The UK’s GDP has been on a downward trajectory in recent months and a recession is becoming more of a certainty globally, making the need to find new sources of growth a necessity.
Lakestar has identified a £1.5 trillion (about $1.8 trillion) growth funding gap that the UK needs to close to lift the economy out of stagnation and compete on a global scale with countries like the US.
We spoke with Sam Gyimah, Lakestar venture partner and former UK government minister for science, innovation and higher education, about how the funding gap can be bridged.
PitchBook: What is the reason behind the UK’s financing shortfall?
Sam Gyimah: You have to look back to the 1980s to understand where we are now. At that time, the UK had a big economic transformation which was driven by privatization and deregulation. Key industries like financial services, energy and healthcare led the economy, mainly financed by traditional banks whose loans were backed by real assets, profits and the growing stock market. The result was GDP growth rates that were in excess of the rest of Europe.
Through various financial crises and even Brexit, the UK’s economic model has come to a head and a lot of key sectors have been given away. On top of that, traditional banks can’t loan to companies with just some lines of code or with no profits because UK regulation prevents it.
As a result of this, currently none of the top 10 UK companies scaled in the last 20 years, and that’s compared to the US, where seven of the top 10 were scaled within that time period. Without new industries and sources of growth, the UK is at risk of falling behind.
Why is it that the US is more effective at scaling these companies than the UK?
Gyimah: The UK as a research powerhouse is ranked second only to the US in terms of the output. When you drill down into how much of that actually is translated into ventures and enterprises that go on to become companies, it is a long way off the US.
Even when companies are created, there is so much more capital in the US to create globally competitive businesses. The US has four times higher value output, compared to the UK when it comes to how much growth funding is available. You can see with rounds of £100 million or more in the UK, they’re very rarely led by investors from the UK or Europe. There just isn’t domestic capital available to scale these companies. And that’s important because where the money comes from ultimately determines where governance and control is based.
Why does the UK need £1.5 trillion in the next 20 years to bridge this gap?
Gyimah: Based on the value of all UK companies and their forecasted development, which includes historic values, incumbent company growth and the overall economic outlook, we calculated that building growth businesses will require £75 billion annually, so almost triple 2021’s funding levels.
This would be used to scale up 10,000 new growth companies by 2040, which would triple GDP growth to up to 3% and create £5 trillion to £7 trillion more value for the economy. It would also require focusing on new strategic sectors like decarbonization, biotech and space over the next two decades.
It sounds like a lot, but bear in mind when you look at the world’s 15 most valuable tech companies, the average financing per company is around £2.6 billion. The average with this new capital would be £150 million.
Where would the money come from?
Gyimah: We’re obviously not expecting it to come from the government but rather private sector capital sitting in our pension funds and with insurance companies. Those are the institutions primarily that VC firms will raise capital from in order to invest, and one of the biggest differentials is that the amount of pension capital that is allocated to venture in the UK is close to zero.
Unlocking the private sector for growth capital is a simple way the UK can make the environment more competitive for businesses, and help raise the capital needed to finance growth. In order to do this, there needs to be more understanding around the asset class. Because venture is still relatively new in Europe and the ecosystem hasn’t been as fertile as it has been in the last few years, I think there is a lack of understanding on the part of UK pension funds and the like. US endowment funds have benefited incredibly from the returns that venture can provide, and we need their UK counterparts to see that too if we’re going to stop our economy from underperforming.
With the downturn, more LPs globally are reevaluating their VC allocations. Is now the right time to go after the UK’s private sector capital?
Gyimah: When other asset classes like property have a dip, nobody ever asks should we invest in property again—you just go ahead and find the right things to invest in. I think that same logic applies to the venture ecosystem; it’s about finding the right sort of companies to invest in, that will drive the growth that we need now.
We’re looking five to 10 years ahead, not at where the stock market will be tomorrow or the day after. So for long-term investors who care about the future growth of the UK, this is the asset class where you need to look, not just because you want to do good, but actually to get the returns. Technology transformation isn’t going to go away simply because the stock market is down 5%, and entrepreneurs are not going to stop innovating for the same reason. There are still tremendous opportunities ahead and we need to seize them.
Featured image by Tim Grist Photography/Getty Images
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