The UK has long recognised that investment in its technology ecosystem is a driver of economic growth. London now ranks among the most productive technology hubs in the world alongside Silicon Valley, Beijing and New York. Why, then, is funding – particularly for companies scaling up – predominantly sourced from international investors luring promising start-ups away from the UK? Why is the UK lagging behind its counterparts in effectively financing innovation?
The US has outpaced the rest of the world in terms of unicorns – private companies valued at more than $1bn – by magnitudes with a model that successfully finances start-ups, from seed funding to fully fledged tech giant. According to CB Insights, the US will continue to generate most of the world’s future unicorns.
In comparison, the UK flounders at the stages of scale-ups and public markets. High-profile historical examples include UK artificial intelligence start-up DeepMind, which was sold to Google for $600m in 2014, and Cambridge-based chip designer ARM Holdings, sold first to Japan’s SoftBank in 2016 for $32bn followed by a subsequent and controversial bid by US chipmaker NVIDIA to acquire the company for $40bn.
Scale-ups swap London for New York
The impact of this lack of scale-up funding in the UK can result in promising scale-ups relocating overseas. The UK risks losing valuable foreign direct investment needed for job creation and economic growth. Tech scale-ups in the UK employ 5% of all scale-up employees globally, compared with the US, which employs about 35% of all workers in these types of company. As the third most productive tech ecosystem in the world there is much economic development to gain from increasing the UK’s global proportion of scale-up employees.
When it comes time to go public, a number of high-profile UK scale-ups have chosen to list on US stock exchanges instead of on home territory. In 2019, the number of London initial public offerings (IPOs) fell by 56% year on year, according to EY’s IPO tracker, reflecting a more general slump for the London Stock Exchange as companies looked to New York and other global exchanges. Cases in point include London-based start-up Farfetch, which listed on the New York Stock Exchange in September 2018, and London based healthtech company Babylon Health, which has announced it will go public in the US this year. UK company Cazoo is also expected to list on the New York Stock Exchange later in 2021 in an IPO valued at $7bn. Founder Alex Chesterman told the London Evening Standard in March: “London investors don’t understand tech like Americans.”
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Saul Klein, co-founder of UK-based venture capital firms LocalGlobe and Latitude, has a portfolio of 16 unicorns, at least ten of which are actively looking to or about to IPO. Much has been made of the listing and financing rules reform proposed in a government review in March 2020, but the concerns of the founders of these companies are being overlooked, according to Klein. When opting for an IPO, what they really care about is good analyst coverage and the depth and experience of the local investor base. Bearing in mind the world’s top companies by market cap are 90% founder-led, perhaps UK policymakers should take heed.
Chesterman’s assertion that London investors don’t understand tech like Americans speaks to a shift towards intangible asset classes. About 90% of value in the S&P500 lies in companies trading in intangible assets such as data and intellectual property, but UK institutional investors are still assessing investment potential with the same mindset they did two decades ago, prompting many promising UK scale-ups to look outside the UK for investment. The rules behind the growth of technology companies dealing in intangible assets in the UK are very different – which means value capture is being missed. Founders such as Chesterman have long been bemoaning the fact that London’s institutional investors take a short-term view by focusing on profits and dividends rather than understanding that tech start-ups need time to scale before profits start to flow.
Bearing in mind the world’s top companies by market cap are 90% founder-led, perhaps UK policymakers should take heed.
Companies are also taking longer in their growth cycle to go public, shifting the value capture of investments from public to private markets. The best investment opportunities are becoming the exclusive domain of venture capitalists and private equity. Most UK pension funds and large insurance companies still have their asset allocation in public markets, where it is becoming harder to generate returns. It seems local capital in London has got the memo too late, and ultimately this means missing out on the value capture of this evolving system.
Has London finally got the message?
It is not all bad news, however. As with any global crisis, post-Covid change is afoot, and there are signs that London’s old economy-heavy stock exchange may be gearing up for change with a flurry of UK IPOs announced in the past few months.
To keep the pipeline going, assessing a scale-up for investment should be a decision focused on the next ten years, not the next ten weeks, otherwise successfully financing innovation falls down. If this is not addressed, the UK will lose out.