Why the UK Government needs a more strategic R&D investment policy

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This content is contributed or sourced from third parties but has been subject to Finextra editorial review.

The UK’s start-up ecosystem plays a crucial role in securing the country’s status as a premier investment destination for both foreign and domestic firms, driving innovation and economic growth for the entire nation. The UK tech sector’s £24 billion raised in 2022 made it the number one technology hub in Europe – and number three in the world.

Ensuring this success lasts relies on a clear approach to back Research and Development (R&D) – the core of any country’s tech sector. So far it has proven elusive.

The recent UK Spring Budget epitomised this problem. The muddled text lacked a clear vision for UK tech, with funding pledges measured in millions that pale before the needs of the global tech sector. Crucially, it drew the criticism of many investors and founders by tightening the eligibility requirement of UK R&D tax credits for start-ups – a scheme that has proven so important in the success of UK tech.

These decisions risk limiting the growth potential of UK start-ups. The swelling list of standout UK tech start-ups like ARM taking their listings abroad, shows how lack of access to growth capital and targeted government incentives is increasingly putting the UK’s status as a tech leader at risk.

As the UK’s most innovative start-ups struggle against established, dominant competitors, we require a more targeted and comprehensive R&D investment from the government to effectively strengthen the UK start-up landscape and prevent it from falling behind international rivals.

Why does R&D matter?

The UK's need for a solid R&D strategy goes beyond a mere lack of funding packages from government departments. Though these are always welcome by founders, piecemeal financial injections from a central government alone cannot build an ecosystem.

To increase the appetite for investment in early-stage tech start-ups, in addition to direct government support, we must also address private investors’ concerns about their profitability and long-term growth prospects.

The earliest stages of a start-up’s life often place a heavier emphasis on R&D: testing, iterating, and rolling out the latest versions of a technology solution for its initial customer base. This is a vital stage that drives innovation and creates the foundation for a wave of enterprise-ready technologies.

If a start-up cannot rely on government support to safely acquire talent, technology, and equipment, then investor concerns about profitability may stifle these new solutions before they begin – if not the company itself.

Why do we need private capital to strengthen our tech ecosystem?

To ensure a consistent pipeline of quality tech companies in the UK, we must smooth a start-up’s transition to its growth phase, easing access to growth capital to expand its operations, break into new markets, and explore new technology offerings.

Taken as a whole, private investors can provide significantly more funding than the Treasury, but they must be incentivised by government policies to invest in these fledgling companies. This is especially true for transformative technologies like AI and quantum computing that may take longer to produce a return on investment.

Currently, large corporations are dominating the market, leveraging their more substantial margins for error to crowd out start-ups, for whom the difference between success and bankruptcy may be measured in weeks, not years.

Investors, as a general rule, are seeking alpha, or multiples, from their investments. If we can prove to them that their equity in promising start-ups exploring fields like AI or quantum computing has strong and long-term growth potential, the UK can reap the benefits of a strengthened tech ecosystem.

What happens if our current policy doesn’t change?

At its core, the UK has a problem in keeping hold of start-ups when they reach a certain level of growth. When they go beyond early stage, and start hitting Series C and beyond, start-ups recognise they can unlock far higher growth capital abroad, with some even relocating their operations to other countries to reach the next stage of growth .

As a result, these organisations may consider listing on foreign stock exchanges, such as the New York Stock Exchange, rather than on the London Stock Exchange. Whilst recent proposed changes from the FCA to listings rules are encouraging, they only go so far. There is a bigger problem that start-ups are lured there by the possibility of higher valuation and access to the kind of game-changing capital that a start-up needs to transition into a true category leader.

This trend is particularly concerning when it comes to successful spinouts from British university systems, such as ARM, which may be lost to international markets as they scale. It’s counterintuitive for the UK to foster and develop these innovative startups through world-leading academic institutions - only to lose them once they reach a certain level of success.

This underscores the importance of implementing effective policies and support systems to marry the influence of government with the abundant growth capital of private firms.

How can the UK be more strategic on R&D?

While a piecemeal approach to supporting the start-up ecosystem may be better than nothing, it is crucial for the UK government to consider more comprehensive measures. Potential approaches could be putting millions of pounds worth of funding in bigger policies or roadmaps to encourage development in the sector, or targeted action like raising percentage points in R&D tax support to provide start-ups with much-needed financial relief.

The UK may not be able to compete with vast funding pledges like the US’s estimated $2 trillion funding pledges across three major laws for areas including infrastructure and tech innovation. What the UK can do is double down on what it does best – ground-breaking R&D in areas like AI and exascale computing – and deliver both direct investment and structured programmes to help firms thrive. Unproductive missteps, like the withdrawal of government funding for major start-up network and runaway success story Tech Nation, or the aforementioned cutbacks on R&D tax credits, need to be avoided in the future to ensure there is no loss of momentum.

Any change, no matter how small, that boosts the tech start-up landscape is commendable and necessary for supporting innovation, but it cannot work alone.

Harnessing the power of institutional investors

Although government funding plays a crucial role in supporting start-ups, private capital has the potential to make an even more significant impact by supporting start-ups through their most challenging stages.

By leveraging their policy-making powers, governments can incentivise institutional investors to purchase equity in UK start-ups to return multiples down the line. This can be achieved through a combination of merit-based rewards and alteration of thorny regulations to encourage private investors to take measured, well-defined risks for long-term financial gains.

We have already seen steps in the right direction here. It was reported recently that discussions are ongoing in the City of London about setting up a potential UK sovereign wealth fund, leveraging the titans of UK pension funds to invest in UK tech start-ups. This is the kind of ambition we need to move the needle for UK tech. It shows the important role that government plays as a convenor for such discussions, with discussions spearheaded by Lord Mayor London Nicholas Lyons.

This collaborative effort will result in a more inclusive investment strategy that avoids picking individual winners or losers. Instead, the government should focus on creating a robust ecosystem capable of weathering the decline of major companies, and fostering competition at the grassroots level.

Looking to the future of the UK

To ensure that start-ups can successfully move beyond the growth phase and contribute to a thriving innovation ecosystem, the UK must implement a more solid R&D investment strategy. Without this, the next ARM might fail before it can even get off the ground.   

This will require the government to work collectively with institutional investors, including pension funds, to develop a structured and robust investment approach. By fostering collaboration and embracing strategic planning, the government can empower start-ups, bolster the UK's technology sector, and ultimately drive economic growth and prosperity.


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This content is contributed or sourced from third parties but has been subject to Finextra editorial review.