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Since the UK officially left the EU in 2020, many – including the IMF (International Monetary Fund) have predicted a bleak outlook for the UK economy. Yet despite challenges such as the COVID-19 pandemic, the UK has continued to defy expectations. In 2022, the country boasted the strongest post-pandemic bounce out of the G7 countries in terms of GDP growth. The UK’s longer-term outlook is also brightening, despite a more bleak global outlook, with the possibility of ultra-low interest rates potentially returning to the UK in the near future. All of this raises the question: what does this all mean for venture capital (VC)? Below, we discuss what some of the latest analyses and projections might mean for early-stage investors. We hope you enjoy this content. To find out more about our investment opportunities, visit our portfolio page here. To enquire regarding our latest projects and funding, you can reach us via:
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What is the outlook for Britain?
In late 2022, the UK was widely expected to enter a recession. Yet early figures in 2023 proved this forecast wrong (although it was only narrowly avoided). More recently, mid-term forecasts have been improved slightly for the economy. The IMF has raised its 2024 growth projection for GDP by 0.1% to 1% (whilst France and Germany were downgraded). This year, however, may bring more economic pain in the short term. Various organisations have predicted a 0.3% – 0.4% shrinkage in the UK economy in 2023, with average house prices potentially falling by 8%.
This comes amidst a squeeze in real household incomes and past interest rate rises, which now stand at 4.25% (the highest since the 2008 Financial Crisis). Rates may start to come down in 2023 as inflation hopefully falls due to, for instance, prices coming down for imported goods and wholesale energy. Consumers will likely still have less money to spend, however, meaning that demand for goods and services may also fall (which would further dampen inflation). Naturally, these trends have important implications for early-stage businesses and VC investors.
What is the venture capital outlook?
Early-stage investors are not constrained in the same way as UK investors who focused mainly on domestic publicly-traded stocks. It is possible, for instance, to build a strong, growing set of startup investments which perform well in 2023 despite a possible economic contraction. With this said, let us now look at some recent VC trends.
In 2022, total VC investment in the UK reached $31bn – a 25% drop compared to the previous year. However, this was still 77% higher than in 2020. The long-term trend of VC investment is quite positive. In 2010, the total stood at $2bn. By 2016 it was $10bn and now we are over triple that figure. The UK, particularly London, continues to be seen as one of the best places to start a business with features such as its “Silicon Roundabout” in the East of the capital.
Volatility continues in the public markets and macroeconomic uncertainty also prevails, which both affect VC markets. Forecasting exit environments beyond 10 years is likely to be difficult right now. Some VC-based companies have put the breaks on making public debuts following recent drawdowns in many tech stocks. Early-stage investors should be prepared for flexible adjustments as the opportunity set in the VC landscape shifts. In today’s landscape of higher interest rates (making it harder to get business loans), funding terms may become more friendly to investors versus founders.
Bear in mind that private company valuations are partly influenced by valuations of comparable companies in the public sector. If the stock prices of the latter come down in 2023, then the enterprise value of VC-funded startups may also fall. This raises the possibility of “down rounds” – i.e. investment rounds where a company valuation falls below that which was marked in a previous round. For founders, employees and existing investors, this could bring a negative impact. Fortunately, down rounds remain a rarity to date (despite making some headlines). An early-stage investor could, in fact, benefit from current public market volatility. For instance, you could support certain companies at prior valuations in exchange for enhanced rights – possibly bolstering your protection in positions.
Investors should be mindful of a healthy “runway” for seed-stage companies (cash raised versus cash burn), which JP Morgan currently suggests at 12-18 months. Certain startups may wish to consider extension if this could delay or diminish down rounds. If this could grant more time for shoring up fundamentals, then it could be a good course. Indeed, more companies going down this route could improve opportunity sets in the future – offering more deals which feature lean, cycle-tested companies.
In summary, whilst the future is uncertain, the VC landscape still offers investors exposure to companies at the forefront of technological progress. Success within this space, as always, will depend on sound asset selection (and a bit of fortune).
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