Is VC Investment In The U.K. Recovering? Well, It’s Complicated

BRISTOL, ENGLAND – JANUARY 24: The HSBC logo is seen outside a branch of the bank on January 24, … [+] 2017 in Bristol, England. High street lender HSBC has announced it is to close a further 62 more high street branches across the UK on top of the 55 closures announced last year, meaning a total of 117 HSBC branches will close in 2017. (Photo by Matt Cardy/Getty Images)

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Having been acquired, rescued and rebranded as HSBC Innovation Banking, the entity formerly known as Silicon Valley Bank U.K. has released a snapshot of VC investment in Britain. For founders in search of additional capital, the report contains some good news – certainly, investment levels are beginning to rise again. But overall, the study paints a complicated picture, suggesting that new hot sectors are emerging at a time when VCs are focusing on businesses that can balance short-term growth with long-term sustainability.

Since March of this year, HSBC Innovation Banking has been operating as a ring-fenced subsidiary of the HSBC banking group. And as Sonya Lovieno – Head of Venture and Growth Banking – explains, since the acquisition it has been pretty much business as usual. In addition to providing banking services for startups, scaleups and post-IPO businesses, the bank continues to work with partners to provide market reports. The latest research comes at a time when many founders have been struggling to raise additional funds but as Lovieno sees it, there is some light at the end of the tunnel.

“The timing of this report is quite good,” she says. “Two months ago there might not not have been so many optimistic elements.”

Sonya Lovieno, Head of Venture and Growth Banking, at HSBC Innovation Banking.

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Interest Rate Stability

Certainly the economic backdrop has changed. “In the US, EU and UK, central banks have signaled that they are more or less done with rate rises and that rates will remain for some time,” says Lovieno.

And while the prospect of high borrowing rates long into the medium term may not fill the hearts of business owners with unalloyed joy, at least some kind of stability is returning, allowing businesses and investors to plan for the future.

There are also more IPOs. “That is enabling VCs to benchmark valuations,” says Lovieno.

So what does this mean in practical terms? The report – prepared in partnership with Dealroom records an upturn in investment quarter-on-quarter. In the third quarter $4.9 billion of investment capital was allocated, representing a rise of 14% from the previous three month period.

It’s not all good news, however. While early stage investment has remained strong, the report finds that later-stage investment has meaningfully slowed. This may exacerbate one of the problems the U.K. has traditionally had. Businesses often struggle at the very point at which they need to find larger sums of money to support scaling.

New Hot Sectors Are Emerging

For many years, fintech has been the poster child for Britain’s innovation economy. It’s still an important segment but HSBC Innovation Banking’s report suggests investor attention is shifting. The climate crisis is undoubtedly playing a part. The top segments in 2023 include energy storage and green energy, with biotech, mobility and Deeptech also at the top of the rankings.

And on the face of it, there appears to have been a shift in investor preferences. The report finds that around 43 percent of investment in startups has gone into manufacturing, against 20 percent into marketplaces and e-commerce and 37 percent going towards SaaS. That might come as a bit of a surprise given that manufacturing tends to require larger sums of money, often with a longer timescale before a return is delivered.

So does this represent a sea change? Well, perhaps the trend is less about investors turning their backs on software and rushing towards hardware and more about the simple fact that technologies such as green energy and batteries require investment on a larger scale. This skews the figures.

“The main investment in manufacturing is going into climatetech and energy,” says Lovieno. “These require more capital, so you see an upsurge in investment.”

Growth In The Regions

According to the report, Belfast, Glasgow and Birmingham are the fastest-growing cities for investment. Lovieno says this is due in part to greater efforts by universities outside the established tech hubs. They are nurturing research-based startups and providing accelerators and funding. The growth may be from a low base in some cases but it is encouraging.

Stepping back to look at the bigger picture, there is a long way to go before we can safely say that VC investment is on the road to recovery. The report suggests that investment levels for the year as a whole will be on a par with 2020, rather than 2021 or 2022. And while VCs have been raising funds – and thus have capital to invest – they are being picky.

“Top-line growth is no longer good enough,” says Lovieno. Yes, investors are looking for growth, but they also want to see evidence that businesses have trading models that can be sustained profitably over the long term.

And there are headwinds. Lovieno cites the business-to-business sector. “Startups are finding it takes longer to sign contracts with corporate customers,” she says.

One result of this might be that existing investors will only support the top-performing businesses within their portfolios. Startups may need to seek investment from external sources. Or indeed, find alternatives to equity, with debt as an option.

Overall, the U.K. retains its place as the top destination for VC funding, although it’s worth noting that since 2019, growth has been stronger in France, Sweden, Spain and Norway. But patterns of investment have been changing and this will affect the ability of founders to raise capital.