Global venture capitalists devalued their investments in UK tech startups in Q3. Here are three reasons why that trend might continue.
It is often said that investment is a world of high risk and high reward. Consequently, those with the highest tolerance for risk often yield the biggest fiscal rewards. This principal applies to startup founders and the venture capitalists who fund their businesses.
But 2016 is not a normal year. If 2015 was a dull year for global markets, its successor is a runaway train. The result is that risk appetite has diminished – especially in the wake of Brexit.
In her speech at this month’s conservative party conference, Prime Minister Theresa May discussed her goal to build “Global Britain” by welcoming capital and labor to the UK from around the world rather than from the EU alone. But Q3 data on global VC trends implies that the capital May claims to want might resist her politics.
The global VC landscape
Let’s start with the good news: there are positive signs that the global VC landscape is stabilizing. 10 of the 14 tech IPOs in the US launched in September. Of these newly public companies, only two are now trading below their opening day IPO prices.
However, this does not mean that Q3 was a strong quarter for global VC. In fact, KPMG’s Q3’16 global analysis of venture funding found that quarterly funding to VC-backed companies declined to $24.1B – the lowest level since Q3 2014.
VC activity in Europe
Global VC investment in Europe took an especially hard hit. Analysis from Tech.eu shows that overall investment volume in the region decreased by 17.4% across the whole of Europe, Turkey, and Israel compared to Q3 2015:
Post-Brexit deals are being devalued
You will notice in Graph 2 that deal volume in the UK remains high; this has not changed substantially from previous quarters. However, the €797 million that UK startups raised in Q3 2016 is a 36% decrease from the €1.2 billion raised during Q3 2015. It also marks the second straight quarter of declining VC activity in the UK.
This suggests that venture capitalists remain interested in UK investments – but they’ve decreased their valuations of those investments. That substantial decrease poses economic risks for the UK moving forward.
The UK tech sector has severe skills gaps
A pre-Brexit report from Tech Nation found that the UK’s digital economy was creating new jobs at a rate that was three times faster than the wider UK job market. This would be great news – if the UK had a homegrown workforce that is ready to meet this demand.
Despite having the world’s largest digital economy, the UK government admitted this year that “a shortage in suitable digital skills for digital jobs persists in the UK labour market.” This report went on to say that 72% of large companies and 49% of SMEs suffer from tech skills gaps. To remedy this problem, the report recommended that the government take a leading role to provide “leadership, coordination, and key resources in establishing the conditions for digital skills development.” This pre-Brexit recommendation is the antithesis of the UK government’s post-Brexit actions.
The Home Office wants to cut the UK’s talent pipeline
The arguable cornerstone of the Brexit vote was – and remains – immigration. May appears intent on controlling who is able to live and work in the UK at all costs – even if that means forfeiting membership in the world’s largest single market.
The terms of EU membership include free movement of goods and people within member countries. That free movement is what helped Britain grow faster than any other EU member country. It is also under direct attack from May’s cabinet.
Earlier this month, home secretary Amber Rudd declared her intent to tighten the resident labor market test that companies must pass before recruiting overseas employees. Her rationale? “The test should ensure people coming here are filling gaps in the labour market, not taking jobs British people could do.”
The problem is that no less than the UK government admits that British people cannot necessarily do those jobs. One in three UK tech employees was born abroad. How, exactly, does clamping down on the free movement that has built the UK’s fastest-growing sector provide the “leadership, coordination, and key resources in establishing the conditions for digital skills development” that the previous government advised?
A rocky road ahead
The UK’s digital economy is creating jobs at a faster rate than it can fill them. To solve this problem, the country could continue to utilize free movement of people and keep recruiting talent from EU member countries. It could also revise its “Tier 1 Exceptional Talent Visa,” which purports to recruit talent from outside Europe but has been a waste thus far.
Instead, the UK’s Home Office is biting the hand that has fed its growth. It is foolhardy to think that global venture capitalists will not do their homework before investing in a sector with unmet skills demand and a politically uncertain future.
It remains to be seen how these proposals will impact Q4 VC investment in the UK. But current signs suggest a continuous devaluation of the country’s digital economy. After months of silence, May’s government has revealed its first hand at post-Brexit strategy. Unfortunately, it is playing the wrong cards.