Economic Insight: Funding gap

George Whitehead, business development director at the National Endowment for Science, Technology and the Arts (NESTA), says that there is still a shortage of funding for worthy growing concerns

A lot of institutional capital has
been invested in UK venture-backed companies. One estimate puts it at £1.4 billion for 2006, an increase of 27 per cent on the year before. But although investors say they’re active at the seed stage, not many actually are.

For companies that are pre-revenue or have very small revenues, we’re finding that not many institutional investors are willing to get involved. In fact, it’s getting fewer by the day, as a couple of funds that were active in this area, Quester and Angle, have gone quiet recently.

There’s a reliance on business angels to fill the gap – but this doesn’t necessarily work. Not all angels have the time to put in the hands-on support the business needs, and not all are investing in sectors they know a lot about. Most private investors are hideously busy people.

Another problem is that people
have overvalued very early-stage companies. Our research suggests that £500,000 to £1 million is a reasonable valuation for an early-stage venture. But Series A investors often value those companies at around £3 million. If you invest too much in the first round, you’re really punished in the second round – and you’re taking on a huge amount of risk. So, as well as the money, more sophistication is needed in the market.