The rise in living costs over the next 12 months is set to be the highest in 30 years as inflation sets in. The UK’s Consumer Prices Index puts the inflation rate at 5.5 per cent, with some economists predicting this figure will rise close to 8 per cent by April. The Bank of England has duly increased base interest rates to 0.5 per cent: a nod to rising inflation, but not enough to offset the impact on savings, as values continue to be eroded.
While measurements of inflation always looks to the consumer as a stress test in the first instance, the ramifications for startups can be just as damaging. Here in the UK, we are lucky to have fantastic schemes, such as the Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS), and Venture Capital Trusts (VCT), which 97 per cent of founders have used to raise capital.
There has been a surge in venture capital funding over the last year, with more set to continue. But there is a clear “gap” emerging at the seed stage (SEIS level), a gap that will only be exacerbated by inflation. SEIS has been around since 2012, and the funding cap of £150,000 has remained the same ever since. Funding for startups has come leaps and bounds in the past ten years, but the spending power of that £150,000 has decreased, and inflation continues to erode the impact that amount can make for an early-stage company.
British employers are expected to raise staff pay by around 3 per cent, the most in at least nine years. At the seed stage, investments through schemes such as SEIS are mainly used to pay the salaries of the founder and the company’s first employees – usually developers. With salaries increasing, and inflation running rampant, we are seeing more and more companies setting up their tech operations outside of the UK to lower their tech development costs.
Even at the seed stage, funding rounds are getting bigger, with many startups having to turn their back on SEIS because their funding needs exceed the cap. Inflation will only increase the challenge as that £150,000 translates into an ever-shrinking runway.
VCs are also becoming increasingly risk-averse, resulting in a steady decline in the number of first-time deals since 2018. In the UK, angel and seed deals are highly dependent on the government’s SEIS and EIS tax schemes, which provide some downside protection to investors and ensure a healthy pipeline of startups.
With inflation and salary increases, the cap limit should be increased to keep investment in the UK and keep the SEIS scheme a crucial part of funding. In order to encourage more startups towards the scheme, the current restrictions on businesses using the EIS and SEIS schemes should also be changed, from “the age of the business” to “the size of the business”. This will help those early-stage businesses who took a little longer to secure funding, giving them the opportunity to utilise these schemes.
The schemes have enabled many startups to become leaders and innovators within their markets. But we need to keep the pipeline alive by ensuring these schemes are up to date, reflecting the impact of inflation and salary increases, so that we don’t lose talent and innovation to other countries.