Investor caution as Scottish venture capital funding takes a hit despite Q3 'outlier' - KPMG report

The amount of venture capital funding pumped into fledgling Scottish businesses leapt in an “outlier” third quarter thanks to a handful of high-value deals, but 2023 is set to be significantly quieter than previous years, new figures suggest.

During the three months to the end of September, 28 deals worth a combined £202 million took place, marking the highest value quarter in Scotland since the second quarter of 2022 when £325m was recorded across 45 deals, according to KPMG’s latest Venture Pulse report.

Despite the spike in values, 2023 as a whole is set to be much quieter than previous years for Scottish venture capital (VC) investment, experts said. The value of the first three quarters of this year stands at £335m, significantly lower than the same totals for 2021 (£529m) and 2022 (£623m), when the market was exceptionally busy in the wake of pandemic lockdowns.

Graeme Williams, head of corporate finance, mergers and acquisitions (M&A) for Scotland at KPMG UK, said: “Q3 has been an outlier for VC investment in Scotland this year, mainly due to a handful of higher value deals taking place. Given the uncertain environment including concerns about valuations, potential returns, the lack of exits, high interest rates and other factors, the time to complete VC deals has slowed considerably across most regions of the world this year.

Graeme Williams, head of corporate finance M&A for Scotland at KPMG UK, says investors are adopting a more cautious approach.

“Investors are adopting a more cautious approach, conducting additional levels of due diligence, and seeking companies with well-defined paths to profitability. However, businesses with a proven product, market fit, and strong customer data will continue to attract the attention of investors.”

Standout deals in Scotland during the third quarter include alternative meat start-up Enough, which raised some £34m in equity to help bring more plant-based chicken, mince and dairy products to supermarkets and fast-food chains. Glasgow-based chemistry pioneer Chemify secured £36m of Series A funding to develop its technology to make complex molecules on demand while Oban-based Oceanium agreed funding to scale up its technology to meet market demand for its seaweed material.

UK-wide, the value of VC investment remained stable in the third quarter, despite the volume of deals falling by more than a third, quarter on quarter. Almost £4.2 billion was invested in UK businesses between July and September, down marginally on the £4.49bn raised in Q2. Deal volumes continued to fall, however, with 469 deals completed during Q3, compared with the 713 completed in Q2 and also down on the same period last year (845 deals). Half of the VC investment made into the UK during the third quarter of this year flowed into businesses based outside of London, across 219 deals.

Amy Burnett, head of KPMG private enterprise access at KPMG UK, said: “Scotland remains an attractive destination for VC investors, especially given our diverse ecosystem of innovators and high performing sectors including healthcare, energy and tech. Investment is also finding its way beyond the Central Belt and north east of Scotland, with significant investments taking place in Oban, Dundee and Perth in the latest quarter. Scotland still has a glut of exciting scale up businesses which are continuing to push themselves to grow despite a tougher market.”

Amy Burnett, head of KPMG private enterprise access at KPMG UK, insists that support is there for Scotland’s innovators.

She added: “Support is there for Scotland’s innovators, including the announcement of a new £150m fund from the British Business Bank to support start-ups. Scottish VC fund Par Equity also launched a new £100m northern start-up fund earlier this year and Foresight has its own £60m fund. These are new avenues of funding which are undoubtedly being used, meaning the year’s final quarter could well result in a higher volume of VC deals.”

Across the UK, venture capital investment is expected to remain relatively soft heading into the closing weeks of the year, given ongoing uncertainties in the global VC market and a “heightened level of investor caution”, KPMG noted. Energy, clean technology (cleantech) and artificial intelligence (AI) are areas that are expected to remain “highly attractive” to VC investors across much of the world.

KPMG said a key question heading into the end of the year was whether there would be any additional stock market activity in the wake of three initial public offerings (IPOs) in late 2023. Although a dramatic reopening of the IPO market is not expected, additional exits could spark a renewal in IPO activity heading into the first half of the new year, the firm said.

KPMG uses PitchBook as the provider of venture data for its regular Venture Pulse report. PitchBook defines venture capital funds as pools of capital raised for the purpose of investing in the equity of start-up companies. In addition to funds raised by traditional VC outfits, PitchBook includes funds raised by any institution with a similar primary intent. Funds identifying as growth-stage vehicles are classified as private equity (PE) funds and are not included in the report.

In August, KPMG released a report showing that private equity investment in Scotland’s mid-market businesses cooled in the first half of the year amid challenging economic conditions. It found that 21 deals worth a collective £2.26bn were completed north of the Border in the period, marking a 25 per cent year-on-year drop, as market volatility and tough trading conditions took hold. The number at a UK level fell by roughly the same percentage, with 689 deals worth £70bn completed in the first half of 2023.

Scotland’s mid-market businesses had attracted a record amount of private equity during 2022, despite investment dipping across the rest of the UK.

Private equity investment in Scots mid-market firms cools in H1