Research from HSBC Innovation Banking indicates that venture capital investors have increasingly relied on “aggressive structures” to safeguard their interests, resulting in a decline in valuations for some of Britain’s most promising tech firms last year.

In contrast, the founders of UK start-ups looking to secure their initial and subsequent rounds of venture capital funding have managed to negotiate more “fair” terms.

The findings suggest that British growth firms encounter what HSBC calls a “scale-up gap.” Although local funds are effective for the early-stage growth of start-ups, established companies aiming for international investors often find their options limited, with more stringent deal terms.

Glen Waters, head of early-stage banking within HSBC’s technology division, noted that start-ups related to AI are particularly benefiting from a wave of investor interest. However, for “later-stage” investments, he observed that terms tend to shift towards being more favorable to investors.

“The positive aspect is that there are more late-stage transactions occurring, albeit at lower valuations and with more aggressive participating stock structures,” he stated.

HSBC’s review analyzed 588 anonymized venture capital investment offers, or term sheets, issued in 2024, compiled from 27 law firms, representing one-third of the deals for companies raising over £500,000 in venture capital.

Waters pointed out that a greater percentage of investors supporting founders securing up to £2 million were open to standard preference share terms. However, for those raising £10 million or more, there was a marked insistence from investors on more protective measures, opting for non-standard, participating preference shares.

Preference shares allow investors to recoup their investments ahead of ordinary shareholders upon the sale of company shares. While standard preference shares receive their proportional share of any increase in company value, non-standard or “double-dip” preference shares enable investors to recover their money first and benefit considerably from value increases beyond what would be expected from their shareholding percentage.

Waters highlighted the potential pitfalls for founders, stating, “If founders sell for £100 million, by the time everything is settled, the amount they actually make can be significantly less due to an unfavorable structure.”

He advised first-time founders to prioritize understanding the specific terms of their offers over the valuation of their ventures.

“The valuation is typically what catches attention on a term sheet, but founders must model potential proceeds to gauge how much they would net under various scenarios,” he recommended.

Some terms can allow minority investors to push out founders if management teams fail to meet specific performance targets, employing control rights and swamping rights. Additionally, investors may require consultation on a range of managerial decisions, including staffing compensation.

Waters emphasized the importance of negotiation, stating that investors expect founders to engage in discussions when term sheets are presented. “Investors would be surprised if founders accepted terms without negotiating; they seek founders who demonstrate initiative,” he explained.

To facilitate effective negotiations, he advised founders to seek specialized legal representation, stating, “Working with a venture capital lawyer who understands the intricacies of this landscape is crucial. Avoid generalists who may not have this specific experience.”

Moreover, even when founders agree to the investment terms and proceed to sign, it merely initiates an exclusivity period with the investor, after which due diligence will follow, according to Waters.

This study from HSBC coincides with the latest analysis by data specialists Pitchbook on venture capital deal volume and value across Europe in the first quarter of the year.

The analysis revealed a decline in fundraising deal values compared to the same timeframe the previous year, with entrepreneurs in AI, life sciences, and fintech fields being the most successful in securing investments.