Despite the challenges of the past two years, Scottish startups have not only endured, but in many cases thrived. Investment has increased, driven in part by several high-profile funding deals.

While there were a few pandemic casualties, most tech startups have managed to grow, and many are looking to expand further in 2022.

On top of that, Edinburgh routinely scores highly on lists of the UK’s hubs providing attractive homes for tech startups. There is little doubt that Scotland has the funding, talent, mentors, and support available to help companies get off the ground.

However, for the country’s tech ecosystem, the next challenge is helping those companies grow further. The journey from startup to scaleup isn’t easy. Too often, with nowhere else to go, companies give in to temptation and sell themselves to larger groups.

Board advisor and scaleup expert Matt Little sees many of these companies selling themselves short, losing out on potential future growth. DIGIT spoke with him about how Scotland’s startups can take the next steps – scaling up to begin competing internationally.

Digital Ceiling

Starting a company is challenging – attracting the right talent, developing technology and product all take time, money, and effort. But there is plenty of seed and Series A funding available for companies at their first stage to help find early product-market fit and attract the first adopters, along with other support channels.

Scotland’s landmark Logan Report emphasised the importance of building the ‘top of the funnel’, ensuring the country supports its early-stage companies. The logic being that the more startups the country produces, the more will make it to the next stages and ultimately join Skyscanner and FanDuel as the country’s next unicorn.

“The risk is we light the blue touch paper on a bunch of startups that grow to a certain size and then implode because there isn’t the infrastructure, funding, or support to help them to the next level,” Little warns.

He notes that there needs to be more funding for subsequent stages, at the £5-million-or-more level, from investors who understand the risks and are willing to take them on for the potential returns.

“If we don’t get scaleups right, we’ve spent a lot of time and money building startups with nowhere to go, effectively destined to hit a brick wall at some point in the future.”

Focusing too much on the early stages can create what Little calls a ‘digital ceiling’, where companies hit a certain level, but can’t grow beyond that because there’s not enough investment.

“I encourage Scotland to be bolder – where are the series B, C and D companies and support mechanisms?” Little asks.

The Walking Dead

This early-stage funding model, with investment pots spread thin among multiple companies, can also create the problem of zombie companies. Rather than helping startups grow significantly bigger, the funding simply keeps the lights on for another six months, at which point another round of funding happens, and the cycle repeats.

“Without the programme for stage two and stage three, we’re going to have a lot of startups who get the first customer, get a bit of product market fit, generate a bit of revenue and then are walking dead,” Little explains.

An ecosystem populated by zombies is not a healthy one – investors, for one, are unlikely to receive a good return on investment simply by keeping companies on life support.

On top of that, staff essentially become locked into stagnant companies. Key staff remain invested with tie-ins, other employees lose out on upskilling and development opportunities, and the companies struggle to attract external talent.

This causes a general stagnation in the ecosystem, preventing more successful companies from emerging.

Ultimately, the funnel shape suggests a natural trajectory for companies – fewer and fewer make it to the next stage. The logical strategy for investors is to follow this path.

“It’s my personal opinion that it might be better to invest more with fewer companies,” Little says.

“If we tighten the focus of funding, then the fittest companies, the best ideas and the best propositions will have access to far greater levels of funding in Scotland. Hopefully that will mean that when they reach that point and need more funding, it’s available at a decent level, rather than forcing companies to sell themselves.”

Ambition and Acquisition

The success of Scotland’s tech ecosystem has often been evidenced by several high-profile acquisitions in recent years. But Little questions whether these exits should be seen as positives.

“When someone says they’re going to exit, the immediate response is fantastic, with no investigation into the quality or scale of that exit.”

Could this show a potential weakness of the Scottish ecosystem – that companies are exiting because they’ve nowhere else to go?

On top of this, the fewer companies that go all the way and reach unicorn level, or even decacorn, means there are fewer Scottish success stories to emulate. Selling too soon can limit the ambitions of the entire ecosystem.

“If people reach a stage of growth and still have significant growth potential, it is a shame if the only option they can see is to exit. It’s a shame because that future growth ends up outside Scotland,” Little says.

“It’s about loss of ambition. If we had 10 other companies that had turned down the first offer of acquisition, and had gone from the 1 million annual recurring revenue to 5 million ARR to 10 million ARR, then others would want to follow them.

“I think there are still too few examples for people to believe that they can do that. And for me, that is probably the biggest downside to early exit – it sets a soft ceiling which people think they should aspire to and cannot go beyond.”

Is Acquisition Right for You?

Failure is a side-effect of the funnel model. In a Darwinian world where only the fittest survive, some companies will need to fold.

As such, knowing when to sell or when to keep going is vital. And this requires an objective eye.

“If you’re having to spend a vast amount of time each year fundraising, not for significant growth but to extend your runway, that’s probably a flag,” Little says.

“And to be clear, most companies have a point at which they need a bit of funding to extend the runway to get to the big win. But if you’ve spent four or five years doing that every six months with all the associated time, effort, costs and hassle, then that’s probably a sign something’s not quite right.”

On the other hand, it can be hard to know when to push on. An acquisition, especially a large one that will make millionaires out of key stakeholders, can be very difficult to turn down.

“If you’re going out for funding, say to double the number of people or to move into a new region, that’s probably a sign of growth and it’s worth staying on that journey,” Little notes.

“And that’s the point at which an acquirer might come along, because they’ve spotted that also. At that point I would say no – the funding is available, the cohorts of experts and people who’ve been there before are available, so I’m going to push on.”

The Next Steps

The pandemic has obviously had a massive effect on Scottish, as well as global, business ambitions. Growth plans have been postponed or curtailed, with many looking for the end of the Covid to get back on track.

However, there are opportunities brought about by these delays. While many investors curtailed activity at the onset of the pandemic, this has caused unspent funds to accumulate.

“There has been talk of ‘war chests’ of cash ready to be invested as soon as the spectre of Covid passes,” Little notes.

“We should use these to materially increase the size of strategic investments, not just increase the number of investments, to have a transformational effect on businesses. Investments should be larger, and investors should push founders to ask for more and to be more aggressive.”

Furthermore, with large investments, companies will need advice and mentoring on how to use it wisely.

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For many, the US models from innovation centres such as the US West Coast or Boston, are the ones for Scotland to emulate. “Their innovative ideas aren’t better, but the support and easy access to funding is there,” Little says.

“They have a community that attracts big investors, but also has that experience where people can go and ask questions. We need to get some world experts in – get two or three of MIT’s best, for example, to come base themselves in Scotland long-term, to really kickstart that ambition and community.

“What I’m encouraging Scotland to do is go big on fewer bets. I would approach investors and say you’ve not invested as much as you expected to over the last 12 months, so invest more in me.

“I see this as an opportunity for firms looking for investment to try to break out of the cycle and actually be asking for more rather than less,” he adds.

“If we’re building really good tech, and really good products, and if we’re building really good teams and really good cultures, the only way to ensure those remain is to get good funding and good support and grow our organisations, rather than transitioning control to someone else.”