How is the UK Government Supporting Deep Tech?

The UK’s start-up and scale-up sector has apparently just passed $1 trillion in value, and the UK appears to be leading Europe in funding its tech companies.

In 2021, I was blown away by the UK’s fundraising for tech companies, which was the highest in Europe by far. That goes for private equity and public equity fundraising. In all, the UK created 29 unicorns (privately owned start-up companies valued at over $1 billion). That’s a new unicorn every 13 days.

• Private equity funding raised for UK tech companies totalled £29.4 billion. This was double that of the second placed country, Germany, and three times that of the third placed country, France.

• Public equity funding raised for UK tech companies totalled almost £20 billion and covered 37 tech IPOs, including Dark Trace, Oxford Nanopore and Wise.

Despite this impressive growth in the UK tech sector, however, there is still a lack of follow-on funding for deep tech companies. A report from the British Business Bank shows that UK deep tech companies are substantially less likely to raise a second round of funding than their peers in the US. For example, 49% of UK start-ups received 'follow-on funding' compared to 63% of US companies. As a result, 39% of deep tech businesses in the UK go bust or run out of investment before they raise a second round of capital.

Most VC firms are understandably reluctant to invest in deep tech companies; the risks are large, and so is the length of time before an investor might expect a return. Deep tech companies are more likely to be led by academics, rather than seasoned entrepreneurs, which can put investors off. VCs are also finding that the specialist expertise needed to advise on deep tech deals is much more difficult to source.

The UK Government’s Approach

I recently heard from Chris Philp MP, Minister for Tech and The Digital Economy, and Parliamentary Under Secretary of State at the Department for Digital, Culture, Media and Sport (DCMS). Chris provided an overview of the UK Government’s approach to supporting deep tech, in which he includes technologies such as AI (especially with application in cyber security and pharmaceutical discovery), advanced semiconductors, and quantum computing. Regarding the commercialisation of the UK’s deep tech ecosystem, Chris divided the key points into four areas: ideas, people, capital and regulation. I’ve summarised each separately below.

Ideas

R&D is the main incubator for developing ideas in deep tech. There are two mechanisms through which the UK Government can support R&D: government spending in R&D, and incentives for private businesses to spend on R&D.

• In terms of government spending in R&D, the UK Government recently announced a 50% increase in R&D spending, over the next 6 years. This takes us from about £15 billion at the moment to £20 billion by 2024, and to £22 billion a year by 2026. The planned spend covers university-based research as well as other government-funded research beyond that. The UK Government’s R&D spending is managed mostly through UK Research and Innovation (UKRI) and Innovate UK. UKRI is the UK’s largest public funder of research and innovation. Innovate UK is part of UKRI and is tasked with helping UK businesses to grow through the development and commercialisation of new products, processes and services.

• In terms of incentives for private businesses to invest in R&D, the UK Government promotes R&D tax credits, which have proved very popular. In the budget in last Autumn, the Chancellor announced an increase in the scope of R&D tax credits to include cloud computing and data acquisition. A few weeks ago, in the Spring statement, the Chancellor also signalled that he’ll be going a lot further on R&D tax credits in the next Autumn budget, which is expected in October or November of this year.

People

Chris pointed out that the UK Government is keen to ensure that deep tech companies can recruit talent in the UK. This requires the cultivation of skills at home, as well as attracting the brightest and best from around the world.

• To nurture talent at home, the UK Government is now funding 1,000 PhDs and 2,000 master’s degree conversion courses in AI. It is also looking to replicate a similar approach in technologies other than AI. Beyond this, Chris acknowledges that more work is needed to promote digital and tech skills at schools, but he points out that he will be working with the Department for Education in the coming months to expand the scope of our digital bootcamps.

• To attract talent from overseas, the UK Government has, over the last year or so, created several global talent visas and global business visas. In the Autumn of this year, for example, the UK Government will be launching a scale-up visa route where fast-growing companies (i.e. companies who are paying more than £33k per annum for specified roles) can bring people in quickly from overseas. By the Autumn, there will be about five or six new visa routes opened up to simplify the process.

Capital

As with any sector, the deep tech ecosystem needs access to capital. Chris talked about his desire to make sure capital is available in the UK for start-up seed finance as well as IPOs. Schemes like EIS, SEIS, and VTC are incredibly important for encouraging private investors, but Chris went on to explain his thoughts on venture capital (VC) funds, pension funds and the London Stock Exchange (LSE).

