In our recent blog we discussed venture debt financing in early Q4, noting there had never been a better time for UK innovation businesses to raise capital. How quickly the world has changed! As a US headquartered commercial bank focused on innovation companies of all stages, as well as VC and PE funds, we tend to see trends emerge quickly. Historically, trends that started in the Valley would take 9-12 months to reach Europe. However, the world is getting smaller and we are seeing similar issues arise for UK and European entrepreneurs at the same time as their US counterparts.

So, after a record 2015, we are now seeing a slowdown in VC funding into UK and US companies. While 2015 saw VC investment in UK companies rise to £4bn (up 26% on 2014 according to Pitchbook). The number of announced VC rounds fell to 790 in 2015 (29% less than 2014). Many of the equity rounds into growth stage ICT companies in 2015 were led by US VCs who participated in some of the largest UK rounds in tech companies we’ve seen including NewVoiceMedia, HighQ, Avecto, Funding Circle, Zopa, WorldRemit, Deliveroo and Farfetch.

The recent slowdown in UK VC funding mirrors that of the US and started in Q4 2015 when UK deal volume fell 10% on Q3 2015. It seems this trend was exacerbated in January; Beauhurst tracked just 77 equity fundraisings (the lowest since January 2013). Venture and growth-stages were hit the worst, recording 37% and 36% drops respectively.

Drilling specifically into US VC investment, we have spotted a recent pullback in UK tech investment. We analysed all VC equity rounds into UK digital or ICT companies from January 2014 to February 2016 (data from Dow Jones VentureSource). Here’s what we found for UK digital and ICT companies that raise a £4m/$6m+ equity round:

• In 2014, out of 21 equity rounds of £4m+ into UK ICT, 9 were led by US VCs.
• In 2015, out of 112 equity rounds of £4m+ into UK ICT, 40 were led by US VCs.

As we can see, 2015 saw a dramatic increase in the number of growth stage deals in UK digital and ICT companies led by UK and US VCs.

However, if we look at the quarterly analysis of 2015 and Jan/Feb 2016 deals, we see a dramatic drop from Q3 15 onwards in number of deals led by US VCs:

Source: SVB analysis of Dow Jones VentureSource data for UK VC 2014-2016

We also analysed the number of growth rounds in UK ICT led by US VCs by stage:

Source: SVB analysis of Dow Jones VentureSource data for UK VC 2014-2016

As we can see, in 2015 the US VCs were investing at all stages from Series A onwards. However, with the recent pullback by US VCs, we expect 2016 will see a reduction in the numbers above. Especially at A and B rounds.

For several months, we have been hearing VCs on both sides of the Atlantic asking their portfolio companies to reduce burn rates and ensure they have sufficient cash to push back the next equity round as far as they can (or reach profitability). Many US VCs are concentrating on supporting their existing portfolio companies or taking bets closer to home, rather than making new investments overseas. That, coupled with the poor performance of many tech IPOs, uncertainty in the public markets and the drop in late stage valuations will not lead to those firms being incentivised to take as much risk in 2016. Hence we expect the number of transactions led by US VCs into UK digital and ICT companies to reduce.

Furthermore, if the US VCs do consider making a new investment overseas, then they are increasingly finding mainland Europe and LATAM more attractive since valuations still remain lower than the US or UK.

At Silicon Valley Bank, we remain cautiously optimistic. We expect quality UK companies that are growing and have good unit economics, especially in SAAS and software, to continue to receive VC funding in 2016. There are more than 30 local UK VC firms that raised fresh funds in 2014 and 2015 who need to deploy capital. Now we have seen a recalibration in valuations, we expect UK VCs to continue to be active at A, B and C rounds into good UK companies. The best funds will also likely continue to see good co-investment from US VCs into their upper quartile portfolio companies particularly the capital efficient growth stage businesses.

The bar has been raised in 2016.

We recommend entrepreneurs should:

• Emphasise sustainable revenue growth
• Track and improve unit economics to ensure profitable growth (especially in SAAS businesses)
• Moderate expectations on valuations (we are hearing “flat is the new up round”)
• Reduce burn if possible to reach breakeven, or lengthen cash runway to pushback next equity round so you can achieve more traction and milestones in the business.
• While you don’t need to get to profitability, being able to tell the story of how and when you will be cash flow breakeven is increasingly important.
• Consider diversifying your capital base and taking a growth loan or SAAS credit line to extend the runway until the next round and save on dilution
• We continue to see large numbers of corporate investors continuing to be active. Consider taking or including Corporate VCs alongside or instead of solely focusing on Institutional VCs.

Erin Platts is MD and Head of Commercial Banking UK at Silicon Valley Bank in London @Erin_Platts

Alex McCracken is MD of Venture Services at Silicon Valley Bank in London @alexmccra

Post produced in partnership with Erin Platts and Alex McCracken at Silicon Valley Bank.