Bigger, Bolder, Better
Early-stage investing in the UK has seen larger amounts going to fewer companies – but is this a supply or demand issue?
Before the lows of 2014, median deal sizes were higher during another risk-averse period for investors. The reality is probably a mix of all of these factors. Companies looking for crowdfunding declare the amount of investment they want at the start of any round. From 2015 to 2018, the average amount sought through Crowdcube, for instance, increased by 28%. Of the successful fundraising companies, 61% received more investment than requested.
In 2018, £356m was raised through 368 crowdfundings. Anecdotally, investors offering businesses more than they were looking for has not been limited to crowdfunded companies. Many entrepreneurs have found themselves being offered up to 50% more than initially sought from angels or venture capitalists. The flipside is that although deal sizes have been climbing, the number of deals has fallen. The drop has been greatest at seed stage. It is mostly angel investing that has been declining. Of all the investors supporting UK early-stage businesses, angels are probably most nimble – they can adjust investment activity in response to any current macroeconomic uncertainty.
The median size of deals with one or more angel networks participating in them reached record levels during Q1 2019. But do larger deals decrease risk? There’s a complicated relationship between risk, diversification, and investment size. A fund with £10m to disburse could invest £1m in 10 businesses, £2m in five, or as much as is required in each of the good companies it can find. The third option is pragmatic, but the fund could end up with, say, two investments and very little diversification of risk. If only one in 10 companies has a ‘home-run’ exit, the first option certainly looks preferable. But there is certainly more work and cost in executing that strategy.
All of thisis a tremendous simplification of the investment process and a fund’s investment strategy, but any investor with limited funds investing in high-risk early-stage businesses must ask themselves the same questions. In 2018, £172m was raised from 154 angel network fundraisings. If funds and angels are doing fewer, larger deals, is it because they want to mitigate economic risk? Or is it just because they’re seeing fewer companies they want to invest in?
In the current climate, it would be understandable for an investor to offer more money to an entrepreneur to give them the best possible platform for mitigating Brexit. And for individual investors there is the incentive to commit certain amounts of money, namely £100,000 or £1m, in a given tax year, dictated respectively by the Seed Enterprise Investment Scheme and the Enterprise Investment Scheme tax relief limits. So, for instance, if only one investible company surfaces in a given year, an investor might offer the full £1m so that they can claim the full £300,000 tax relief.
So what are companies doing with this extra cash? While some are hiring, many are struggling to find enough talent to meet their needs. But what if a company holds on to a proportion of the investment it has received as some kind of buffer or safety net? This could well mean a subsequent dip in the number of future fundraisings – more money now could mean less needed later. We are in uncharted territory. Early-stage megadeals, where more than £50m was raised, peaked in 2017. Will those companies return for bigger rounds –and bigger fees for advisers? Or will we see more deals between £1m and £10m?
About the author
Henry Whorwood is head of research and consultancy at Beauhurst, which publishes data and analysis of investment in the UK’s high-growth companies.