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Technology / Emerging Technology

A lack of ‘follow-on’ funding for UK deep tech start-ups jeopardises their economic potential

VC funding in UK deep tech start-ups is growing, a new study reveals, but they are more likely to fold or sell up before raising a second round than US counterparts.

Venture capital investment into UK deep tech start-ups is growing and compares favourably to the US, according to a report published this week. But they are also more likely than their US peers to fold or be acquired before raising a second round of capital, jeopardising their contribution to the UK economy. This ‘follow-on’ funding gap may reflect insufficient technical knowledge among investors and an appetite for quick returns.

UK deep tech funding
Deep tech companies have the potential to provide long-term economic benefits but a lack of ‘follow-on funding’ in the UK endangers their growth (Photo by Forance/Shutterstock)

“Deep tech has the potential to significantly alter the world we live in, improving people’s lives in new ways, solving complex societal problems, and creating sustainable economic growth,” the report from investment data provider Beauhurst and the government-owned British Business Bank argues. “Deep tech not only drives economic growth but is also important for the UK’s international competitiveness and creation of high-quality long-term employment.”

The study found that the number of VC deals for deep tech start-ups has grown 78% over the past five years, up to 440 in 2020, faster growth than in the US or Europe. And UK deep tech start-ups receive more funding as a proportion of GDP than their US and European counterparts. This reflects growing interest in deep tech among investors, thanks to developments in AI and the success of companies including UK chipmaker Graphcore.

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Despite this overall growth in investment, UK deep tech companies were substantially less likely to raise a second round of funding than their peers in the US: 49% of UK start-ups received 'follow-on funding' compared to 63% of US companies. As a result, 39% of deep tech businesses in the UK go bust or run out of investment before they raise a second round of capital.

"Follow-on funding is particularly important for R&D-intensive companies due to their long and costly commercialisation processes before generating revenue," the report explains. "This makes them reliant on external sources of funding early in their lives and an inability to secure follow-on funding will significantly worsen their prospects (e.g., slowing down their R&D activities)."

UK deep tech companies are also more likely to exit (ie. be acquired) before raising a third round than their US counterparts. High-profile examples include Google's $500m purchase of AI pioneer DeepMind in 2014, and US social media company Snap's acquisition of augmented reality display developer WaveOptics earlier this year. "This suggests UK deep tech companies are exiting at earlier stages compared to US companies potentially leading to lower benefits to the UK economy."

Why is deep tech funding in the UK limited?

The dearth of 'follow-on' funding suggests "there may be a funding constraint at the second round of VC funding for UK deep tech companies," the report concludes.

Indeed, few venture capital firms in the UK are prepared to invest in early-stage deep tech companies, confirms David Grimm, investment director at Albion Capital and a co-manager of the company's UCL Technology Fund. "I would say the capital [available to] really early-stage big risks on deep tech is still very, very sparse."

One reason is the length of time – sometimes up to a decade – before an investor can expect to see a return from a deep tech start-up, explains Matt Wichrowski, partner at seed-level deep tech VC Fly Ventures. As a result, they tend to favour less risky areas, such as fintech or software, where returns are more immediate. "I don't think that's all that surprising, particularly when you consider how much room there is to grow with fintech," he explains. "That's where the real money is."

Nurturing deep tech start-ups also requires different experience and capabilities than developing those that are based on more mature technology, says Grimm. "It's a different skill set," he explains. "People who found deep tech companies generally come from less commercial backgrounds, [and] tend to be staffed by academics from the start. In many ways, it's much more hands-on because you're coaching people to leave academia and turn into great entrepreneurs."

Deep tech funding in Europe

The UK is not alone in struggling to find investment for its deep tech industry. A newly published 'manifesto' from a group of 200 EU-based founders, investors and policymakers, called Scale Up Europe, calls for "appropriate funding mechanisms" for deep tech companies in the bloc.

In fact, says Suranga Chandratillake, general partner at VC firm Balderton Capital, the UK is in a better position than much of Europe. "I think in general, investment in the UK is just stronger than it is in Europe," he says. "One country that produces a lot of really interesting technology from the point of view of quantum and AI is Italy. But Italy has one of the smallest sort of native VC capital ecosystems in Europe."

Europe also suffers from a dearth of wealthy technologists who might provide early-stage investment for deep tech companies. "The reality is that if you look at historical wealth in Europe, what the angel investors made their money doing, they will almost certainly not be technical people," says Chandratillake. "They will probably be business people of some other sort, which is great, but they won't necessarily understandably have the confidence to invest in some new quantum-based algorithm."

This is one reason tech hubs, where technical expertise and investment capital congregate, are so important, Chandratillake adds. He points to the example of Cambridge Angels, a group of experienced technologists turned early-stage investors based in the UK city.

Cambridge "has been creating billion-dollar tech companies now for 20 or 30 years," he says. "And so there's a bunch of people who've made a lot of money in tech and they're all still in the Cambridge area. They invest in a lot of tech companies, including many that I think a lot of people struggle with, and that's great. It means that those companies have a chance to sort of get going. But that's pretty rare."

Claudia Glover

Reporter

Claudia Glover is a staff reporter on Tech Monitor.