Mind the UK funding gap

This article is part of our Biotech Review of the Year - Issue 12 publication.

The geopolitical, economic and climate crises affecting the world have had a marked impact on investment into UK biotech companies, and the venture capital (VC) space generally.

Many VC firms have been struggling to raise capital, and they have become more selective over their investments, which has meant founders and earlier-stage biotech companies have been struggling to secure the investment needed to drive innovation. With interest rates remaining high, what does the landscape look like for UK biotech investment?

Current investment landscape

Since the dizzying heights of investment we saw during the pandemic in 2021, investment into UK start-ups and growth capital companies cooled significantly. With the wars in Ukraine and the Middle East, the uncertainty surrounding the result of the US election, the currently high interest rates (at least in comparison to those of the last two decades) and the risk that climate change poses to portfolios, investors have been nervous about when, and how much, to invest. Funds have been holding back on deploying capital into VC firms, and when they have deployed, they have been concentrating their investments into fewer firms, reducing diversity in the market. VC firms have been undertaking more extensive diligence on potential opportunities, trying to be more discerning with their investments. The cool M&A and IPO markets have also contributed to this reduced investment due to fewer liquidity events, which has meant that capital has not been made available for redeployment elsewhere. Together, this has resulted in lower, and slower, deployment of capital. 

However, the outlook is looking rosier as we head into 2025. UK VC firms are on track to raise a record $12.2bn in dry powder (cash available to be deployed) by the end of 2024. According to the European Investment Fund’s latest VC survey, VC firms are also more optimistic about the investment outlook over the next 12 months. Specifically looking at the UK biotech space, the latest report from the BioIndustry Association (at the time of writing) indicates that £536m was invested into UK biotechs in Q3 2024, only slightly down from the £622m invested in Q2 2024. However, these were the highest quarterly investment figures since 2021. This all suggests VC firms’ increasing confidence and belief in the UK biotech space. With any luck, this upward trend will continue into 2025, allowing optimised innovation. 

But could there be more?

VC money in the UK predominantly comes from the US. According to the latest Dealroom’s analysis at the time of writing, 42% of UK VC funding for H1 2024 came from US investors, compared with 30% from domestic investors and just 10% from Asian investors. But are there other funding pools out there that are missing out on the potentially huge returns that can be provided by investments into UK biotechs? 

Pension funds

The UK’s defined contribution (DC) pension funds represent a total of £1.4tn of assets, but a very small proportion of that is being invested into UK VC. In 2022, UK-managed VC and growth equity funds received only £48m from UK pension funds. The potential for high returns on investments in VC and growth equity presents an excellent opportunity not only for pension funds looking to increase their returns for savers, but also for those innovators reliant on VC funding. 

Barriers to entry

The relatively modest investment by DC funds into VC has often been attributed to a number of barriers to entry, including:

• the fees charged by VC firms are typically higher than those of funds investing in public/liquid assets, and, until 2023 when changes were made to the Department for Work and Pensions charge cap rules, DC funds were prohibited from investing in those VC firms which charged carried interest and performance fees. DC funds have primarily focused on a low cost offering, with less emphasis on overall returns;
• the lack of daily valuation for private capital investments – VC firms typically price their funds on a quarterly basis, but some DC funds calculate a fair daily price for pension savers; and
• VC funds tend to be small, which would require DC funds to make many small allocations. This would require not only expertise to select suitable VC managers, but also a sufficient number of people within the DC funds to manage the portfolios. 

Change is afoot

However, steps are being taken to address this dearth of UK pension funding into VC.

As this author has commented before, 20 of the UK’s VC firms have signed a “Venture Capital Investment Compact” (the Compact) – a pledge to boost UK pension investments in unlisted equities. The VC firms have voluntarily committed to invite UK pension funds as limited partners in their funds, as well as to increase engagement with a view to encouraging pension funds to deploy capital into the dynamic private market in the UK. The British Private Equity and Venture Capital Assocation, in partnership with the Association of British Insurers and Pensions and Lifetime Savings Association, convened a Pensions & Private Capital Expert Panel (the Panel). This has been tasked with overseeing, monitoring and reporting on the progress in delivering the commitments set out in the Compact. Its interim report (available here) has made a number of recommendations for increasing investment into private capital, which the Panel hopes the UK Government will address. 

