US late-stage VC is spilling into European markets

Late-stage investment in the UK soared in 2020, due largely to financing from US firms. British investors are catching up. Will this strategy become a mainstay for VC?

Late-stage investing in British start-ups has grown to record heights, driven in large part by US firms, according to the 2021 Tech Nation report titled The Future UK Tech Built.

The UK has maintained its status as the premier tech hub for venture investors, raking in $15 billion last year for UK tech, $200 million more than the previous record set in 2019. This ranks the UK as the third-largest global hub for tech investment, behind the US and China, respectively, among international investors.

“The UK is more attractive to international investors than ever; 63 percent of investment into UK tech came from overseas in 2020, up from 50 percent in 2016,” the report says.

In particular, US late-stage venture financing, which has ballooned in recent years, is spilling into European markets as foreign investment in the UK rose to 84 percent at the $250 million-plus level of funding rounds.

The influx of capital by traditional asset managers and investment advisors is at least partly responsible for the growth in the UK’s late-stage activity.

“The late-stage segment of the [venture] asset class, the participants have actually changed over the last decade-plus,” Daryl Brown, director at DuPont Capital, told Venture Capital Journal. “We saw the traditional public equity managers start investing in venture, in terms of late-stage venture, not necessarily early-stage.”

But late-stage investment is not just swelling, it’s taking over the traditional venture investing framework as seed-stage financing continues to decrease.

Of the $15 billion invested in the UK last year, about $3.5 billion, or nearly 25 percent, went to 10 companies, seven of which – Octopus Energy, Arrival, Cazoo, Gymshark, infobip, Gousto and Hopin – are now valued as unicorns with private valuations above $1 billion, meaning the companies require ever-larger funding rounds.

“Investment in seed-stage companies is decreasing as a proportion of overall tech VC investment (14 percent to 6 percent over five years), and Series B and C investment is rising in the UK,” the report says.

This could have an overall worrying effect on local investors, such as pensions, which aren’t allocating as much when compared to American investors.

“What’s missing is a lot of [British] money spent at that last stage of the journey,” Suranga Chandratillake, partner at Balderton Capital, recently said. “It’s not that founders can’t get the money, it’s just that they’re getting it from abroad. We see it in France, Germany and the Nordics.”

On a micro level, this phenomenon is also not endemic to Britain, as other European technology hubs like Berlin and Paris are experiencing similar trends.

But the reality that “those [European] scale-ups are being picked up by US investors,” according to Chandratillake, may be the byproduct of this general industry transition to later-stage deals, and away from the early seed investments that made them famous.

How we got here

As more traditional asset managers began to enter venture investing through the less risky late stage, the influx of large amounts of capital began to tip the playing field in favor of the strategy.

“That has helped to drive up deal valuations, deal sizes, as well as the number of transactions on the later end of the market,” Brown added.

These don’t necessarily come from dedicated venture vehicles either, Brown pointed out, as some public strategies contain provisions that allow investment into more illiquid strategies.

But traditional venture managers began noticing that these late-stage investments were still making similarly attractive returns, without the seed-stage risk.

Thus traditional VC managers began to dedicate separate vehicles to later-stage strategies, Brown said.

The covid effect

The covid-19 pandemic a year ago accelerated this trend, Brown said.

When many began working from home in March, founders without a track record were largely seen as riskier investments, leading venture capitalists to turn their back on identifying early-stage deals and continue to allocate even more to late-stage strategies.

“From a diligence standpoint, [shutdowns] had an impact on deal activity across the market, but more specifically, it had an impact on the earlier-stage deal activity,” Brown said.

“In the earliest stage of venture, [choosing a deal] tends to be as much of an underwriting of the entrepreneur or the person itself, as it is the technology, the market, the adoption risk,” he added.

Early-stage investments also imply a more personal relationship, as VC managers often want to meet in face-to-face settings to become comfortable with the founder.

But as public markets began to rebound in Q2 and Q3 of last year, early-stage investments began to rebound as well, but still didn’t outpace late stage.