Why investment in small UK technology companies in the 2020s could provide sustainable returns

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Andrew Aldridge, Partner at Deepbridge Capital shares his thoughts with Business Leader regarding the importance of investing in small tech firms in the UK to generate sustainable returns.

The UK is widely regarded as one of the greatest places to start an innovative tech company. This shouldn’t come as any surprise given the world-class academia we have to offer, the legacy of innovation and, importantly, the funding opportunities available to entrepreneurs. Of course, we also have a language advantage for global businesses which shouldn’t be underestimated.

There can be a temptation to look to the USA and the glamour of Silicon Valley, and indeed this may be where some companies ultimately end up in order to achieve their ‘Unicorn goals,’ but that doesn’t tell the whole story.

At Deepbridge Capital, we are fortunate to work internationally and all of the aforementioned points are regularly raised as reasons for growth-focused tech companies wanting to be involved in the UK ecosystem, as well as the other sector-focused appeals of the UK.

For example, for medtech companies, the rubber stamp of having the globally-recognised NHS trialling or adopting a device can be of massive significance. Such a testimony opens doors with healthcare providers elsewhere and the scalability that offers.

To a similar degree, fintech can find a natural home in the UK, as a global financial hub, with initiatives such as the FCA Sandbox providing a test bed which can empower fintech innovators to prove concept and showcase innovation.

I could continue by looking at legal tech, biotech, agritech and many more. Indeed, the UK has developed a number of ‘hubs’ across the country to provide opportunities for collaboration and innovation in specific fields of tech. Often these hubs are associated with academia and other influential partners. Outside of the ‘golden triangle’ of London, Oxford and Cambridge, examples of such hubs, include Liverpool as a gaming and virtual reality hub (indeed our investee company vTime is at the forefront of this); Manchester as a digital hub but also the home of graphene (again, we have helped a great company in this sector, Flex-G, create a Manchester base); Edinburgh and Bristol as digital innovation hubs, and numerous less well known areas such as west Wales (working with the likes of the University of Aberystwyth) focussing on agritech.

Naturally, our excitement in all of this is centred on the investment opportunity. As highlighted earlier, the funding ecosystem in the UK is a big reason for the success of tech companies here. This is particularly true in what is often the most difficult funding stage, being the first commercialisation funding or early Series A funding.

The first funding a company received is usually self-funding, or the attraction of funding from friends, family or a supportive business angel. This is usually based on a ‘good idea’ and goodwill towards the founder. This funding tends to be relatively small ticket and, in reality, is an investment ‘punt.’

When you then get to later funding rounds, later Series A and Series B, tech companies are usually expected to have significant recurring revenues and there is no shortage of funding opportunities both here in the UK and elsewhere.

In both of these examples, the UK has a strong track record of funding, but where the UK really excels is at the stage ranging from ‘seed’ funding to early Series A. At this point, a tech company is likely to be beyond the cheque-size which can be offered purely on goodwill, but is unlikely to have the revenues to support interest from the VC, PE and institutional funds looking for a de-risked opportunity.

Historically, this funding gap has been described as the ‘chasm of death,’ as it is often where a company will choke due to lack of funding. However, this is an area where the UK has a significant competitive advantage on international peers; the Enterprise Investment Scheme.

The Enterprise Investment Scheme (EIS) provides the incentive to investors to support growth-focused companies through unparalleled potential tax reliefs. Over recent years, between £1.5bn and £2bn of funding each year has been availed to growth-focused companies under EIS. Founders and investors globally regularly remind us of their jealousy of the UK in this regard – it is important that UK investors and financial advisers are aware of this global envy and the fortunate position they are in.

The tax reliefs offered under EIS provide a degree of risk mitigation for investors, with early-stage investments naturally being high risk, but it is critical that investing at this stage is undertaken with due care and in conjunction with a sector-experienced investment manager.

This stage of investing has great growth opportunities and taking a company from proof of concept through to a significant annual rate of return, can be a significant value inflection journey. At this point of investing, we are looking for companies which have used their initial funding to prove concept and develop initial market traction, with our funding then empowering the commercial growth to subsequently attract large-scale co-funding for corporate growth and then an exit for investors.

There has never been more technology innovation around us and in a digital world it is natural that this is where investment opportunities will lie. If investors are looking for growth, then UK tech is a great place to be and arguably the growth point is exactly where EIS funding is applicable.

We have already seen the shift of tech companies becoming the world’s largest, so it is not a surprise that tech is at the heart of most investment portfolios. However, the long-term growth opportunities often lie at an earlier stage and the UK is a great place to empower this, thanks in part to EIS. And, why wouldn’t investors want tax reliefs, CGT free growth and potential loss relief?

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