UK technology VC investments fall by 17% in 2004

In contrast to the renewed sign of confidence in seed level (Chilli S3, R1) and start-up activities amongst the angel investment community (see related article), the picture for VC investments, which normally kick in at Chilli R1, R2 (early stage) and Chilli R3, R4 (expansion/late stage) couldn’t look much dimmer.

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According to a report by PricewaterhouseCoopers from data compiled by BVCA (British Venture Capital Association) members, the total UK private equity/VC (PE/VC) investment activity increased by 50%, but the vast majority went into MBO/MBI (management buy-outs/buy-ins).

MBO/MBI/overseas opportunities occupy most PE/VC
Roughly £4.0 billion or 77% went into MBO/MBI of existing legacy firms; this was mostly in non-technology, low growth sectors like shops, restaurants, hotels and leisure. A large chunk, namely £4.3 billion representing 45% of total activity, went looking for overseas opportunities, leaving net investments in the UK of £5.3 billion.

Start-up and early stage VC funding is flat
Although the amount going to start-ups increased by a small amount to £96 million in 2004 compared to £73 million in 2003, the amount going to early stage companies fell to £188 million in 2004 from £190 million in 2003. The combined start-up and early stage figure of £284 million represents only around 5% of the total PE/VC activity. The average deal size for early stage companies dropped to £0.7 million from £0.8 million. The number of companies receiving early stage funding rose slightly to 264, up from 242 in 2003.

Technology sector still in the doldrums
The amount invested in the technology sector decreased by 17% to £678 million, which represents roughly 6% of the total. This is a drop from £817 million in 2003. Looking at it another way, non-technology represents 94% of the UK PE/VC activities. The technology sector includes computers hardware, software, communications, electronics, medical electronics, biotech and pharmaceuticals as well healthcare.

A sizeable portion of the total technology pool, 27%, went into the software sector, which took £180 million – most of which went into late stage investments.

Communication lines at an end
The communication sector is still out of favour and the amount in this sector fell by a massive 78% to just £58 million. This amount is a small drop in the communication sea, compared to the potential size and growth in this market.

The semiconductor sector took £23 million over 15 companies, equally spread between start-ups/early stage and late expansion stage. Biotech, the darling of the last few years, fell out favour, falling by 14% and taking £72 million. Things for the e-commerce sector didn’t look very bright either, where the amount invested fell to £72 million, a far cry from the £399 million on 2003.

Regional divide widens further
The South East and London region got 56% of the PE/VC cake, with the amount for the South East trebling to reach £1.5 billion. The North West/Merseyside was next with £654 million, representing 12%. The West Midlands was next with £335 million, followed by Yorkshire at £314 m, both representing around 6%, The South West was at £265 million, and the Eastern region, the home of the so-called Cambridge phenomena stalled at £232 million.

Scotland came in at £176 million, Wales at £99m and the North East at £90m. The figures for the regional splits may be skewed somewhat, due to the overbearing MBO/MBI activity, which can tend to be highly concentred on a few large mega/super deals. Nonetheless, the underlying trends are such that the regional development agencies will have to redouble their marketing, imaging and promotional activities, as well as support for local start-ups and SMEs, if they are to make better use of their regional funds and assets.

Where is the PE/VC money coming from?
The total amount of new funds raised fell to £3.3 billion in 2004, a sharp drop from the £8.9 billion the year before. New fundraising tends to be lumpy, with a few good vintage years. Overseas investors contributed 66% of the funds raised in 2004. Were it not for the overseas pension funds, corporate, academic and government funds, the British PE/VC activity would fall into a terminal decline. The UK government’s belated effort resulted in £93 million going into PE/VC fund, which is a small trickle compared to their overseas counterparts, who reduced their massive £1.1 billion in 2003, to £75 million, following the British example.

The Chilli perspective High net worth individuals (HNWIs) contributed more than the government at £220 million, which is three times the amount they put in 2003. This shows that the more successful exits there are, the more HNWIs there will be who will contribute to angel, VC, PE funds and create a slow waterfall, which will in turn fund more successful start-ups and so on. But first, the market failure in start-up and early stage funding needs a kick-start before that can happen. We hope that the upcoming Enterprise Capital funds will not be “still born” due to failure on the part of the DTI and Treasury to listen to various inputs.

The relatively small values for both the average deal size and the absolute amount in the technology sector points to a total market failure in start-up and early stage, as The Chilli has highlighted over the last few years. It would seem totally unfair for UK start-ups and early stage companies to deliver spectacular results based on the starvation and undercapitalised budgets compared to their US counterparts. After all, as an example, a fabless start-up in the UK needs the same amount of venture capital investment as a US or Taiwanese fabless start-up.

It seems that the policy makers may be blinded by the confusing and misleading large headline figures masquerading as real VC figures, when most of this goes into MBO/MBI. The headline figures as highlighted in this article have very little to do with real venture capital and the amounts going in to the high technology, high growth, high productivity sector. At least in the US, the vast majority of VC figures reported are real VC figures and do not include leveraged buy-outs and buy-ins which are reported by separate organisations. It may be very helpful if the UK figures for real VC figures are reported separately, not necessarily by separate organisations, so that appropriate data and information can be gathered and reflected in the right perception and policies.

© Chilli Publishing Ltd 2005

31MAY2005