In 2021, global VC investment reached a record $673 billion, nearly doubling from $347 billion in 2020. There are now more than 1,000 unicorns around the world — that is, privately owned start-up companies with a value over $1 billion.
The global trend has been reflected clearly in the UK, where the VC sector saw 745 deals completed in the first three months of 2022, raising over £6.9 billion. The UK is in fact home to the largest number of unicorns in Europe, with 42 at the end of July 2022.
Although VC has historically been favoured by angel investors making direct investments, the recent growth in the VC sector has been fuelled by much broader investor involvement, from the person on the street to large institutional investors such as pension and insurance funds.
While VC comes with higher risk than traditional investments or listed equity funds, those who invest at an early stage can see substantial rewards. In addition, VC funds can help lower risk through diversification, since they invest in a range of start-ups and scale-ups.
This article looks at the strong UK venture capital market and provides some important considerations for fund managers considering launching a VC fund.
Why the UK is a key VC player
The UK is likely to be a beneficiary of an increased interest in fund managers launching VC funds. While the US attracts the most venture capital and private equity investors, the UK is in second place.
Whereas the US VC market grew predominantly out of Silicon Valley, the UK market has grown out of the “golden triangle” of London, Oxford and Cambridge. UK market growth has been driven in part by government incentives and initiatives. These have helped VC firms start up and scale up and have helped generate innovative investment opportunities.
For example, the UK has provided tax relief for research and development, and schemes such as Innovate UK, which provides funding and support for innovative UK businesses and other organisations.
For investors, there have been schemes such as the Enterprise Investment Scheme (EIS) and the Venture Capital Trust (VCT) scheme. The EIS offers tax relief to investors who buy shares in small, unquoted trading companies, whereas the VCT is similar to an investment trust in that it spreads risk across a number of small companies, while also offering tax relief.
There have been a number of recent developments that could promote additional investment and prompt fund managers to launch UK VC funds. First is the introduction of the Long-Term Asset Fund (LTAF) in 2021. This is an open-ended fund, which is authorised by the Financial Conduct Authority and will enable investment in long-term illiquid assets, including private equity and venture capital.
The LTAF’s long-term nature should appeal to institutional investors who have longer time horizons for their expected rate of return. The fact that LTAFs are open-ended, albeit with longer dealing frequency and redemption periods, also adds a measure of liquidity.
Alongside this, the UK government is encouraging defined contribution (DC) pension schemes to diversify their portfolios into illiquid asset classes, including venture capital. The starting point for this is DC pensions with over £100 million in assets under management having to “disclose and explain” their policies on illiquids. If institutional investors do move into alternative assets, this will further drive the UK’s VC fund market.
Underpinning this are efforts to ensure the best talent is available to foster start-ups. Notable here are visa schemes designed to make it easier for skilled people to come and work in the UK. This includes the scale-up visa, aimed at highly skilled and qualified applicants; it’s effective from 22 August 2022.
Moving into the market
Given these incentives and the growing UK market, many existing private equity fund managers are turning to venture capital for the first time, while specialist VC managers already in the market are launching new funds to build on their existing portfolios.
There are also first-time fund managers who have either spun-off from existing managers or are sector specialists. Sector specialists have no previous fund management experience, but understand a particular sector (such as healthcare) and create a fund that invests in related start-ups.
The challenge for anyone looking to establish a VC fund is that administration is complex. VC funds must not only be tax-efficient but compliant with regulations. These challenges are especially difficult for fund managers because to be successful they must focus primarily on finding and growing investments, not on fund administration.
Final thoughts: Some steps for launching a VC fund in the UK and beyond
All venture capital fund managers, new and experienced, must have a clear plan before launching a fund. While this article has focused on the UK market, the following steps apply to all regions.
- Ensure your investors are informed. Establishing a fund can take time, depending on the regulator and where you choose to domicile the fund. In particular, all investors are subject to anti-money laundering and know-your-customer checks, which can be time-consuming and complex. Make sure your investors understand what’s involved in this process. Transparency and proactive communication in this area will minimise surprises, inefficiencies and ill will.
- Determine the fund domicile. The tax profile of your investors will have a direct effect on the choice of domicile, as will the number of investors. For instance, there are certain Jersey structures that allow only 100 investors. As a manager, you’ll also need to demonstrate substance in any given jurisdiction where you want to market your fund and make investments.
- Vet and hire an experienced partner. No manager setting up a VC fund will go it alone, as they’ll need legal and structuring advice. Ensure that your third-party administrator is reputable, understands all applicable regulations, and has a flexible fund-administration platform to help you launch and maintain your fund in a compliant, efficient way.
- Determine costs. Fund-establishment fees are often the most significant and include a range of costs, including those of third-party providers. Ongoing fees in year two and beyond are typically much smaller. Understanding short- and long-term costs is critical to creating accurate budgets and realistic investor expectations.
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