Henry Whorwood of Beauhurst explores why start-ups are still able to attract plenty of investment during the global pandemic, and whether this might continue over the next year.

Venture capital, and investment in private companies more generally, are usually thought of as counter-cyclical to those areas of the economy hit hardest during a typical recession. When listed markets drop, that is traditionally seen as a good time to invest.

By their nature, early-stage private companies are not looking to make a return immediately – perhaps not even until after a downturn has turned into an upturn. In many ways, their illiquidity is their strength. They aren’t subject to the vicissitudes of the panic that cause a typical recession.

Strange times

But this is no ordinary recession. And yet private companies continue to see decent volumes of capital flowing towards them. Between the UK’s first lockdown in late March and 19 November 2020, £8.17bn has been invested in UK private companies in straight equity deals. Plus, the UK government-backed Future Fund has made available convertible loans of £876m, which are matched by private sector investors, meaning at least £1.75bn has been received by the fund’s portfolio. 

Private businesses have therefore seen a total of £9.92bn invested during the crisis (including the government money). £10.5bn was invested over the same period in 2019.

There is always a lag of a few weeks on unannounced deals being declared at Companies House, so the final figure for the period will be higher than the £9.92bn. It’s reasonable to suggest that 2020 doesn’t look too different to 2019.

However, we were seeing fewer deals. There were 14% fewer announced in the period than over the same period in 2019. Where we see this decline most clearly is in first-time raises. In the period 23 March to 19 November in 2019, 370 companies raised their first equity investment (raising a total of £1.21bn). In the same period in 2020, only 262 companies did – for a total of only £585m. This category of business also receives little succour from the government; an explicit requirement of the Future Fund is that businesses must have received at least £250,000 of equity funding previously. That said, there could be some positive reasons for the dip.

Since March 2020, the capital requirements of start-ups and scale-ups have changed. The first time a company raises equity it might spend the cash on new hires and office space. Little needs to be said about the impact of COVID-19 on jobs and the real-estate sector. Some lucky businesses might need less money than they did before. Others, with demand ebbing away, will be burning through more cash than before.

Overall, it’s fair to say the start-up segment of the economy is by no means the worst affected by the pandemic. Indeed, early on, it was the youngest, smallest businesses that were most able to shift and pivot – not only to survive, but also perhaps to take advantage of the economic upheaval the country is facing. 

Since then, larger businesses have caught up and have brought their greater resources to bear. Overall, Beauhurst has identified 435 start-ups and scale-ups that fundamentally changed their business models during the lockdown. That didn’t save three of them, but four have exited successfully. A mixed bag was inevitable.

Go again

Should we expect the same through 2021? In terms of investment, I expect to see a continuation of the strong volumes of investment we have seen so far. The money is there; so are the companies looking to raise, perhaps to a lesser extent. This sector is cyclical, but we’re not at the end of the cycle yet, so I also foresee a proliferation of megadeals. 

We should, however, prepare for a rising death rate among companies. Start-ups are risky in certain times, and these are times of extreme uncertainty.

Luckily when it comes to companies, founders and directors do get a second chance. There have been 424 phoenix founders in the UK since 2011, founders whose first (or second) business failed but whose current business is thriving. 

Some world-class businesses will be born out of this crisis. The capital markets are well placed to nurture them to success – if, of course, they can tolerate the risk and uncertainty.  

About the author

Henry Whorwood, head of research and consultancy, Beauhurst, a publisher of data and analysis on UK high-growth and ambitious companies

About the article

This is extracted from the  Corporate Financier December 2020 /January 2021 edition - exclusively for Corporate Finance Faculty & Faculties Online members - who can access our award winning magazine in its originally designed form, and our extensive archive brought to you by the ICAEW Corporate Finance Faculty

 

This is extracted from the full article in the Corporate Financier December 2020 /January 2021 edition - exclusively for Corporate Finance Faculty & Faculties Online members - who can access our award winning magazine in its originally designed form, and our extensive archive brought to you by the ICAEW Corporate Finance Faculty