The investment case for UK innovation: exploring the opportunity in venture capital
Now may be a good time to consider the benefits of UK venture capital - we highlight the case for technology and life sciences investment.
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As an experienced firm investing in global venture capital (VC), we often ask ourselves if the US success in scaling up promising start-ups with domestic institutional capital (see chart below) can’t be replicated closer to home.
The UK has the third largest VC market globally, and the largest market in Europe based on the number of Series A funding rounds, the first significant round of VC financing in the life cycle of a start-up company. The industry would seem ideally placed, therefore, to target companies looking for capital on the next stages of their growth journeys.
And that is why private sector-led reforms aimed at establishing a focused UK VC growth fund sector fill us with such excitement (see: UK venture capital: why now for UK pensions).
Venture capital has supported the growth of some of the largest companies in the world
Over the past decade, the UK has gone from only a handful of private companies valued at more than $1 billion, so called 'unicorns', to over 50 today. Many of these companies have generated exceptional returns for investors who’ve backed them at the earliest stages.
Overseas investors captured most of past returns
The dilemma, however, is that despite the buoyant VC market, the bulk of returns have been captured by overseas institutional investors. As limited partners (investors) in the best UK early-stage VC funds, they have been able to identify promising candidates ripe for scaling.
And, in the absence of a focused UK VC growth fund sector with access to institutional capital, they’ve been free to cherry pick these opportunities without any competition from domestic investors.
Examples of their past successes have included artificial intelligence (AI) cybersecurity specialist Darktrace, international money transfer service Wise and online food delivery company Deliveroo. All three were among a raft of VC “exits” via a series of initial public offerings (IPOs) on the UK equity market in 2021.
The lost opportunity is perhaps even more stark when looking at UK private companies whose VC backers are yet to exit, such as Revolut, the financial technology company that is now the most highly valued VC backed company in Europe.
We are fortunate to be among a small group of domestic institutional investors that backed the company, via our venture fund managers, from an early-stage over multiple financing rounds.
There is a notable omission from the company’s financing history, however, with none of its growth rounds (Series B or later) being led by a domestic institutional fund. Lead investors included DST Global, a global growth investor headquartered in Hong Kong; TCV, an American investment firm; SoftBank, the Japanese multinational conglomerate; and Tiger Global, a US hedge fund.
Revolut is certainly an encouraging proof point for the opportunities that may lie ahead for the UK’s focused UK VC growth fund sector and its institutional backers.
Likewise, we’ve seen the benefits that Google-owner Alphabet is now accruing from its 2014 acquisition of UK AI start-up DeepMind, prompting us to question whether more of these benefits could have been captured for UK institutional investors.
DeepMind revenues have built steadily, and good progress has been made to prove new potential AI use cases, from weather forecasting (Met Office collaboration) to medical discovery (AlphaFold project and Isomorphic Labs).
UK as a global competitor in early-stage VC industry
We certainly envisage no shortage of talented UK entrepreneurs fit for scaling their high-growth companies of the future. Of course, past successes are no guarantee of future ones, but we are very hopeful a new breed of focused UK VC growth fund will have many new scale-up opportunities to choose from.
Generative AI, together with advances in quantum computing and other sectors, for example the space industry, are now promising a 5th industrial revolution. All the ingredients are in place for the country to be at the forefront of several megatrends expected to unfold over the coming decade, not least in life sciences.
The UK biopharma sector has a proven track record of developing successful therapeutics across all stages of the biopharmaceutical value chain, which has resulted in new treatment options for patients suffering from various diseases. Many VC-backed biopharma companies in the UK continue to develop experimental therapeutics for areas of large unmet medical need.
In parallel, large pharmaceutical companies face patent expiries at risk of substantial revenue losses. Consequently, these large pharmaceutical companies have amassed combined reserves totaling several hundred billion dollars, with the aim of acquiring VC-backed biopharma companies to replenish their therapeutic pipelines.
