UK start-ups saw a 40 per cent decline in venture capital activity in the past two years, according to new research by the National Endowment for Science, Technology and the Arts (NESTA).

The number of exits has fallen by 40 per cent and fundraising dropped by more than 50 per cent both in terms of the number of funds raising new capital and total amounts raised.

‘Venture Capital: now and after the Dotcom Crash’ also compares today’s venture activity trends with the dotcom crash, and finds this crisis compounded by the challenges already facing technology entrepreneurs since 2002.

Two new trends are having a particular affect on today’s market. First, the time taken to successfully exit, through a flotation or takeover, is said to be getting longer. Globally, this averages almost seven-and-a-half years, the longest period seen over the past two decades. This global trend is reflected in the UK market and has a knock-on impact on a fund’s ability to attract further investment.

Second, both the dotcom and financial crises are said to have resulted in a significant reduction in the number of new venture capital funds established. However, current fundraising activity is considerably lower than levels seen after the dotcom crash and consequently the lowest level seen in the last decade.

The report goes on to state that the fundamentals of the UK venture capital market appear sound, with evidence of funds exiting companies and making good returns.

For example, in the last decade, 54 per cent of UK exits recovered between one and five times the amount invested; 10 per cent of exits returned five to 10 times their invested capital and nine per cent made more than 10 times the investment. Twenty seven per cent of exits returned less capital than was initially invested.

Further, with significant amounts of capital invested in new companies between 2004 and 2007, a large number are expected to bear fruit over the next few years.

Mike Lynch, chairman of NESTA’s Investment Fund, said: ‘High-growth technology start-ups will be critical to the UK’s recovery. Our ambition to balance the economy must take into account the difficulties of early stage investment.’

2009 is said to have seen the lowest venture capital investment activity in recent history, with the number of investments down by 17 per cent on 2008 and a drop of 27 per cent on the total amount invested (£677m compared to £930m).

Matthew Mead, managing director of NESTA Investments, said: ‘There is positive news to emerge from our research. Funds made good returns on exits in the middle of the recession, so with a peak of investment activity between 2004 and 2007 many funds will be able to harvest their portfolio. Hopefully, this will coincide with economic growth and renewed M&A activity.’