As wealth managers' clients can play a part in supporting venture capital and other forms of seed financing of startup firms, this article looks at current trends in the UK.

Wealth managers and family offices are targeted by firms and funds seeking "seed" financing for various projects. It pays to learn about how the different stages of seed financing work and what trends are in this space. To address these issues is Alexander Sleigh, investment director at Newable Private Investing. The editors are pleased to share these thoughts and invite readers' replies. Remember that the publication does not necessarily share all views of guest writers. Email tom.burroughes@wealthbriefing.com

A startup funding trend from the US - for fewer, but larger, early-stage rounds - has come to the UK. But what does it mean for the UK investment and startup ecosystem?

The percentage of US Series A funding rounds exceeding $50 million increased by an incredible 721 per cent between 2008 and 2017. This has had a trickle-down effect on seed rounds, which have grown in size from an average of $550,000 to one of more than $2 million. It has also spread across the Atlantic to be replicated in the UK and European markets, with 23 companies in the region - from Revolut and Atom Bank to Graphcore and Benevolent AI - raising rounds of €100 million or more in 2018.

Providing startups with a longer financial runway is good for both parties in the funding relationship. Investors can rest assured that the entrepreneurs they back will be able to focus on achieving key growth milestones rather than getting trapped on a never-ending funding treadmill. Those entrepreneurs, meanwhile, enjoy the opportunity to focus on the core of their business that is afforded to them by greater financial stability.

An investor cannot spend the same dollar twice, though. So while early-stage funding rounds have increased in size, the number of startups securing these vital investments has gone down.

Cream of the crop
This means that startups are likely to encounter a lot more “tough love” from investors - whether at the angel, VC, or corporate or institutional level. Those who might have easily secured funding before are having to work even harder to provide solid proof of concept or indeed commercial viability. For the lucky few, however, securing a larger round is a great vote of confidence, and they could also benefit from more individual attention and support as part of a smaller portfolio. In time, this greater selectiveness could drive up the overall quality of startups, with the cream rising to the top.

Larger seed rounds do not negate risk
Investors who put their trust - and their money - in only the most promising startups are not immune to risk. On the surface, if the quality of startups goes up, then so should overall success rates and investor returns. However, fewer but larger investments also means there is less diversification within the VC’s portfolio to hedge against failures. No matter how promising a company, at such an early stage in their development catastrophic failure remains a very real possibility.

Co-investment is becoming more commonplace as a way of minimising the risk attached to less diverse portfolios, enabling individual funds to diversify while retaining sufficient firepower to support their investee companies through follow-on funding rounds.

Changing the nature of angel investors
While VC funds are largely riding the wave of the “fewer, but larger” trend, there is a risk that larger rounds at seed stage could start to price out another crucial class of investor in early-stage innovators. Alongside the much-needed cash injection that angels provide, the value they add in terms of expertise and access to their networks can be crucial to a startup’s growth before VCs come on board. Startups which target a sizeable early round that precludes angel involvement could be doing themselves and the wider ecosystem a massive disservice.

Many smaller angel investors are, therefore, increasingly investing via consortia and funds in order to be able to access larger deals - and larger potential upside, as many funds (especially at seed stage) are starting to demand larger equity slices for their investment.

Investors going down this route should study a fund’s investment process before committing - the best angel groups now have sophisticated due diligence and high-calibre investment committees in place that see them increasingly match those of early-stage VCs.

The concentration of risk as a result of funds investing more capital in fewer deals should be offset by portfolio companies being better capitalised. Many larger venture capital firms managing funds raised from retail investors are nevertheless choosing to be less active in seed rounds as they look to protect their ability to invest in larger high-growth companies further down the road. There is, therefore, a significant opening for this new generation of angel investor to continue to play a pivotal role in the early-stage growth of the UK’s most promising startups.

The high-stakes game of investing and securing funding has never been straightforward, but it is clear that we are at a crossroads. The investment economics that have seen a number of recent UK unicorns raise several plus-sized rounds are now trickling down and impacting businesses at the earliest stages too. Gone are the days where startups were rewarded with "participation prize" investments. We are now in a race where the “winner takes all”, and angels have a big part to play in getting entrepreneurs off to the best possible start.