International VC trends: The UK experience. Interview to Howard Watt of Fladgate LLP
1) How did the UK startup/VC market evolve in 2021/2022? Have you noticed any changes in terms of numbers, size, sectors, and types of investments due to the Covid-19 pandemic?
So far there has not been a material shift in the amount of work coming through, though the expectation is that a slowdown will arrive at some point and early pipeline signals do suggest a slight dropoff in VC financings, somewhat balanced with an increased activity in opportunistic M&A and ‘rescue’ bridge financing. The buoyancy in the investment deals appears to relate to sectors which remain ‘hot’, being (currently, from our viewpoint) climatetech and Web3/Crypto and the associated fintech and infrastructure companies to such sectors. We are still seeing competitive rounds and strong valuations, though not at the excessive levels we had reached in 2021.
2) The Russia-Ukraine war is impacting everyone’s daily lives from trading and consumer perspectives. Do you think it will significantly affect the establishment of new startups, VC investments, and cross-border transactions? If so, how?
We aren’t seeing any direct effect but the ripple effects of a recession economy are being felt in the way we would expect – hints of lower activity, feedback from VC Fund clients that they are slowing deployment until the new year, etc. It’s important to realise how bullish the market was prior to the conflict, and realise we are returning to what might otherwise be considered more ‘normal’ levels of activity. It certainly does not feel like the almost total shutdown which the early stages of the pandemic were like. I think investors understand how to navigate a recession economy whereas no one really understood what the pandemic would mean in terms of how we would live and work.
3) What is your experience with VC cross-border transactions (i.e., sector, size, and typology of the investments)? What changes in a VC transaction when dealing with foreign investors?
It has little material bearing, as whatever jurisdiction an investor comes from, is usually different anyway from the offshore/tax friendly domiciliation of the fund itself. Deals are almost always done in local law, so we could have an alien VC Fund from Mars invest into a UK Company and it would still be UK law docs! The only difference is overseas investors sometimes come with specific boilerplate clauses such as PFIC/CFC or ERISA provisions for US Funds. As such VC deals tend to be by their nature both cross border (parties’ domicile) and not cross border (docs are almost always just local law).
4) What were the most challenging clauses that you negotiated recently?
A very curious thing I have seen is that the economic slowdown has meant far fewer true ‘hot’ companies. Since there remain at least some investors keen to deploy, that has somewhat counter-intuitively meant that some really ‘hot’ companies are able to push for far friendlier Founder terms than I have ever seen, because the threshold for a good company is much higher, and so the ‘supply’ of such companies is far lower, while the ‘demand’ provided by investors keen to deploy, is still relatively stable. I have now seen several companies push for extremely Founder-friendly terms when the current climate might have suggested investors have the leverage. That increased leverage has meant more difficult conversations and negotiations.
5) What kind of exit opportunities does the UK VC market offer?
The UK VC market appears to remain the most popular market in Europe, and remains a very familiar jurisdiction for investors and companies. It provides a logical ‘jump off’ point for both European expansion and US exploration, and the government’s most recent budget changes suggest a recognition that investment and growth and particularly investment into early stage companies, remains a focus. The perceived negative effects of Brexit have not yet had a visibly material impact on the UK as a preferred destination for players in the VC space, and there are no indicators that this will change anytime soon.