From a top-down viewpoint, a number of events impact investment activity and market outlook for the EIS/SEIS fund and early stage venture capital sector, of which the main ones are:
- The increasing Bank of England interest rate, which is currently at 4.5%.
- Inflationary pressures, and in particular, wage inflation.
- The pension allowance increase as announced in the last Spring Statement by the Chancellor of the Exchequer (for details of this policy change have a look at Ben's earlier blog "UK Spring Statement 2023").
Rising interest rates increase the cost of capital, creating downward pressure on valuations and making us question reported run rate sustainability. Inflationary pressures are also negatively impacting forecasts, as costs are squeezing margins across most sectors.
The latest pension allowance increase threatens to divert away EIS / VCT investment from those high earners who historically would invest in EIS / SEIS upon maxing out their pension allowance. This increase in allowance appears to be substantial enough to impact EIS, SEIS and VCT funds.
In order to be able to assess the level of impact these events have on enterprise, it is important to account for the journey of early stage VC so far.
Private equity and venture capital started outperforming public markets immediately after the 2008 financial crisis. Since then, institutional investors have gradually increased their allocations into private equity, with venture capital now accounting for more than 10% of portfolios. Money has steadily flowed into this space and, undoubtedly, it will continue to do so. As more money flowed into the VC space, more investment started trickling down into start ups and earlier stage companies, creating a micro-VC or early stage VC sub-sector. This is where most SEIS and EIS investment resides as it typically precedes pre series A financing rounds.
As mentioned in Bronagh's latest blog "Latest SEIS and EIS statistics for the 2021 2022 tax year", HMRC announced a 39% increase in EIS investment for the 21/22 tax year. This represents an impressive inflow of £2.3 billion into UK early stage companies within just one year.
What drives investors into the EIS / early VC space is a winning formula: the injection of capital by specialist mentors into a bootstrapped entity early in its life cycle.
However, valuations have started to decrease, albeit gradually over the past six months, and we expect this to continue. This is due to market uncertainty brought on from those events listed previously. The downturn is already noted in VCT investing stats where we note a circa 20% decrease in investment levels for the 2022/23 tax year.
Despite adverse macro-economic winds, Sapphire funds' investee companies continue to make steady progress towards achieving their goals and delivering on their plans consistently. They are treading carefully, mindful of the impacts that monetary and fiscal policy will continue to bear on consumer confidence, operational efficiency and access to capital.
