ICAEW.com works better with JavaScript enabled.

There are plenty of red flags being hoisted in the world of early-stage investing, but (almost) always the optimist, Henry Whorwood of Beauhurst looks for the positives.

I hate to be negative, but I am worried about the UK’s economy. I’m not alone. While the Bank of England says it’s now predicting growth for the UK, which is a change from its prediction only made in February, analysis of some of the data Beauhurst tracks on UK private companies shows a couple of red lights on the economic dashboard.

One of the key metrics we note is the rate of investment into UK start-ups and scale-ups. While equity investment isn’t appropriate for every business, and as a result not used by all of them, its availability is key to the most innovative segment of the UK’s business population. We track every primary equity deal in private companies, from friends-and-family rounds at the earliest stage, through to multi-million-pound growth rounds. 

And I’m afraid to say that across the board there’s been a decline in the quantity of investments into UK start-ups and scale-ups. The number of deals has fallen by 14% quarter-on-quarter, but by 37% compared with the same period a year before. The amount invested has fallen 36% quarter-on-quarter, and by a whopping 68% against the same period last year. Every stage of investment has seen a drop.

In absolute terms, the biggest falls in deal numbers were at the seed and venture stages – but this is somewhat to be expected, as these are always the busiest stages for investment. In terms of amounts invested, the growth stage saw such a substantial fall that it reached parity with the venture stage. And megadeals fell to their lowest level since early 2018.

Most types of investor did fewer deals than just six months before – although venture capital and private equity has held steady over the past two quarters after extreme declines last year – and most sectors saw a fall-off. 

In recent months, pretty much the only sector defying the trends has been AI. Clearly, the recent buzz about generative AI has given investors a boost of confidence and that has even spread to non-generative AI investments.

Alarming though these numbers are, there are people out there – including some VCs – who suggest that a return to 2018 levels is not so bad – 2018 felt frothy compared to 2013. There are also VCs who say they are only holding back from investment because they feel the market, and in particular valuations, has further to fall. Once the market has bottomed out, they might turn the taps back on – or rather, they might once they start seeing deals that look too good to resist. That’s maybe as optimistic as we can realistically be at the moment.

We carried out research for SFC Capital earlier this year, which found that first-time deals have been declining since 2018. These are deals where new companies come on to the funding ladder, taking money usually from friends, family and angels. The number of new companies fundraising fell in a big way between 2021 and 2022. Luckily that drop was arrested at the beginning of the year. But nonetheless the pool of early-stage companies has diminished compared with earlier years, which will mean less competition – a bad thing for the start-up ecosystem.

There is some good news

I genuinely do hate being the bearer of bad news, so what about some positivity? The first quarter of 2023 was a record one for new companies registered at Companies House – just below 225,000. And we’ve not yet seen a spike in insolvencies – although obviously saying ‘not yet’ doesn’t sound wholly positive; anecdotally a number of investors tell me they’re seeing more insolvencies presented as opportunities than usual.

It makes sense, as conditions for raising external capital tighten, that some companies – especially those that were loss-making and so highly reliant on new capital – would not survive. But we’re not seeing that (yet). Is it too optimistic to think the companies that got a bit drunk on easy capital in 2021 have been able to cut their burn rates enough to survive? 

Another positive: given the number of companies that have been backed in the past five years, there are many investment opportunities and private equity still sits on record levels of dry powder. The second half of this year will reveal far, far more.

Henry Whorwood, head of research and consultancy at Beauhurst, a publisher of data and analytics on UK high growth companies and a member of the Corporate Finance Faculty