Henry Whorwood of Beauhurst says resilient growth rather than growth at all costs might see a new approach to VC.
It’s fair to say that the stats for UK investment deals and exits have not been good for the past year even though sentiment around M&A seems to be improving. Our data shows declines pretty much across the board. Investment volumes in 2023 were down 29% compared with the previous year, and the deal count was down by 12%. This year so far looks set to cement those declines rather than turn the situation around. By the end of May, investment deals had reached a total of £5.64bn. If investment continues at that rate (using a simple extrapolation) the grand total for 2024 will be around £15.4bn – which will be 14% down on 2023. Of course, let’s see what happens after the UK general election.
If we look at the earliest stage of the market, the situation is the most concerning. For first-time rounds – deals that typically involve friends, family and angels – amounts invested are down 28% and deals are down by 24%. These are the companies that go on to become the job creators of the future, but they’re getting funded at the same rate as in 2014 and 2013, which was far lower than in the recent past. Either the pipeline has dried up or, given how much investment has gone into those businesses in prior years, investor appetite might not be there.
The top end of the market doesn’t look too great either. Acquisitions of equity-backed firms peaked in 2021. The subsequent drop-off hasn’t been as dramatic – we’re now at 2018/2019 levels. But the absolute number of equity-backed companies seeking an exit has certainly grown due to the years of high levels of investment, while the rate of exits has slowed, creating a bottleneck in the ecosystem.
Green shoots
I’m a glass half-full kind of person, though. First, some of the declines we’re seeing are arguably just the fall-off from the frothy exuberance of the markets during the lockdown easing years. And that might not be a bad thing – it’s no huge revelation that some of those deals made no sense.
Moreover, it’s possible to interpret some recent transactions as green shoots of recovery: £840m into Wayve; £410m into Zenobe; £340m into Monzo. But it’s worth noting the caution on display – some of the total value of those transactions is debt rather than equity. Taken together, these deals mean that Q2 has overtaken Q1 for funding volumes, and May was the second best month in the past 12 months.
Can these green shoots blossom into a definitive recovery? Exits are the key determining factor for angels and VCs, as well as the limited partner investors in VCs. Until we see corporates doing more deals – 90% of exits for entrepreneurs and early investors have historically been through trade sales – the whole ecosystem could continue to crawl along.
On the face of it there’s a year of political upheaval ahead, which might persuade chequebook-holders to sit on their hands a while longer. But that may be overplayed. Election outcomes will be factored in.
On average, price multiples still look high, particularly when compared with five years ago, and the macro outlook is not certain. Something that might help in that regard is interest rates. Even a small drop in base rates could make deals seem more affordable and signal the opening of a new dealmaking season.
Company needs
The above focuses on the supply side: things affecting how investors’ money flows to private companies. It’s salutary to think about the demand side, which has been undergoing its own changes that suggest perhaps the current funding dynamic could become the new normal.
As external finance has become harder to raise, start-ups and scale-ups have sought to decrease their reliance on it. Existing investors have been encouraging their portfolio businesses to look to a different set of metrics. The focus is no longer on growth in valuation at all costs. This is clear in our data – we’ve seen the average deal value decrease.
The VC model of growth at all costs was arguably a zero (or near zero) interest rate phenomenon. For one thing it relied on buoyant exit markets. Equity investment for the longer term and targeting resilient growth certainly can work, but it’s a reinvention of the most recent version of the asset class.
Henry Whorwood, head of research and consultancy at Beauhurst, the data and analytics company with a focus on high-growth firms, and a member of the Corporate Finance Faculty