• Global VC investors, particularly those in Asia and the US, deployed record amounts of capital into UK scaleups in 2021. Although British Business Bank and British Patient Capital are investing in UK VC funds, Chris would like to see more, and larger VC funds in the UK. He wants to see our VC community become as vibrant as possible.

• Chris is conscious that, in the UK, our pension funds are massively under allocated to deep tech. Compared to those in the US, for example, UK pension funds have been reluctant to invest in pre-IPO tech and VC funds. In the US, 70% of funds going into VCs comes from pension funds. In the UK, on the other hand, only 12% of funds going into VCs comes from pension funds. Chris wants to address this, and the UK Government is now consulting on removing the last regulatory impediment, which is carried interest on the pension fee charge cap.

  • The current pension fee charge cap of 0.75% is designed to keep costs down for savers in default arrangements within defined contribution (DC) pension schemes. It has been criticised by some in the pension industry, however, for being too restrictive, preventing schemes from investing in alternative investment, such as VC funds and other illiquid assets. Once this impediment is removed, Chris hopes and expects UK pensions funds to deploy capital into this sector, noting that it is capable of generating returns far in excess of more conventional asset classe

• The London Stock Exchange was hugely successful in 2021, with 37 tech IPOs, and Chris pointed out that the UK Government is committed to making it even more attractive as a place to IPO. In the last 6 months, the UK Government has implemented various recommendations of the Hill review, which was launched by the Chancellor in November 2020 specifically to further enhance the UK’s position as an international destination for equity listings. For example, within the last 6 months, the UK Government has:

  • Reduced the free float requirement from 25% to10%. Free float, also known as public float, refers to the shares of a company that can be publicly traded and are not restricted (i.e., held by insiders). In other words, the term is used to describe the number of shares available to the public for trading in the secondary market.

  • Allowed a dual share structure. Dual-class share structures give specific shareholders voting control unequal to the amount of equity they hold in the company. This is to satisfy owners who don't want to give up control of their company but do want to tap the public equity markets for financing. Proponents say they allow founders to pursue a long-term vision, rather than face pressure to focus on short-term results. (Detractors, on the other hand, say they create an entrenched class of shareholder, free to make bad decisions with few consequences).

  • Loosened up the SPAC rules. A SPAC raises capital through an initial public offering (IPO) for the purpose of acquiring an existing operating company. Subsequently, an operating company can merge with (or be acquired by) the publicly traded SPAC and become a listed company in lieu of executing its own IPO. The UK’s first SPAC floated in December 2021.

Regulation

Chris sees regulation as a potential source of competitive advantage for the UK, now that the UK is out of the EU. Chris describes his philosophy to regulation as light touch, proportionate, and favouring growth, innovation and investment.

For example, the UK Government is currently reviewing the GDPR, which, in Chris’ opinion, can be overly stringent, stifle innovation, and impose additional costs on businesses. The UK government now wants to lighten those burdens whilst respecting personal privacy. Importantly, Chris points out that the approach taken must maintain the technical basis for a data ‘adequacy’ judgement with the EU. ‘Adequacy’ is a term that the EU uses to describe other countries, territories, sectors or international organisations that it deems to provide an ‘essentially equivalent’ level of data protection to that which exists within the EU.

Summary

Hearing Chris speak about the UK’s tech sector, I am generally encouraged by his views, and the importance he places on deep tech to the UK’s economic future. He sees deep tech as particularly important in laying the foundations for future growth in productivity, increasing wages, and significantly influencing our geopolitical position in the world.

In my opinion, the UK government’s approach is producing excellent results in the wider tech sector. I’m heartened by the UK Government’s approach to increasing public and private investment in R&D, attracting and growing talent, encouraging pension funds to invest more heavily in VC funds, and to regulation.

When it comes specifically to deep tech, however, the impact is more subtle. I believe the UK Government is making the right moves, but the key challenge is in how investors assess the risks of investment in deep tech. We shouldn’t be looking to the UK Government to fix this. Instead, VC firms need a better way of assessing the risks of deep tech. There are some notable VC firms who have already recognised this and are exploiting the opportunities.

So….how should VC firms assess the risk of investing in deep tech? How should they assess the risk of not investing in deep tech? How are the world's best deep tech VC firms doing it? Well that’s for a separate post, which I’ll get around to soon.