The UK’s Seed-to-Series A gap is growing. Should we fix it?

The UK’s Seed-to-Series A gap is growing. Should we fix it?

The UK produces world-class early-stage technology companies. From B2B software to healthtech to AI, scores of talented founders are assembling impressive teams to tackle real-world problems with cutting-edge technology. As early-stage investors, we see this potential first-hand every day.

Much is made of the UK’s struggle to maintain sovereign tech prowess as its standout companies scale – our tech darlings are routinely snapped up by overseas giants rather than building to global scale from home. But the root cause emerges far earlier: too many high-potential UK companies simply aren’t given the runway to scale.

Label changes alone can’t explain the funding gap

Roughly only 4-5% (https://www.scalewise.com/venture-graduation-crisis-startup-scaling-failure/) of seed-backed UK startups now reach Series A, a dramatic fall from over 12% in 2020. Healthy ecosystems always necessitate high failure rates, as it’s important that capital flows towards winning propositions while floundering ventures are put to bed.

Some of this can be attributed to structural changes in the investment lifecycle. A decade ago, “seed” meant the first institutional VC cheque – often £500k-£1.5m – and the concept of “pre-seed” barely existed outside of angel rounds.

Today, what many call a pre-seed would once have been a seed, and some “seeds” are the size of what used to be considered a small Series A. That re-labelling can make the Series A gap look larger on paper than it may be in practical terms.

Nevertheless, a 95% attrition rate suggests too many viable companies are stalling before they reach their first major growth round. And current market dynamics are making this journey harder than ever.

The AI effect – and the rising bar

One reason the funding gap is widening is the distortion caused by a handful of AI companies achieving extreme growth, with the likes of Cursor and Lovable going from zero to rumored nine-figure annualized revenues in under a year. When investors see that trajectory is possible, they raise the bar for everyone.

Whereas £1m in annual recurring revenue (ARR) was once the standard Series A benchmark, the “hottest” assets today may be doing £5m+ ARR or have a clear line of sight to it. That sets a hurdle most non-AI companies – and many AI ones – simply can’t reach on a typical seed-to-Series A runway.

This is compounded by groupthink in venture capital. The biggest US funds are chasing a tiny pool of hyper-growth companies; everyone else hovers around the edges hoping to get in. The result is a long tail of startups that are ignored, even if they’re building solid businesses in less fashionable sectors.

A perfect storm

The UK still suffers from a shortage of domestic growth-stage capital, which leaves many founders reliant on overseas investors to fund their scale-up ambitions. At the same time, investors have raised the bar on profitability and capital efficiency, expecting companies to demonstrate stronger fundamentals earlier in their journey.

Tighter fund cycles mean venture firms are under more pressure to deploy selectively, and founders too often lean heavily on narrative and technical prowess at the expense of the underlying business case.

Between us, we have reviewed thousands of seed pitch decks, and the ones that go on to secure Series A funding are those that combine a compelling story with disciplined unit economics, a clear market model, well-defined customer value, and a credible plan for the runway ahead. Storytelling matters, but it can never substitute for the numbers.

Wait it out or close the gap

It remains to be seen whether the AI balloon will deflate. This could restore some stability to startup funding and re-balance attention towards a broader set of sectors and more realistic growth benchmarks

But there’s also an argument for the UK ecosystem to be more front-footed and proactively address the funding gap. After all, fewer successful startups reaching Series A will mean less deal flow for later-stage funds and reduced recycling of founder and employee wealth back into early-stage investing.

Episode 1 recently examined (https://www.newsletter.datadrivenvc.io/p/seed-to-series-a-conversion-the-startup) more than 20,000 seed stage founders and companies, and found that total seed funding was the biggest determiner of future Series A conversion.

So one practical step would be for UK investors to facilitate seed extension rounds: small, same-terms follow-ons from existing investors – and potentially additional short-term partners – to give founders an extra 9-12 months to hit key milestones before raising Series A.

It’s a model that has been successful in the US, where the biggest funding gap is between Series A and B. The extension round allows founders to extend the runway without compromising valuation and enforce discipline by keeping funding tied to real market readiness instead of hype.

Of course, as with any funding round, extensions work best when used to execute against a plan, not to postpone hard decisions.

The UK tech ecosystem is worth backing

With the possibility of an AI market correction growing, UK investors could sit tight on the assumption that the funding gap will naturally close. Doing nothing is a strategy.

However, the risk is that we leave brilliant early-stage startup teams short of runway, or force them to look further afield for funding. The UK has all the elements of a thriving tech ecosystem except growth capital. By most metrics it is a world-leading home for early-stage startups.

Preserving this advantage isn’t something we should leave to chance.