If you’re going to start and scale a startup, you’re in for a tough time. But if you decide to start and scale a deep tech startup, the odds are often really against you.

So what is the early-stage funding space like for deep tech across the UK?

As part of our PreSeed 2024 look into the early-stage landscape right now, today we catch up with DSW Ventures, a VC focused on first cheques into deep tech startups.

There’s a lot of good stuff in the conversation, so grab a coffee and have a read.

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PreSeed 2024: Checking the state of early-stage deep tech, with DSW Ventures

PreSeed Now is exploring the state of the pre-seed market in the UK in 2024. Share your input with our two-minute survey for investors, founders, and people who work with startups. Share your input today!

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Early-stage startups don’t need one-size-fits-all support. Deep tech startups in particular require savvy investors with an appetite for unproven technologies.

DSW Ventures operates in this space. I spoke to founding partner Keith Benson and investment manager Emma Cassidy to get their view of how things are for right now for early-stage deep tech startups.

MB = Martin SFP Bryant, KB = Keith Benson, EC = Emma Cassidy

MB: What’s your take on the state of the pre-seed market right now?

KB: Obviously, we're a regional investor, so we're regional-first and deep-tech first at the earlier stages. And that market, I would say, continues to be well served at the seed and post-seed stage. It’s probably still a bit tough at the very pre-seed stage.

We see some competition for deals, but not a huge amount. Certainly nothing like we'd see in a £3 million round for a software scale-up. And actually, from a co-investor point of view, it can be pretty tough. Especially with university spinouts, when the science is difficult to get your head around. In those instances, we've sometimes looked for Innovate UK to step in. They've been very helpful.

I think it's probably getting slightly better once you get to the next level. and scale up, it’s maybe getting a little less challenging there.

EC: I think there have been small improvements. The market’s better served where there are regional pots available.

In Belfast, there are some region-specific investors. And then the North has Northern Gritstone, the Midlands has Midlands Mindforge. So I think it's a much better outlook where there are dedicated regional pots available, because it just means you do have that co-investment available to top up the round and give it that little boost.

KB: And LYVA Labs in Liverpool and Praetura’s [Northern Powerhouse Investment] fund is really helpful.

But there are a few dysfunctions and a few challenges around very deep and very capital-intensive technology.

MB: So, there’s been an improvement in the number of funds available to support early-stage deep tech?

KB: At the very early stages, I wouldn't say there's that many. Over the last six months, there has been an increasing attractiveness of SEIS because of expectations around what will happen with capital gains tax and what that means for people's wealth over the next decade.

So we've definitely seen an uptick of investor involvement there, which will probably have a knock-on effect in terms of those very early stage funds. But here the science is tougher to get your head around, and it takes a longer to do the due diligence, and maybe you're a bit more reliant on the next stages of funding, then things are not that well contested still, and the availability of funding for those types of business isn't necessarily there.

It's much easier for an investor to get their head around a software business or a startup in the consumer space, a marketplace or a product. And I think there is a natural attractiveness towards those deals. Whereas we find deep tech to be a bit tougher.

MB: How much is the attractiveness of SEIS going to impact on deep tech when high net worth individuals aren't necessarily going to understand deep tech, and maybe think it's a bet too far to bet on some some technology like that?

KB: Our proposition to our investors is that we're a professional fund manager, and it's our job to get our head around these businesses. So we'll take the time to do it, and we'll do a proper job of it, and we'll get the right people in. We'll surround the founders and the boards with the right people, the right consultants, the right non-executives, the right key opinion leaders, to get to a place where we're maximising the opportunity for success.

If you have SEIS money to deploy, attempting to deploy it into deeper tech yourself is really challenging, and not the faint hearted, and I wouldn't recommend it.

The right place for that type of money is through funds that have the time and capacity and the muscle memory of investing in those types of businesses.

I suspect we'll probably see a bit more on CrowdCube and the crowd funders. But that's a tougher space again, especially with the FCA having made it more challenging for them to do investments that don't have an institutional co-investors. So I suspect they will stick to their knitting in the less deeper technology areas, and a lot of the fund managers will probably stick to what they know, which is software and consumer.

EC: A key way that we differentiate ourselves is we see a really high volume of deal flow and a lot of deal flow from the universities. So we are seeing those IP-rich companies. So the difference with us versus an angel or individual trying to deploy SEIS into deep tech on their own, is we're seeing all the technologies that are coming out of accelerators, universities, and incubators.

So we know what there's a million of, and what's what's not really defensible, or everyone's trying to do it. We know what's kind of interesting, and unique, and a bit different, and has that competitive edge.

MB: What are some of the problems you see in the early-stage deep-tech space?

