The UK’s growing early-stage funding gap risks a generation of startups

For many founders, the most difficult part of building a company isn’t securing the initial capital to get their idea off the ground. It is surviving the stretch between validating the idea and convincing the next investors that the business is ready to scale.

In the UK, that stretch has become particularly difficult to navigate. As a recent report by the Tony Blair Institute highlights, Britain is struggling to give its innovative startups sufficient runway to build momentum and grow without having to seek capital elsewhere. 

The result is a familiar pattern. Despite producing world-class early-stage tech firms, the UK fails to realise their full economic potential. Instead, we wave them off as they cross the Atlantic in search of investors with deeper pockets and a greater appetite for risk.

The seed-to-Series A gap is bigger than ever

The venture growth journey has never been easy. Historically, around nine out of every ten VC-backed startups fail, typically because one or more elements of the ‘holy trinity’ – team, timing, and execution – are missing.

As venture investors, we don’t obsess over this failure rate. Building a successful business is inherently difficult, and it’s natural that only a small minority go the distance. Market forces usually determine the eventual winners.

However, what we’re seeing in the UK today is different. Only about 4–5% of seed-backed startups now reach Series A, down from roughly 12% in 2020. Yes, many rounds labelled “pre-seed” today would previously have been considered seed rounds. But labels aside, this level of attrition is unsustainable for any early-stage ecosystem – particularly one with the strategic long-term importance of the UK tech sector.

The UK has long suffered from a shortage of domestic growth-stage capital, leaving founders reliant on overseas investors to fund their scale-up ambitions. And since the post-Covid market correction, investors have also raised the bar on capital efficiency and profitability. Companies are now expected to demonstrate stronger fundamentals earlier in their journey, and capital is being deployed far more selectively. For founders still in the earliest stages of company-building, this combination makes the path to Series A materially harder.

AI continues to command a disproportionate share of investor attention and capital. While there is undoubtedly hype in parts of the market - particularly where companies have built point solutions rather than durable businesses - AI itself is not a bubble.

The issue is that a small number of AI companies have achieved nine-figure revenues in a remarkably short period of time, and this has had an unintended side effect: quietly ratcheting up investor expectations across the board.

Growth curves enabled by AI’s unique economics – rapid scaling with limited headcount, compressed sales cycles, and access to entirely new budget lines – are increasingly treated as a reference point. Even then, only around 20% of AI-native startups reach Series A within 24 months. For most non-AI companies, those dynamics simply don’t apply.

The upshot is that many founders are heading into Series A conversations with the sense that unless they can demonstrate £5m+ in ARR, or a very fast path to it, capital will flow elsewhere. It’s a rising funding bar shaped by AI-specific outliers rather than the underlying health or long-term potential of the majority of businesses.

This dynamic is reinforced by headline funding data and a growing degree of pattern-matching across venture capital. The largest US funds are competing aggressively for a narrow cohort of hyper-growth AI companies, while a much broader pool of strong, well-run startups is overlooked.

That is bad news for the ecosystem as a whole. It creates a long tail of high-quality companies – often operating in less fashionable but highly profitable sectors – that struggle to secure the capital they need to progress.

It may not always feel like it, but we are still only at the beginning of the AI journey. That partly explains why markets have been ‘jittery’ at any sign of AI underperformance. Whether valuations eventually compress or normalise remains to be seen, but any reset would likely bring investor expectations back towards more achievable growth benchmarks across a wider range of sectors.

For the UK ecosystem, however, the early-stage funding gap is already too acute to ignore. As fewer startups progress to Series A, later-stage funds will see thinner pipelines, with less founder and employee wealth recycled back into early-stage investing.

When early-stage investor Episode 1 analysed more than 20,000 seed-stage founders and companies, they found that those that raised more capital at seed were significantly more likely to secure a Series A later on.

That is a strong argument for UK investors to think more creatively about seed extension rounds: providing additional capital on the same terms as the original seed round, and giving founders the runway they need to hit key milestones before approaching Series A investors.

This model is already well-established between Series A and B, often involving a combination of existing investors and short-term partners who do not dilute the cap table. There is no reason the same approach cannot be applied earlier in the lifecycle. When executed well, seed extensions allow founders to stick to their business plans and avoid compromised valuations, while still enforcing discipline by ensuring capital remains tied to genuine readiness rather than hype.

With the possibility of an AI market correction on the horizon, UK investors have a choice: sit tight and see if the funding gap closes on its own, or step in to plug the gap with creative funding solutions. The former risks weakening the wider ecosystem over time; the latter can strengthen it today.

The UK has an abundance of high-quality early-stage startups that need capital today. If they cannot access it domestically, they will be forced – assuming they wish to survive – to look overseas at ever earlier stages of their growth journey.

By almost every measure except growth-stage capital availability, the UK remains a world-leading home for early-stage tech innovation. Addressing the shortage of scale capital is essential if the country is to realise its full ambitions. 

Ivan Nikkhoo is founder and managing partner at Navigate Ventures