Given this landscape, we anticipate that large pharmaceutical companies will continue to target and acquire carefully selected VC-backed UK biopharma companies to address the forthcoming revenue gaps they face.
Established VC firms with the networks and access to the best entrepreneurs at the earliest stage (seed and Series A) are best placed to help provide access to the future growth potential of start-ups.
This might be as they enter either the scale-up phase (in the case of technology companies) or prove-up phase (life sciences, through the process of discovery, clinical trials and regulatory filings) on their journeys to commercial and financial success.
The UK’s dynamic early-stage VC ecosystem is underpinned by world-class universities and research institutions, such as the University of Oxford, Cambridge University, and Imperial College London. These, and other leading institutions in the life sciences and technology sector add to the steady stream of innovative ideas, and highly skilled talent, fuelling the growth of UK start-ups.
That some of the biggest global investors in research and development have local teams and offices in the UK – Google is building it first purpose-built European office in London – will, we suspect, only bolster the pipeline of opportunities.
Private sector-led reforms taking UK VC industry to next level
These advantages have helped position the UK as a leader in European innovation and a crucial player in the global technology scene.
This success is reflected in VC deal values, which have grown more than six times since 2013, over which time UK VC firms have consistently accounted for around a third of the continent’s venture funding - and a growing number of its venture 'unicorns' (see charts below).
European venture deal values have grown - and UK is at the forefront of the market
As a hub for innovation, no other European capital can compete with London on the scale of Series A funding rounds. Based on aggregated financing (2015-2020) the city is among the top 10 global locations for this early-stage funding round, alongside the major hubs in China (Beijing, Shanghai) and the Bay Area of the US.
The US, however, as the birthplace of traditional VC, has a more mature VC ecosystem, with deep pools of long-term institutional capital, experienced investors and a strong cultural alignment with entrepreneurship.
This means the US industry is very well equipped to not only fund the most promising start-ups, but also give informed strategic guidance on the next stage of their growth journey. This helps avoid some of the pitfalls which typically occur when scaling a company from a small to large enterprise.
These are some of the key gaps private sector-led reforms such as the “Mansion House Compact” are seeking to close, by fostering the growth of a focused UK VC growth fund sector, with access to a required deep institutional pool of capital to enable investing at scale.
It’s clear to see how overseas VC funds have historically dominated the growth rounds of the most successful UK company exits in the past decade. These exits include the IPOs Wise ($12.2 billion exit valuation, 2021), Deliveroo ($10.5 billion exit valuation, 2021) and Betfair ($2.4 billion exit valuation, 2016). The latter subsequently merged with a rival, valuing the business at the time at $10.1 billion.
Meanwhile, Cambridge University spin-off Darktrace ($2.4 billion exit valuation, 2021) was taken private again. Its shareholders (including its original US VC backers) approved a $5.4 billion bid from US private equity firm Thoma Bravo, which has expertise in consolidating industries.
Diversification and potential return benefits of UK VC
Domestically funding VC companies right through the cycle – from start-up to scale-up – potentially means that vital knowledge and expertise is much more likely to be retained and built upon. The potential “multiplier effects” involved, not just for the VC sector but the wider UK economy, are material, with every pound spent on a new UK scale-up potentially producing many future ones of UK economic output.
And we are certainly very excited about the scope for UK VC growth funds to build on the success of the country’s existing VC sector. An analysis of its member funds by the British Private Equity & Venture Capital Association (BVCA), covering all stages of the private equity market from the VC to the buyout sectors, found they significantly outperformed UK and European public equity markets over five and ten-year periods (see: Performance Measurement Survey 2023). Of course, past performance should not be seen as an indication of future performance.
Meanwhile, diversification is one of the most frequently cited benefits of considering a new asset class within in a portfolio, and in that regard VC investments, particularly at the earliest stages, tend to be fundamentally less correlated with public equity markets.
For all these reasons now is a good time to consider the benefits of UK VC as the asset class becomes more widely available to domestic institutional investors and their pension savers in particular.
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