Nothing ventured: Scotland's scale-ups face funding fragility - but there are grounds for hope
Reasons for start-ups to be cheerful despite a generally gloomy outlook
This week the Confederation of British Industry (CBI) became the latest organisation to sound the alarm over the dismal state of the UK’s public equity markets.
In a report calling on the UK government to “turn the tide” on cratering listings on the London Stock Exchange – now at their lowest level in 30 years – the lobby group cited a stark statistic. Domestic pension and insurance funds own a mere 4 per cent of the UK market, compared with over half in 1997. With some understatement, the CBI said this had “weakened a vital source of domestic risk capital in the UK”.
To understand this is to understand one reason why the venture capital market for Scotland’s early-stage businesses is fragile. Without the ability to tap the public markets, a key source of funding is choked off for company founders as they look to cash out or fund the next stage of growth – or both.
Investors prickly
Given that founders typically recycle the funds raised back into the business, early-stage companies are increasingly starved of ongoing funding opportunities. That, in turn is forcing venture capital firms that made initial investments to extend holding periods as they wait for the market to turn. Throw in a pretty dispiriting macro-economic environment, with global growth anaemic and uncertainty caused by increasingly ugly geopolitics, and investors have become more picky.
Scottish Enterprise, in its annual assessment of the state of the Scottish risk capital market for 2024, points out that following “peak returns” in 2021 and 2022, venture funds are under more pressure to deliver returns to their backers.
This means they are less willing to consider investing in younger startups, which would typically require up to £1 million (classified as “seed” funding) to up to £10m in so-called Series A funding. Instead, they are focused on deals above £10m involving businesses with solid revenues and more of a track record.
There’s another problem. Without fresh funding, board composition remains stagnant. As Shane Corstorphine, former Skyscanner chief financial officer and veteran of the scale-up scene, puts it: “At some stage you need new blood coming onto your board for the next stage of growth, but that’s not happening.”
This backdrop partly explains why Edinburgh-based Par Equity, one of Scotland’s leading venture capital firms, this week completed fund-raising for Par Equity Ventures Fund I, a new fund worth £75m. It will focus on larger deal sizes of between £5m and £10m and beyond, and have three areas of focus: industrial tech, climate tech and health tech.
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The move comes after the firm last month unveiled a merger with Manchester-based Praetura Ventures to create PXN Group. Half of the new fund will be used to back existing portfolio companies, with the rest deployed afresh in Scotland and the north of England.
This marks a new direction for Par Equity, which has since inception in 2008 been focused largely on seed-to-Series A funding of businesses such as Current Health, a medtech acquired by Best Buy which the North American company last month sold back to Scottish founder Christopher McGhee.
Glass could yet be half-full
Yet while the climate for smaller businesses looks tough, three structural features of Scotland’s funding environment mean the glass may yet be half-full.
First, half of the UK’s most active angel investor networks are in Scotland, most clustered in Edinburgh. This is providing an important foundation, with a lot of the cheques being written by former founders. The latest example came this week with the participation of Beena Sharma, co-founder and chief executive of Aberdeen-based CCU International, a carbon capture firm, in a £1.2m investment in sports tech start-up Theo Health, founded by 29-year-old entrepreneur Jodie Sinclair.
This recycling of founder capital is a Scottish strength. “In Scotland the ecosystem is massively important. We can’t write the second cheque for a larger sum unless someone writes the first cheque,” says Paul Atkinson, chairman of the Par Investor Network, an angel investor group.
Second, venture capital funders tend to be more collaborative, often agreeing so-called “club deals” with others. An example of that was the £11m investment in artificial intelligence startup Aveni. The Series A round was led by Puma Growth Partners, a London-based firm that opened an office in Edinburgh last year, and included Par Equity, Lloyds and Nationwide.
“The environment is not so competitive and that probably plays to the fact that there’s a shortage of capital and a surplus of opportunities, which is probably the reverse of the situation that you’ve got in the south east of England,” explains Paul Munn, Par Equity managing partner.
Finally, government funders, chiefly the British Business Bank, National Wealth Fund and the Scottish National Investment Bank, are starting to pay an outsized role in Scotland, including involvement in club deals. This week, the British Business Bank said its Investment Fund for Scotland had provided over £25m in funding to Scottish businesses since it launched 18 months ago.
In fact, government funds generally accounted for as much as 56 per cent of equity deals announced for Scotland last year, according to the British Business Bank, compared with just nine per cent for England. This tells us something.
So, while government’s ability to shift the dial on the public equity markets remains to be seen, when it comes to Scottish venture funding the picture might just be brighter.
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