Investec Comment: Why UK investors have warmed to tech firms

London has all the ingredients to remain an attractive location for technology companies to grow and seek investment. The capital has thriving public markets that have warmed to tech stocks. More and more VCs are putting money into London startups. There’s a greater number of incubators and accelerator programmes around.

 

UK investors have also become better at analysing tech firms. For instance, ARM was for many years viewed as purely a hardware business but, over time, investors understood it had developed world class IP and they began to appreciate how valuable such a business can be.

 

Alongside global leadership in some key niches, such as healthcare, education and financial technology, the UK has developed a broad tech ecosystem with 344 technology companies listed on Aim and the main market in June 2015 (73 having software activities).

 

Indeed, the Aim market remains a big advantage for the UK. For growing businesses, the ability to benefit from a lighter touch regulatory environment compared to the main market combines with significant tax advantages for founders floating businesses and retaining stakes. Most important is choosing the right adviser: regulation is decentralised from the exchange to the Nomads, so it’s vital to select your adviser carefully to ensure the “right stamp of quality”.

 

Some of the technology IPOs which have come to market in this most recent IPO “window”, particularly those that listed in early 2014, came to market with huge valuations, based on very high growth expectations and promises of margin expansion. While a few IPOs have underperformed the expectations they set the market at the time of the IPO, many have delivered on growth forecasts and have been justly rewarded: managing expectations properly remains the key tenet of any successful IPO.

 

The IPO market has evolved. The second wave of flotations which arrived after the initial flurry in the first half of 2014, and following nervousness around the Scottish referendum last year, has predominantly been of quality companies with more realistic valuations. Businesses like FDM and Gamma Communications, whose flotations we ran, have managed expectations well and have traded up very positively since IPO. There’s a lot of money chasing growing tech firms – and as we are still seeing plenty of technology businesses being taken private, these increases help gain attention from fund managers seeking to deploy capital into technology companies. But it’s also the better quality companies (in terms of growth, recurring revenues, quality of management) that are now receiving disproportionately better ratings.

 

How does the UK stack up against the US? The size and scale of the US giants – which have the benefit of a huge domestic market – is clearly of a different magnitude to Britain’s tech firms, which are more reliant on exporting their technology overseas. Recent developments, however, give us reason to be more positive. In the past, promising UK firms might receive VC backing, get to a £200m valuation, but then be snapped up by US corporates or private equity. Now it seems UK tech businesses can find the right support at many stages of their life cycle – with interesting ideas backed at the early stages by family offices and small cap VCs. The public markets are now willing to support high quality companies at high valuations allowing them to stay independent. Consequently, UK firms are no longer so keen to be snapped up – and with luck we’ll likely see more and more $1bn London unicorns.