The Compact followed on from the then Chancellor’s Mansion House speech in July 2023 at which he announced that nine UK DC pension providers had agreed to allocate 5% of their default funds into unlisted early-stage and private equity, with a view to investing £50bn of capital by 2030. This commitment seems to be having some traction:

• Aviva, Phoenix and Schroders have already launched new funds / investment teams to increase investment into private capital. 
• SETSquared, a group of six universities in the southwest of England, has announced a partnership with VC firm QantX to establish an investment company to support their spin-outs, which is seeking to raise £300m, including from pension funds. Northern Gritstone, a similar fund targeting spin-outs from the universities in the North of England, already has a number of local authority pension funds as investors. 
• The British Business Bank is establishing the British Growth Partnership, a new vehicle which it is proposed will take investment from UK pension funds and other institutional investors and deploy that capital into VC firms and innovative businesses directly. 

The Canadian model

The current Chancellor has also made pension reform a key part of her economic strategy, launching a pensions review shortly after coming into office with goals to boost investment and increase saver returns. The UK Government is considering, as part of those reforms, adopting the Canadian model for public pension funds investment.

Canadian public sector pension schemes are consolidated into large, professionally-managed funds, which allows for significant investments in more diverse, and potentially riskier, assets, including private equity, due to pooled resources and reduced admin costs. In the UK, however, the local government pension scheme is fragmented, with 86 individually managed funds. Proponents of reform argue this fragmentation has led to inefficiencies, reducing the returns to savers and has also meant that the funds cannot diversify and deploy their capital into the, admittedly, riskier VC/growth capital spaces as they do not have capital to balance against that risk. Although not necessarily causal, Canadian public sector pension schemes have deployed 22% of their assets in private equity, compared to just 6% for the UK’s local government pension scheme. Clearly something in that model must be working, and the UK Government is looking at potential reform. Watch this space. 

Look to the Middle East

In addition to reforming the deployment of domestic capital, the market has recently been experiencing an increase in investment from funds in the Middle East. Whilst those funds have historically been present on the UK and European investment scenes, capital being deployed has been overshadowed by investments from UK/US/European investors. Middle Eastern funds have historically tended to be passive investors, investing through other funds and not directly. 

However, this is changing. The European start-up scene has seen a marked increase in investments from the Gulf, totalling $3bn in 2023, up from $627m in 2018. Commentators have suggested that this is attributable to those funds having now built sufficient knowledge of the European investment scene and that taking investment from funds in the Middle East has become more widely accepted as establishing the credibility and viability of earlier-stage companies. Although a number of Gulf-based funds are principally focused on increasing capital available to local innovators, significant capital is now being deployed in Europe and the UK. For example, in 2021 Mubadala (the Abu Dhabi-based sovereign investor) agreed with the UK Government to invest £800m in UK life sciences over a five year period, alongside the UK’s £200m Life Sciences Investment Programme. 

Whilst it is not publicly clear what level of investment Mubadala and other Gulf-based funds have invested into UK biotech, the amount of capital available for deployment by those funds, and the fact that they are actively pursuing investments in Europe, represents a huge opportunity for UK biotechs. 

Concluding remarks

The funding landscape for UK biotechs is looking healthy as we head into 2025. Proposed reforms to pension funds, combined with the commitments given by DC funds to increase their investment, and the potential for further investment from the Middle East, offer a phenomenal opportunity for UK biotechs to capitalise on an ever-increasing availability of cash. This is arguably already being reflected in the market, with some colossal Series A and Series B fundraisings in the offing. Technologies directly impacting on biotech continue to advance at a rapid pace. With the impact of AI on diagnostics and therapeutic modelling and the explosion of research into new therapeutic areas, such as radionuclide therapeutics, there is plenty of opportunity for that capital to be put to good use.