The vibrant start-up ecosystem in the UK makes it a premier investment destination for global capital, fueling innovation and contributing to robust economic growth. Raising £24 billion ($29bn) in 2022, the UK tech sector leads Europe and ranks third globally. However, sustaining this success requires a clear R&D support strategy.

The UK’s Spring Budget lacked vision, with limited funding and tightened eligibility for R&D tax credits, risking the growth of start-ups. Prominent UK tech start-ups listing abroad highlight limited access to growth capital and incentives. To overcome challenges and surpass international rivals, focused and comprehensive R&D investments are vital to fortify the UK start-up landscape.

The importance of R&D

The need for a robust R&D strategy in the UK extends beyond the absence of comprehensive funding initiatives from government entities. While such packages are undoubtedly beneficial for founders, relying solely on sporadic financial injections from the central government will not lead to a thriving ecosystem.

In order to foster a greater appetite for investment in early-stage tech start-ups, we must address the concerns of private investors regarding profitability and long-term growth prospects, in addition to providing direct government support.

During the initial stages of a start-up's journey, R&D takes center stage, encompassing crucial activities such as testing, iterating, and launching cutting-edge versions of technology solutions for the initial customer base. This phase is pivotal as it drives innovation and establishes the groundwork for a wave of enterprise-ready technologies.

If a start-up cannot depend on government assistance to secure talent, technology, and equipment, investor apprehensions about profitability could smother these nascent solutions before they even have a chance to flourish.

This will potentially jeopardize the entire company itself. Therefore, it’s essential to alleviate these concerns by creating an environment where start-ups can safely access the resources they need for sustainable growth and development.

Public capital is no longer enough

In order to ensure a steady flow of high-quality tech companies in the UK, it is crucial to facilitate the transition of start-ups into their growth phase. This involves streamlining access to growth capital, enabling them to expand operations, enter new markets, and explore innovative technology offerings.

When considered collectively, private investors possess the potential to contribute significantly more funding than the Treasury alone. However, it is essential to incentivize these investors through government policies, particularly for transformative technologies such as AI and quantum computing, which may require a longer time frame to yield returns on investment.

Presently, large corporations dominate the market, leveraging their wider margins for error to overshadow start-ups. For these fledgling companies, success or bankruptcy can often be determined within a matter of weeks rather than years.

Investors, in general, seek a high return on their investments – measured in the VC industry by the ‘multiples’ benchmark of money invested against the final exit valuation of its stake. By demonstrating to them the strong and long-term growth potential of their equity in promising start-ups exploring fields like AI or quantum computing, we can inspire confidence and encourage investment. In doing so, the UK can enjoy the advantages of a fortified tech ecosystem that propels innovation and prosperity.

Challenges facing the UK in the future

At its heart, the UK faces a challenge in retaining start-ups as they reach a certain level of growth. Once these companies surpass the early stage and enter Series C and beyond, they recognize the significantly higher growth capital available abroad, prompting some to even relocate their operations to other countries to achieve the next phase of expansion.

Consequently, these organizations may contemplate listing on foreign stock exchanges, such as the New York Stock Exchange, instead of the London Stock Exchange. While recently proposed changes to listings rules by the Financial Conduct Authority (FCA) are encouraging, their impact is limited. The larger issue lies in start-ups being enticed by the allure of higher valuations and access to game-changing capital necessary for them to transition into true category leaders.

This trend raises significant concerns, particularly regarding successful spinouts from British university systems, like ARM, which may be lost to international markets as they scale. It’s counterintuitive for the UK to foster and cultivate these innovative start-ups through its world-leading academic institutions only to witness their departure once they achieve a certain level of success.

This highlights the importance of implementing effective policies and support systems that effectively combine the influence of government with the abundant growth capital offered by private firms. Such measures are crucial to ensure that the UK can retain and nurture these promising start-ups, leveraging their potential for long-term growth and reinforcing the country's position as a thriving hub for innovation.

Strategic thinking needed

While some level of fragmented support for the start-up ecosystem is better than no support at all, it’s imperative for the UK government to consider more comprehensive measures. These could include implementing larger-scale policies or roadmaps that allocate millions of pounds in funding to encourage sector development, as well as targeted actions such as increasing the percentage points in R&D tax support to provide much-needed financial relief to start-ups.

It's true that the UK may not be able to match the vast funding pledges seen in the US, such as the estimated $2 trillion allocated across three major laws covering infrastructure and tech innovation. However, the UK can leverage its strengths in ground-breaking R&D areas like AI. By delivering direct investment and structured programs, the UK can foster an environment where firms can thrive. It’s crucial to avoid unproductive missteps, like the withdrawal of government funding for major start-up network Tech Nation (a huge part of the UK start-up ecosystem) or the cutbacks on R&D tax credits. These mistakes should be prevented in the future to maintain momentum and avoid any setbacks.

An area of positivity in this regard is the establishment of HSBC Innovative Banking. Rising from the ashes of Silicon Valley Bank UK, this entity will be a central focus for bringing together private equity and promising British start-ups. This institution will play a vital role in driving the innovation economy forward, particularly tech firms.

Any change, regardless of its scale that enhances the tech start-up landscape is commendable and necessary for supporting innovation. However, it’s important to recognize that these efforts cannot work in isolation. A holistic and comprehensive approach is required to truly empower and advance the tech start-up ecosystem in the UK.

A leading role for institutional investors

While government funding undoubtedly plays a crucial role in supporting start-ups, the potential impact of private capital in aiding these ventures during their most challenging stages cannot be overstated.

By utilizing their authority in policy-making, governments can incentivize institutional investors to acquire equity in UK start-ups, allowing them to reap substantial returns in the future. This can be achieved through a combination of merit-based rewards and the adjustment of complex regulations, encouraging private investors to take calculated and well-defined risks for long-term financial gains.

Encouragingly, we have already witnessed positive strides in this direction. Reports indicate ongoing discussions in the City of London regarding the establishment of a potential UK sovereign wealth fund, leveraging the influence of prominent UK pension funds to invest in UK tech start-ups.

The idea was further discussed at London Tech Week during a panel with the Chancellor of the Exchequer, Jeremy Hunt. It considered pension reform as a way of increasing investment in UK tech start-ups. This ambitious initiative exemplifies the crucial role that government plays as a convener in facilitating such discussions.

This collaborative effort will foster a more inclusive investment strategy that avoids favoring specific winners or losers. Instead, the focus should be on creating a resilient ecosystem capable of withstanding the decline of major companies while promoting competition at the grassroots level.

By aligning government efforts with private capital and facilitating these discussions, the UK can unlock the potential for a robust and thriving tech landscape, empowering start-ups to navigate challenges and flourish in the long term.