KB: As an investor, one of the areas that we really look for is defensible technology that's highly scalable with relatively, and I use that term loosely, rlow levels of capital. If you've got a drug, it's still many millions, tens maybe even hundreds. But it's relatively low levels of capital to get to the point where you've got a level of certainty that actually this is going to work.

The areas where we really struggle is the more capital intensive, big construction-spend propositions, especially in the green sector.

So if you've got a proposition where it's like 20 or 30 million quid to see whether a pilot plant may or may not work, for an investor it’s a huge bet, because you've not really got enough capital to get to the point where you've got any idea whether it's going to be successful.

So there's no value increment to take it to the next stage and the next stage of funding, and the next stage of funding after that, which you do have with life sciences and with deeper technology.

So that area is a real dysfunction. There are people like Green Angel Ventures that will have a go at that type of investment. But actually that's really difficult for the market in general.

I think that's an area where actually we need the government needs to step in, and lean into those kinds of spaces more, because it's simply not an area we can invest in with any sort of certainty over investor returns. And actually, in the majority cases, we look at those and think ‘we're going to lose our money on this’.

MB: Which areas of deep tech are exciting you at the moment?

KB: What we’re excited about is platform technologies, where we are creating societal change in a positive way, but also moving with the change in demographics of not just the UK, but the Western world.

We've got a business which is developing drugs in rheumatoid arthritis; one in chronic skin conditions, particularly in the elderly; e've got one which is accelerating research in it with next generation PCR [by co-incidence, PreSeed Now caught up with that one last week].

So we're really about taking those dynamics, but also allowing the next generation of therapeutics that will be delivering healthcare into that changing demographic.

The other area we're really interested in, really excited about, is it is around semiconductors and next-generation AI-enabled chips.

We've obviously got a very resource-hungry ecosystem of AI models that are being created so tackling those edge cases around edge computing, Internet of Things, computing for AI-enabled models is really interesting. And that's both on the phones, on wearables. So we're looking quite, quite closely at that space as well.

MB: You mentioned university spinouts earlier. The common issue for a long time has been that universities hanging on to too much equity, and that makes the businesses un-investible, or lead them to struggle in the market, is that still an issue is improving?

KB: I think the USIT Guide has helped with that in some respects, and not helped in others, in terms of the way we look at university spinouts. I think it gives a bit more of a realistic target equity share for a university. But actually we rub up against some of the other aspects of discussions with university, particularly around royalties and IP ownership.

Our view really is that when we invest in a company, we are creating an entity in which all the stakeholders should be aligned in terms of the outcome for that that business. So we look to build a cap table and IP transfer arrangements that are consistent with that goal.

The approach we've taken is that the university absolutely deserves a share of the equity for incubating that IP over many years. But actually it needs to be right in the context of the fact that the founders and the board and the people who are in the business from today are the people who are going to be driving future value.

So for us, it's about finding that right balance between the two. And you know, actually, in many cases, we've found common ground and a way through that. Where we haven't found that, we don't do the deals. We'll let someone else do those deals.

So I would say in summary, yes, equity stakes are improving and universities’ flexibility is improving. But we still find there are deals that are just not doable, despite the fact that there's a good business there, because of a level of inflexibility, be it around equity share or IP transfer and ownership arrangements.

MB: Any other thoughts about spinouts?

KB: The ICURe Programme is really good. We find the quality of businesses that have gone through the programme to be much higher than those that haven't. That's not to say the technology's necessarily better or worse, but the people are much more prepared in understanding what makes a good, scalable business. The founders are just much better prepared.

They've usually done a little bit of market validation themselves and spoken to people, and often have surrounded themselves with people who know what they're talking about and have been there and done it before.

So I think that's a really great programme, and actually, it's been very helpful for us in terms of not having to completely re-engineer businesses because some of that work has already been done.

EC: In terms of tips for founders, you can never start too early in terms of getting professional help for business models.

If we know you've got outsourced help, even if they're just preparing your annual accounts or preparing your forecast as a one off, I think that de-risks an investment for us a lot, just knowing that the numbers are going to add up properly, and to visualise those assumptions a little bit better.

KB: Yes, if you've got a really strong feeling that everything's there and has been thought through, it takes away a huge amount of the uncertainty around ‘what have we missed?’ that you have as an investor, especially in early-stage companies when you don't have a history to look back on.

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What’s YOUR take on pre-seed in the UK in 2024? Take our two-minute survey now.

Back on Tuesday

We’ll be back in your inbox on Tuesday. We have a pipeline of really interesting startups to bring you in the coming weeks but we’re always looking for more.

If you know (or are the founder of!) a B2B or deep tech startup anywhere from inception to seed stage, get in touch!