Britain’s technology startup businesses face an unpredictable future should the UK vote to leave the European Union on 23 June 2016. In a recent survey conducted by the Silicon Valley Bank (“SVB”), 72% of startup executives said leaving the EU would have a negative effect on their business. Small businesses are particularly concerned about the effect of Brexit on the availability of funding and their ability to recruit. Further, startups fear that access to the single market could be a complex and expensive process. In this article we consider the potential impact of Brexit on technology startup businesses.
How do we leave?
The process for leaving the EU is set out in Article 50 of the Lisbon Treaty. Following a vote for Brexit, the UK Government must notify the European Council of its intention to leave the EU. There is no time limit by which this notification must be made. Once a notification has been issued, the UK will leave the EU upon entry into a withdrawal agreement (a trade agreement setting out its future relationship with the EU) or, if no agreement is reached, after the passing of 2 years. The 2 year period may be extended by unanimous agreement between the remaining 27 member states (but if recent history is repeated, unanimity on any subject is hard to achieve). The process of Brexit would therefore be slow, and the basis of the UK’s future relationship with the EU might not be clear for some time: the recent trade agreement between the EU and Canada took 7 years to conclude and it seems unusual for any international trade agreement to be concluded in less than 4 years. In this interim period, the UK would almost certainly retain significant amounts of law of EU origin and there would be transitional measures to cover any ‘gaps’.
What could Brexit mean for startup funding?
In the immediate aftermath of a Brexit vote there is likely to be significant uncertainty both in the UK and the EU. This uncertainty may translate into a short term lack of access to capital for many small businesses as VCs, angel investors and PE funds choose to wait and see how the exit will unfold. However, the medium-long term impact of Brexit on the economy remains a hotly disputed topic.
An area of particular interest for startup businesses is whether the UK would continue to attract significant foreign direct investment (‘FDI’). In 2014-2015, the UK was the number one destination for FDI in the EU with the USA, India and France being the largest contributors. The head of the Bank of England, Mark Carney, has explained that he expects to see at least a short term drop in FDI if the UK votes for Brexit. Although the extent to which EU membership attracts FDI is debatable, investors can use Britain as a gateway to the EU and are able to benefit from the free movement of capital and the tariff-free environment. Any fall in FDI will be an issue for Britain’s booming startup businesses, many of which rely on foreign capital for growth.
However, startups may still be able to access EU funding should the UK vote to leave. The EU has a number of funding initiatives, and some are open to non-EU members. For example, countries such as Israel and Norway are part of the EU’s flagship ‘Horizon 2020’ innovation and research funding framework. Furthermore, whilst at present the UK benefits disproportionately from EU funding for innovation, following Brexit it is likely that the UK would set up its own initiatives. As a net contributor to the EU, those in favour of Brexit would argue that the UK might even be able to increase overall funding for startups and early-stage tech businesses.
What could Brexit mean for recruitment?
In the recent SVB survey referred to above, 95% of startup executives said it was challenging to find the right people. There is concern that Brexit may reduce the size of the talent pool and make it even more difficulty to find people with the required skills. Tech startups tend to be particularly reliant on workers from Eastern Europe, and they may be particularly hard hit by any tightening of immigration rules. Nonetheless, proponents of Brexit argue that the UK would be able to tailor the UK’s immigration policy to attract those with skills in areas that are required.
Leave or remain, it is unlikely that the UK would immediately ‘pull up the drawbridge’, however, Brexit may well make the UK a less attractive place to move for skilled EU workers.
Will startups lose access to the single market?
The nature of any trade deals following Brexit and the potential impact on startups is impossible to predict. Arguments over the relative bargaining power of the UK and the EU have been debated at length without resolution. In the absence of any agreement with the EU, the World Trade Organisation rules would apply. Consequently, UK imports and exports to and from the EU would face tariffs whilst the import and export of services would be significantly more challenging.
The EU is the UK’s largest trading partner and membership gives UK startups free access to 500 million consumers and tariff free imports. The extent to which startups benefit from the common market depends on the nature of their business. Many small enterprises focus on the domestic market using local suppliers whilst others operate without borders. The leave campaign argue that the UK would be free to negotiate agreements with the EU as well as nations across the world. Even if they are correct, these negotiations would take time and startup businesses would need to be flexible to weather the uncertainty.
What about our entrepreneurs?
The Global Entrepreneurship Index recently voted the UK the most entrepreneurial country in Europe, and the fourth most entrepreneurial country in the world. However, those in favour of Brexit have often mentioned the top 3 on this list (the US, Canada and Australia) as countries with whom the UK should be trading more often.
As a breed, tech entrepreneurs are highly motivated and creative, and many will see Brexit as opening up many more opportunities to trade with emerging economies across the world. On the other hand, there’s no doubt that Europe has always been the main trading partner for those startups with international ambitions. Startups can only prosper when funding is available, and we suspect that the impact of Brexit on the current scale and diversity of FDI will be closely aligned to the impact on tech entrepreneurs.
How will Brexit affect regulation?
The removal of ‘red tape’ for small businesses is an oft cited argument for Brexit. However, it is unlikely that there would be significant change in the short term. There is even a possibility that the UK would continue to be bound by EU rules depending on the deal struck. If this is not the case, over time there may be some regulatory divergence between the UK and the EU in certain areas.
Startups which wish to export to the EU will still need to comply with EU regulations. Businesses with EU suppliers or partners may also be required to comply with some regulations in areas such as data protection. They will therefore have to ensure compliance with both UK and EU requirements. This will be more challenging for some startups than others. For example, “Fin Tech” startups with international ambitions may be required to seek approval from the FCA as well as a regulator within the EU whereas a startup with more local ambitions may benefit from a relaxation of regulations. What is more, whilst UK exporters will have to comply with EU regulations, the UK will have no say in how the regulations are determined. The UK has been a liberalising voice in the EU and there is concern that in its absence, business regulations may become more stringent.
The majority of startups are unlikely to benefit significantly from domestic regulatory change. However, the burden of complying with multiple regulators may be an issue for many businesses with international customers and suppliers.
Should we stay or should we go?
Before heading to the ballot box on 23 June, startup owners should think carefully about what is best for their business in the longer term. If the UK votes for Brexit, then the process whereby the UK will then negotiate to leave the EU is necessarily an uncertain one in the short term (and that’s without taking account of the effect on Scotland and Northern Ireland, where the populations are predicted to vote strongly in favour of remaining in the UK and where further referenda on independence may well follow).
The real question facing startups is whether the cost of such short term disruption is a price worth paying in the longer term. While the answer to this may hinge on the deals Britain can strike with the EU and other trading partners, those startups which are not so reliant on funding and which already have the potential to trade with emerging markets will undoubtedly have much better prospects
The culture of angel and VC investing in the UK has developed strongly in recent years, but it has always been sensitive to the success of the economy as a whole. Some would argue that this culture is now unstoppable, as is the UK’s pre-eminence in entrepreneurship, but it’s hard to resist the argument that progress in this area has been directly linked to the UK’s membership of the EU, rather than being in spite of it.
A shorter version of this piece first appeared on www.businessadvice.co.uk