London is considered by most in the venture capital industry as Europe's capital for start-up companies seeking early stage investment, but despite its crown the UK market is showing little sign of recovering from the credit crunch. According to Stan Westlake, executive director of research at the National Endowment for Science, Technology and the Arts (Nesta), an independent body which was funded by the UK Lottery to invest in start-ups as well as provide industry knowledge, the UK venture capital market is "in a worse position now than after the dotcom collapse. Venture capital investment fell 40% in 2009; fundraising was down 50% on 2008, which in itself was not a good year". In 2009, venture capitalists invested just £677m in UK start-ups, the lowest level for 10 years.

The venture capital industry is expected to continue contracting in the UK, Europe and US and grow in emerging markets, such as China, according to a recent British Venture Capital Association survey. The survey, which canvassed the opinions of more than 500 global players from small to large investment firms, found that venture capital investment was very important to economic health and that an entrepreneurial environment and government-supported research and development were the most important factors for a favourable investment climate. The main deterrent to investment cited was a weak initial public offering (IPO) market. The IPO market in the UK has been extremely quiet for the last few years. One of the most recent IPOs was the flotation of online supermarket retailer Ocado, which sells Waitrose products online. The retailer, which immediately joined the FTSE 100 due to its £900m market capitalisation, has seen its share performance flounder since its IPO in the summer. The share price fell 10% immediately after its July flotation and this was after the offer price was cut 20% in order to get the IPO away.

During the recession, investors reined in their investment spending and focused on companies in their existing portfolios, according to one senior banker. There was also more focus on investing in companies at a much later stage of development as it is less risky. Many of the larger private equity firms which also invest in venture capital have moved away entirely from early-stage investment, he said, and focused on much larger deals where there are opportunities to strip out costs. 3i, which was formerly a behemoth in the sector, disposed of its venture capital fund and Apax has entirely exited the sector. "The titans of private equity are now out of the sector," according to Westlake. According to the Nesta report Venture Capital – Now and After the Dotcom Crash, which was published in July, "venture capital has benefited little from the explosion in the value of private equity investments, which trebled between 2003 and 2007 from £4bn to nearly £12bn".

Research by Calibre One London, an executive search firm, showed that venture capital funds invested £484m in European technology companies in the second quarter of this year, up from £413m in the first quarter. However, the total number of investments declined to 144 from 178 and a significant number of investments were follow-on fundraisings, which suggests that venture capital investors are continuing to favour larger, less risky deals.

The most common reason cited for the slowdown in venture capital investing is its high risks and low returns. Returns are impacted by the length of time to exit or take profit through a flotation or acquisition. According to the Nesta research, the time taken to successfully exit through a flotation now averages almost seven-and-a-half years, which is the longest time over the last 20 years. Lower returns result in venture capital funds finding it more difficult to attract investors. Fundraisings in 2009 were the lowest in the last decade, according to Nesta. In 2009, 11 venture capital funds raised capital compared with 22 in 2008. The funds raised £573.6m, down from £1.6bn in 2008. This gives an insight into the declining confidence in the sector and shows that growth is unlikely to return any time soon.