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After years of slowdown, are the green shoots finally here?

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Funding, red tape, hype: all the right pieces seem to be falling into place for the success of London’s Tech City. After years of economic slowdown, is the climate turning?

The wider economy is already showing signs that it is finally bouncing back from a prolonged slump. In the second quarter of the year, the economy is estimated to have grown by 0.6 per cent, according to the Office for National Statistics, the second quarter of growth in a row.

Economists agree that the economy is on track to keep expanding, and Capital Economics even predicts that the UK may see annual growth of four per cent in the second half of the decade. Things are looking up for sure.

Yet as always, the devil is in the detail. While macroeconomic trends are all pointing in the right direction, how is London’s fast-growing tech industry faring? Is it growing in line with the rest of the economy? Is it safe to talk about “green shoots” yet? There is only anecdotal evidence to go on, but so far so good.

Deals, deals, deals

Not one week has gone by in 2013 without an impressive funding deal being announced. Dealflows in the last month indicate that the Tech City scene is getting the funding it needs.

Davor Hebel
Davor Hebel

Some highlights from Tech City News’ investment section include Smarkets’ $2.3m, Scoopshot’s $1.2m, Shazam’s whopping $40m, Yplan’s equally-impressive $12m, Conversocial’s £2.95m, Urturn’s $13.4m, TransferWise’s $6m… it’s an impressive list, with strong companies seeing serious investments in their future.

“The tech scene is generally doing better and better,” says Hoxton Ventures’ Hussein Kanji. “The VC market here is still small and in fact is probably declining – there is less money at Series A levels, more money at seed.”

Davor Hebel, partner at Fidelity Growth Partners Europe, says that the environment for VCs is still uncertain.

“The environment is a bit two-speed, with a few funds continuing to be very active while the overall market is less vibrant. That being said, the UK certainly seems to have a lot of great entrepreneurs and also its fair share of nice exits,” says Hebel, pointing to Mendeley ($80m sale to Elsevier) and Ubiquisys (to Cisco for $310m).

Pro-tech government

Kanji attributes some of the success – particularly at the very early-stage level – to government intervention, for example through the Seed Enterprise Investment Scheme (SEIS). Introduced in April 2012, SEIS offers private investors enhanced income tax and capital gains tax reliefs in return for investing in a startups. SEIS was specifically designed to help smaller, risker, earlier-stage UK companies, and it has – by and large – been one of the government’s more successful initiatives.

Hussein Kanji
Hussein Kanji

Jos White, partner and co-founder of Notion Capital, agrees that the government has been making the right noises.

“This government really understands the importance of growth businesses and how the tech sector is a driver of the UK economy,” he explains.

White says that tech startups are being supported by government in a number of ways: “R&D tax credits, SEIS, Tech City… this government seems to ‘get’ it. But of course, they can’t do it all on their own. Some of these tech businesses now need to break through and prove that they can emerge out of that environment and build sustainable global businesses that support the economy.”

The London “ecosystem”

Christian Hernandez, Facebook’s former UK and Pan-Euro director  who recently joined angel investor Eric Martineau-Fortin at White Star Capital, says London is on the right track.

Christian Hernandez
Christian Hernandez

“Why is the Valley the Valley? It’s because of the access to capital and the ecosystem out there, made up of entrepreneurs, advisers, angel investors and VCs. There is enough success to fuel the next VC fund and there are enough exits of significant sizes,” Hernandez explains.

He believes that ecosystem now needs to be further developed in London. “You already have the density of successful entrepreneurs – Michael Acton Smith from Moshi, Ricardo Zacconi from King, Betfair’s Ed Wray… these are all guys who have done well and are now active as angels.

“The next stage is for companies such as ProFounders, Passion Capital and us to do early-stage investing in a more institutional way and to get the likes of Accel, Index and others on board. The density of the Tech City ecosystem has already evolved significantly in the last few years and this is all good news.”

A clearer path

One historical challenge for London’s tech community has been what startups do once they’ve outgrown London. The US has generally been perceived as the right goal for startups; a sun-filled destination where investors welcome your British-incubated startup with open arms.

London stakeholders are trying to change this. There is Tech City, of course, which has done a lot to promote London as a place for fast-growing businesses to set up and grow from, but perhaps one of the more concrete measures has been the recent introduction of a new High Growth Segment by the London Stock Exchange.

Jos White
Jos White

The High Growth Segment has been specifically designed as a solution to meet the capital needs of Britain’s fast-growing companies, and there is no secret that its main goal is to keep firms growing in Britain, stopping them from emigrating to the US for growth capital.

Its introduction has been widely praised by everyone in the ecosystem, both for giving entrepreneurs the opportunity to engage with investors and raise funding, but also as it gives startups a clearer path to strive for. Companies can be born in London and stay in London.

Yet Notion Capital’s White says that, at the moment, there is simply still no tech sector within the UK public markets – the last major tech IPO was Mail.ru, years ago. “It’s become extinct. This means that companies still look to sell or move their operations to the US and go public there. It’s a drain on the UK economy.”

He hopes that the HGS  will change this, for the benefit of tech companies as well as investors, once it takes off. “What we need is to see some tech companies IPO using the High Growth Segment and to make it a success,” says White. “This will pave the ways for others to follow.”

Funds and funding

Funds seem to be taking London seriously, and investors are keen to get on the Tech City bandwagon. Hernandez himself is set to become a player – his plan at White Star Capital is to raise a new $100m fund, with him and Martineau-Fortin as managing partners. There is no doubt that having another London-based fund is good news for the ecosystem, and will hopefully trigger others to consider London as a valuable destination to invest.

Yet, for all the positive signs from funds, Hoxton Ventures’ Kanji says that companies are still being held back by a lack of funds.

“In Series A and B, there is a cap because there are less funds, less capital,” he explains. “Why? Because the performance of funds is catching up with them. It means that fewer funds are being raised and there is less money in the ecosystem. But company growth is doing okay, especially since a lot of new money went into growth in the last five years.”

There is a notable difference between the size of US rounds and European rounds. Data from the European Private Equity and Venture Capital Association (EVCA) shows that in 2011, the average seed round in the US was for $2.3m while just $100,000 in Europe. Likewise, the average A round in the US was $5.8m and only $1.1m in Europe.

“When you look at the comparable data between seed and A rounds in Europe and the US, there is a fairly large gap,” says Hernandez. “At the end of the day, how can European companies compete? Startups in London and New York are going after the same market, but one is hampered by having just one fifth of the funding.”

Yet this isn’t just a London vs the US story; competition is also fierce from our European neighbours. According to data from VentureSource, British companies raised $656m in venture capital between January and June 2013 – 15 per cent less than a year earlier. And French and German companies are catching up, seeing the total amount of venture capital increase to $399m and $343m respectively.

London and Tech City cannot afford to rest on its laurels. Yes, things are getting better, and all the right pieces seem to be falling into place. But the community needs to continue to renew itself to remain an attractive destination for entrepreneurs and investors alike if it is to blossom fully.

image credit: flickr/Jorge Luis Zapico

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