Founders face many challenges when trying to get their companies off the ground: finding product-market fit, capturing investors’ attention, hiring great people and demonstrating the potential to scale their new venture.

One of the main worries for founders is whether they can obtain sufficient and timely funding, which is crucial to make their ventures grow and thrive. Since the National Security and Investment Act took full effect this month, UK founders have expressed concerns over how this new tool in the government’s hands will affect speed and certainty of funding.

These concerns seem justified. While countries across the globe, including the United States, China, Australia, Japan, and several EU countries, significantly tightened their investment screening regulations over the last couple of years, the UK’s far-reaching approach to national security screening is seemingly unprecedented. The regime does not only capture foreign, but also domestic investors. The government’s call-in powers extend to any sector and are not subject to any materiality thresholds in terms of the company’s revenues, assets or transaction value. 

Consequently, many UK startups, including those who are seeking seed funding, are going to fall within the ambit of the new regime. To not hamper the development of the UK’s next-generation industrial champions, the government should do its very best to provide UK startups with much-needed predictability and transparency. The government should also undertake rigorous regular reviews to assess the effect that the new rules have on the UK’s startup sector, and adjust the rules where necessary. 


What is the NSI Act about?

The National Security and Investment Act was introduced to allow the UK government to scrutinise and intervene in acquisitions that could harm the UK’s national security.  

For the first time, acquirers of certain UK businesses are now under a legal obligation to seek approval from the government before they can close the acquisition. This pre-screening regime applies where an investor acquires a 25% stake in a company that operates in one of 17 ‘sensitive sectors’. 

These sectors include high-growth sectors such as artificial intelligence, data infrastructure, computing hardware, or advanced robotics. Before such transactions can be completed, it is now mandatory to notify the government and wait for its approval. Importantly, the obligation to notify applies to foreign and UK investors alike.  

Other investments do not have to be notified, but the government at its discretion can call them in – even after closing – if the investor obtains ‘material influence’ over the UK business and there is a reasonable suspicion that the acquisition poses a risk to national security.  The ‘material influence’ test is vague and can be difficult to apply. Even acquisitions of a low shareholding, potentially even below 15% in certain circumstances, can be enough to trigger the government’s call-in powers. 

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Impact on UK founders 

Much of past discussions on the NSI Act revolved around its impact on takeovers, mergers and other late-stage acquisitions. But the new law could also have a chilling effect on early stage investments.  

The NSI Act covers wide areas of the economy, and therefore affects many investors and businesses. Based on our review of the catalogue of 17 sectors the UK government deems ‘sensitive’, we expect the fast-growing technology sectors to be particularly impacted. Since the NSI Act does not distinguish between small and large businesses, early stage ventures are equally caught. 

We have reviewed more than 2,500 funding rounds completed on SeedLegals over the last couple of years. We estimate that almost one out of 10 rounds would have resulted in a mandatory pre-approval requirement if the pre-screening regime had been in force at the time. 

We believe the government should be aware that businesses at the early stage in their life cycle rely on timely and sufficient funding to survive and thrive, and usually have less flexibility than later stage companies to fund themselves through third party debt financing because they are often pre-revenue companies. Where funding rounds that get materially delayed or even fail, this can have dire consequences for the businesses involved. In the worst case, they may need to be liquidated and with them the innovative ideas they were about to bring to the market. 

The NSI Act seems to already bite UK startups. SeedLegals has spoken to several founders who felt forced to postpone funding rounds due to the new regime taking effect. Some of these delays will be due to ‘teething issues’ until the market adapts. However, a certain amount of delay and uncertainty is inherent in a pre-approval regime and will continue to affect UK startups and their investors in the future. 

Founders ask for predictability and transparency

I am not a national security specialist, and I cannot comment on whether the UK NSI Act is the right approach to protect the country’s national security or not. Through my own entrepreneurial journey and by working with many of the UK’s most promising startups at SeedLegals, what I learnt is that early stage businesses are fragile, and the timing and outcome of funding rounds is often a matter of life and death for these promising young companies. 

The government stated that it only expects a small minority of acquisitions to result in national security concerns, and for most deals to be able to proceed without delay. It is important that the government acts on its promise and provides to UK founders and their investors the much-needed predictability and transparency when applying the new regime.