2020, representing 23 per cent of the total number of VC deals (1,849). The amount invested in “true venture” deals was GBP2.8 billion, 25 per cent of the total amount (GBP11.2 billion) invested into VC in 2020.
Chand Chudasama, Partner at Price Bailey, comments: “The proportion of venture capital going to “true venture” scale businesses is surprisingly low, which gives the lie to the prevailing view of the market as one of record investment. These “true venture” businesses are not the untested seed stage enterprises which typically struggle to access funding, they are established businesses seeking their first substantial institutional funding. Entrepreneurs hoping for VC funding may be disappointed by the lack of investor appetite and forced to explore alternative, less attractive funding sources.”
“Earlier investments carry with them higher risks but also the possibility of greater returns. “True venture” businesses should yield more than mature venture investments do, so on that basis we would expect to see greater investor appetite for this tranche of the market.”
He says: “The common misconception is that equity funding is like a pyramid with the largest number of deals being for the first small rounds, and relatively small volumes at the high end. The true shape is more like a diamond in which there are a small number of “true venture” deals, a larger proportion of deals occurring in the middle, where businesses are at the GBP1-2 million range of recurring revenue with a high growth rate, and a handful of big ticket deals right at the top.”
According to Price Bailey’s analysis, the number of ‘true venture’ companies which received funding declined by 18 per cent between 2019 and 2020, from 515 to 422. In contrast the number of all VC deals increased by 12 per cent, from 1,648 to 1,849 over the same period.
Chand Chudasama says: “The shrinking proportion of VC funding going to “true venture” businesses is a cause for concern, particularly if non-UK funding eco-systems establish themselves as a better home for entrepreneurs. We know that there is an abundance of capital looking for a home, so it is likely that many of these businesses do not fit a risk profile that investors are comfortable with.”
According to Price Bailey, 38 per cent of true venture deals are achieving cheque sizes of between GBP2 million and GBP3 million, and 67 per cent of all deals in the last four years have been less than GBP5 million. What this means is that a true venture entrepreneur who successfully raises capital has a 1/3 chance of raising more than GBP5 million.
Chand Chudasama says: “We were not expecting the amount of money going to “true venture” businesses to be this low. In many cases these are substantial businesses for whom a few million pounds in investment is unlikely to make a transformative difference to how the business scales up. Entrepreneurs looking to take their businesses to the next level may find that VC funding on its own is not sufficient.”
Price Bailey points out that employees are a proxy for self-sufficiency because they are funded either by debt or profit (the research strips out equity). If funded by debt, then they are an asset that can be borrowed against.
Chand Chudasama says: “We were expecting businesses within the “true venture” group to have far fewer employees. It is surprising that businesses that are this developed in terms of employee numbers should struggle to attract investment. In many cases, these businesses are either profitable or have substantial assets, yet the vast bulk of institutional funding is going to more mature businesses.”
He adds: “There needs to be more incubation support to encourage funds to look at “true venture” businesses. Further de-risking through improved tax incentives, such as the Enterprise Investment Scheme or Seed Enterprise Investment Scheme, are mechanisms that should be explored to channel more capital into businesses looking for substantial institutional funding.”