There are signs that the global economy may be stabilizing and recent M&A activity in the tech sector offers hope that tech will be closer to the front of the pack. But that may not be much consolation to many UK startups that are hurting for cash.

According to Jonathan Kestenbaum, CEO of the National Endowment for Science, Technology, and the Arts (NESTA), as many as 800 young companies face an “unimaginable dilemma” that threatens their survival. The cause of this dilemma: a frozen market for venture capital.

As reported by Bloomberg, in the first half of 2009, VC investments in the UK dropped to £407m, down from £628m in the first half of 2008. Firms with capital are keeping their powder dry and coupled with the overall economic malaise, this puts startups that need capital in a very difficult spot.

More troubling: there are signs that the VC market is in for a longer-term pullback. According to the British Private Equity and Venture Capital Association (BVCA), only £319m were raised by VCs for investment in the first two quarters of the year; that’s down from well over £1bn in Q1 and Q2 of 2008. Kestenbaum says that “you’ve got the beginnings of a crisis in this market“.

While VC markets around the world have been impacted by the downturn, the UK has been particularly hard hit. Some pin much of the blame on a UK market that isn’t as friendly for entrepreneurs and investors; the BVCA and NESTA recently called the UK market “underdeveloped“. To that end, the government is looking to do what it can to help. A £1bn fund is a big part of that.

Developing a more attractive market for investments in young companies is obviously a worthy goal but I also think it’s natural for special interests to exaggerate things. Downturns are painful but they also represent a natural culling of the herd. Many companies that don’t survive wouldn’t have survived anyway; the downturn only hastens the end. And we shouldn’t forget that downturns typically see the formation of scrappy new businesses that manage to get off the ground and thrive in the toughest of times.

Obviously, access to capital plays a big role in supporting the development of innovative new businesses. But for anyone looking at the ways entrepreneurs can be encouraged to start new businesses and high-growth companies can be supported, it’s not all about capital. In my opinion, a friendly business environment, favorable tax regime and competitive infrastructure may provide far more stimulus than a healthy VC market.