Early-stage startups struggle to secure funding during lockdown

Only 5% of technology startup funding raised since the coronavirus lockdown began has gone to firms raising investment for the first time, according to updated industry research.

UK technology startups have received just over £1bn since 23 March, but only £52m of that has gone to early-stage startups and entrepreneurs who have never raised money before.

The research was conducted by co-working and innovation space company Plexal and Beauhurst, a UK database for fast-growth companies, which analysed investment activity around the UK’s 30,000-odd startups since 23 March.

Previous research by the firms revealed that £663m had been raised in lockdown by 27 April, with just over £50m going to startups that had never raised funds before.

With just a small increase in total funding for early-stage startups since the previous figures, the new research reveals a total of 61 deals have been made – 20% less than in the equivalent eight-week period last year.

On average, this means investors are committing less that £1m to these companies per funding round. In turn, the total value invested into each startup has dropped by 83%.

“While investors injected the capital required to protect their portfolio companies immediately after lockdown, we are now seeing a much more cautious and risk-averse investment landscape,” said Henry Whorwood, head of research and consultancy at Beauhurst.

“The figures for first-time funding shows a stark drop in the levels we have come to expect in the UK and suggest that the weeks to come will be very challenging for early-stage tech companies.”

The research also found that for all tech startups, there have been 35% fewer deals and a 50% fall in funding compared with the same period in 2019.

This trend is accelerating, with funding plunging by 73% in the second four weeks of lockdown, compared with a 37% increase in the first four weeks.

“While tech companies are still raising funding in the UK, we risk losing a generation of tech entrepreneurs at the earliest stages of their startup journey,” said Andrew Roughan, managing director of Plexal. “The research shows that government support can’t come soon enough for the early-stage tech companies that are unable to raise investment as a result of Covid-19.

“By only backing companies that have already raised funds, investors are ignoring the very companies that will define the future success of the British economy.”

While early-stage companies struggle to get funding, support for already-established startups is being consolidated by the Future Fund, a £250m startup rescue package officially launched on 20 May, which will provide loans ranging from £125,000 to £5m to UK-based companies, subject to at least equal match-funding from private investors.

But on 22 April, Computer Weekly revealed that more than 80% of UK startups were ineligible for Future Fund loans because only 5,000 of the 30,000-odd startups can meet the criteria of having raised at least £250,000 in equity investment from private, third-party investors in the past five years.

However, a number of changes have been confirmed since the fund was first announced that further limit how much money early-stage startups can access.

For example, companies that have previously raised investment through the Enterprise Investment Scheme (EIS) or the Seed Enterprise Investment Scheme (SEIS), which offer tax advantages to individual startup investors, will be ineligible – despite many early-stage companies relying on these schemes to secure funding from investors.

On top of this, firms will only be eligible if half or more of their employees are based in the UK, or when half or more of their revenue comes from UK sales. Companies must also have been incorporated on or before 31 December 2019.

Although the government has separately pledged to distribute £750m worth of targeted support loans through Innovate UK and the British Business Bank to the most research and development-intensive small and medium-sized firms, this too will only reach 3,700 firms, according to HM Treasury.

“The Future Fund is perhaps more complicated than the other state-backed financial support schemes that have been created to help UK businesses through the pandemic,” said Nic Redfern, finance director at KnowYourMOney.co.uk. “On the one hand, early-stage businesses are undoubtedly in need of urgent help, so the fund will be welcomed by many entrepreneurs; however, as we are now in the eighth week of the lockdown, it has taken too long for the initiative to launch.”

Redfern said there were understandable concerns about several elements of the scheme. “The fact that it is not EIS-compatible has already caused grumblings of displeasure from investors and startups alike,” he said. “Meanwhile, the fact that a loan can be converted into ‘discounted equity’ if a startup cannot repay it within three years poses interesting questions around business valuations and how the government will eventually realise the value of its equity in countless British businesses.

“Startups must tread carefully and thoroughly research the Future Fund before jumping ahead with any applications.”