ICAEW.com works better with JavaScript enabled.


Times are changing

Author: Henry Whorwood

Published: 12 Feb 2024

In tougher times for early-stage investing, Henry Whorwood of Beauhurst says it’s time to go even more counter-cyclical.

Innovative companies are the driving force for growth in the economy, and they rely on risk capital and growth capital – or at least they did until recently. At Beauhurst, we track all 5.3 million companies that make up the UK’s economy, with a particular focus on businesses that are growing and innovating. As we start 2024, the landscape for using equity finance (among private companies at least) will look quite different. 

A few macroeconomic and cyclical factors are conspiring to change the dynamic between founders and investors, so before looking at what those factors mean for the next couple of years, it is worth taking a look at the numbers. Final year figures for 2023 for growth capital investments are down on 2021 and 2022 for sure. They are around 1,300 deals down from the 2020 level as well. But all told, 2023 was not more than 15% down on the total of 6,832 deals seen in 2020. That’s still a lot of deals done.

Sounds like relatively good news? My concern is that the change in deal numbers so far only reflects a correction because of the change in sentiment caused by the macroeconomic environment. We’ve not yet seen the full depressive effect of interest rates because it takes a while to bubble through to the private equity market. For example, its impact on allocation has yet to be fully seen: it will mean VCs not raising the next fund, or the next fund being smaller than the last. Emerging VC fund managers might not get off the ground at all.

Vicious circle

The impact on liquidity and valuations has not yet been fully seen either. Exits are scarcer, so angels lack the liquidity enabling them to make new investments. Valuations are lower in exits that do get done and so create fewer angels out of entrepreneurs. Less money returned in exits means VCs struggle to raise the next fund. And so it goes on, in what soon becomes a negative feedback loop. It seems easy to imagine a world in which there are further similar drops in activity this year. Another 15% drop would see the number of deals dive below 5,000.

And that’s just the supply-side issue. What happens if demand changes too? It looks as though it is changing already, perhaps for a couple of different reasons. First, fewer new ventures are being created; the number of companies getting their first round of funding peaked in 2019. And second, demand for finance among the existing ventures is changing. The drop in average deal size in 2023 suggests greater caution on the part of investors, entrepreneurs – or both. 

Balancing act

Usually entrepreneurs need to carefully weigh up the difference between growing faster with more funding and preserving equity. Certainly that was the main balancing act in the zero-interest-rate era. Now, with both higher interest rates and slower-growing economies, growth is harder to achieve. This means founders and investors alike are keeping a keener eye on profitability. Adding to the cost base now looks risky in a way it perhaps did not previously – or rather the risk was previously easier to justify and accommodate. Therefore the demand for capital will go down too, at least among later-stage businesses.

So where’s the good cheer to inaugurate the new year? I’ve often described seed-stage investing as the most countercyclical part of an already off-cycle asset class. So in a year of sluggish growth around the world, new ventures – often in deep tech – will be able to attract investment for the development of ideas and technologies with the view that they will come to market commercially in better times.

Henry Whorwood, head of research and consultancy, Beauhurst, the data and analytics company with a focus on high-growth companies and a member of the Corporate Finance Faculty

Open AddCPD icon

Add Verified CPD Activity

Introducing AddCPD, a new way to record your CPD activities!

Log in to start using the AddCPD tool. Available only to ICAEW members.

Add this page to your CPD activity

Step 1 of 3
Download recorded
Download not recorded

Please download the related document if you wish to add this activity to your record

What time are you claiming for this activity?
Mandatory fields

Add this page to your CPD activity

Step 2 of 3
Mandatory field

Add activity to my record

Step 3 of 3
Mandatory field

Activity added

An error has occurred
Please try again

If the problem persists please contact our helpline on +44 (0)1908 248 250