British tech investors want the Treasury to hand over an extra £900 million after Brexit

New UK venture capital funds face a huge cash shortage after Brexit
A major EU backer for funds has frozen activity as Brexit negotiations continue
Now fund managers want the Treasury to hand over £900 million to make up for the shortfall

One immediately negative outcome of the Brexit vote was that British venture capital investors, hugely important to the UK's thriving startup scene, suddenly lost access to a major source of EU funding.

The European Investment Fund froze new investments into UK funds because, it said, of the extra due diligence required during the Brexit negotiations.

The Treasury estimated that the EIF invests £900 million into UK funds each year.

A submission sent to the government's Patient Capital review, which aims to boost investment into long-term finance, argues the government should make up for this shortfall.

The submission, sent by Episode 1 Ventures and seen by Business Insider, said the Treasury should more than double its current funding to the British Business Bank, the UK's state-owned development bank.

Episode 1 managing partner Simon Murdoch wrote: "[The] EIF has been investing [around] £900 million a year in UK venture capital, and it seems extremely likely that this source of funding has ended. If so, then the UK government urgently needs to increase investment in the sector by up to £900 million a year."

Part of the problem is that the EIF acted as a cornerstone backer for UK funds, encouraging other investors on board.

But VCs told Business Insider earlier this year that the EIF freeze has put their ability to raise new funds at risk.

VCs see the British Business Bank as the 'obvious' alternative to the EIF

Chancellor Philip Hammond already made £400 million in new funding available to the British Business Bank in January this year. That's being handed out to early- and late-stage VCs as part of the bank's VC Catalyst programme, with the bank able to supply up to 33% of a fund's total. There's also the Enterprise Capital Funds programme, where the bank will match investments made by VC funds.

Funnelling an extra £900 million would allow the bank to triple the size of both programmes, according to Episode 1.

Murdoch wrote the British Business Bank was "helpful and diligent" but somewhat "under-resourced."

This is a common sentiment among British fund managers. One told Business Insider earlier this year: "If the EIF is no longer there, that gap needs to be filled, and the British Business Bank is the most obvious UK institution. It's probably the most well-positioned to do it, if the government wanted to."

With the status of EIF funds to the UK uncertain, the bank has already stepped up to an extent. Philip Hammond increased the amount the bank could invest individual funds from 33% to 50% in June. Business Insider understands at least two funds sought a greater share of investment as a direct result of the change.

Investors said there's a crisis in seed funding

Both Episode 1 and a second consultation submission, sent by Capital Enterprise, drew a connection between the EIF's freeze in investment and an apparent crisis in late seed funding.

Their argument runs counter to the general narrative in UK that British startups have a problem "scaling up," and that it's easier to raise cash at the earlier stages.

John Spindler, chief executive of Capital Enterprise, wrote: "[All] the evidence points to a persistent and present market gap in funding is for tech startups raising late seed and series A rounds ( between £0.5 — £2m)."

He added: "[We] would like more action from the British Business Bank and the Treasury to finance more seed and early stage A funds."

Spindler cited PitchBook analysis showing that there were 61 micro funds closing each year between 2007 and 2013 in Europe. Just four have closed so far in 2017 in Europe. Seed-focused funds, and therefore investments, have therefore tailed off. He suggested that the EIF's pause in funding hadn't helped.

Episode 1 similarly argued: "[The] gap [in funding] is most acute for companies raising between £500k and £5m especially where they have not fully proven they have dependable unit economics suitable for pure growth capital."

The slowing in seed funding doesn't just apply to the UK. According to a Reuters report from July, there's been a 40% slowdown in financing since mid-2015.

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