Venture capital investors are bracing for a “real toughy” of a year ahead as further interest rate hikes restrict the flow of cash and inflict more pain on the sector, analysts have warned.
UK venture investment plunged 25 per cent to $31bn (£24bn) last year as soaring inflation and rising interest rates roiled markets and ramped up the cost of cash.
Investors and analysts had been hoping for a rebound in the second half of this year but the resurgence looks set to be scuppered by a period of longer, higher interest rate pain in the UK.
Henry Whorwood, head of research at investment analysis firm Beauhurst, said that the latest rate hike by the Bank of England would force VC fund’s big investors – their LPs – to shift their cash elsewhere.
“This will take a while to trickle through to GPs [venture fund managers] as a whole, although they’ll all be well aware of it looming, and GPs raising [money] will be feeling it at the moment,” he said.
“However they impact indirectly as well in the way they exacerbate the liquidity issues for GPs, through depressed valuations and a reduction in M&A. I think we’ll be reliant on private equity funds to keep a bit of liquidity flowing until confidence returns – if and when rate rises stop.”
Whorwood added that if PE funds sit on their stored up ‘dry powder’ cash then next year “could be a real toughy”.
The Bank of England hiked the base rate to its highest level in 15 years last week to tame stubborn inflation still ripping through the economy. City analysts are now pricing in an eventual base rate of over six per cent.
Analysts at Pitchbook said the further rate hikes had pushed up the cost of cash for investors.
“With rising interest rates leading to higher for longer financing costs, we’d expect deal activity growth to remain muted through the rest of the year,” Navina Rajan, private capital analyst at Pitchbook, told City A.M.
“Higher rates are also likely to continue to impact valuations, where we expect more down rounds through the year, meaning a tougher environment for startups and GPs is likely to persist.”
The higher cost of cash has already forced some high profile firms to suffer major ‘down rounds’ over the past year, with Klarna among the big name firms to suffer a major valuation cut.
Michael Moore, CEO of the British Venture Capital Association, told City A.M. that interest rates this year will “have an impact across the economy” but the sector would weather the storm.
“Private capital funds are patient investors and often have the flexibility to ride out short to medium term uncertainty, but we need to ensure the conditions for investment are right,” he said.
“As times get tougher, reforms to pensions, certainty on tax incentives for research and venture investment become even more important.”