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15-12-2017 - - 0 comments
Five reasons startup investors should be cautious about Brexit

 

While the UK venture capital industry is digesting the response to the Patient Capital Review, the budget this year was firmly aimed at Brexit. Others will comment on whether it hit the mark, but Brexit should be the hot topic for startup investors. One year ago I highlighted at an industry forum how noone was talking about it. This is still largely true, but now the areas of risk are becoming clearer. Here are the largest ones that investors need to consider:

 

1. Staff Availability

 

A recent article in Politico highlighted the difficulties that tech workers are having in deciding to stay in the UK. It also gave the example of Once, a dating app that started up in London. Last summer it moved to Paris because it couldn't recruit programmers.

 

Its not just tech that has had difficulties. Fortnum and Mason has had difficulties recruiting enough chefs, with 20% of posts currently vacant.

 

In his speech the Chancellor said he considered 1.4m unemployed as too many. In reality the UK is approaching what many economists would consider full employment. More importantly, that pool of labour is unlikely to be endowed with the specialist skills that many startups require. If EU workers are less keen to come to the UK, and existing ones are more likely to leave, then a potential alternative source will shrink and make recruitment a bit harder.

 

2. Single Market

 

It looks increasingly likely that the UK will not be in the single market after Brexit. Any trade agreement is unlikely to give even the same access across the board. Consequently, any company that relies on exports to that market could find it harder.

 

Brexit fans will point to new trade deals elsewhere, but the expectation is these will take 5 years or more to negotiate. If an exporter is subject to tariffs in the meantime, then competitiveness and/or profitability will suffer accordingly.

 

3. Customs Issues

 

Although linked to the single market, it is deserving of a separate comment. If the UK leaves the single market, then at its simplest there will be more administration for both imports and exports. Unfortunately UK border control is not set up to handle this. The most extreme example is a new computer system that was designed pre-Brexit with a capacity that would give lots of headroom for growth.  However, post-Brexit the specification is inadequate for the expected increase in volumes. The Naked Capitalism blog has been obsessing about this, for example here (follow the links therein for more).

 

The good new is that it appears the government is waking up to this as an issue. The bad news is that if David Davis is right about not getting a deal then there may be a legal limbo until this is sorted out.

 

4. Regulatory Equivalence

 

The issues around passporting for financial services have been well voiced, not least by the bodies that support or lobby for the City in London. However there are many other regulatory issues. A recent testimony by car companies to parliament revealed that the UK approval scheme will no longer be valid in the EU. The default position will be that all existing cars will need new approvals from an EU body. This process will usually take six to eighteen months, during which production must cease. Apparently this was news to the UK government.

 

While it seems likely something this serious will be addressed, there are hundreds of agreements affecting thousands of products and services. It seems unlikely the EU will grant a simple transition to something similar to current arrangements for everything. Financial services is  a good illustration of that. At the moment we have little idea which regulations will be subject to successful negotiations, or if these will be in place by April 2019. Which makes it hard for an investor to know who will be left out or suffer adverse consequences.

 

The fifth reason

 

At the moment we have a huge amount of uncertainty about how the UK's trading arrangements will look after Brexit. While we may or may not get greater clarity as we approach the date of exit, the reality is businesses need to start planning now. Startups have a potential advantage, in that they are more flexible and probably need a shorter timescale to adapt than more established companies. The downside is that many will be forced to wait because they don't have the resources to put contingencies in place alongside business as usual.

 

This latter point is what really matters for startups. Some of these will have serious consequences for larger companies. But most of these can perhaps run without a couple of programmers for a year or devote resources to creating systems for different customs scenarios.

 

For startups things are more marginal: the lack of the right person, extra cash burn or higher costs could be fatal. This isn't to say that swathes of startups are going to fail because of Brexit. However, there will be some that fold that otherwise might have made it. How many depends on how severe any disruption is and how long it lasts. And the harder the Brexit, the greater the disruptions.

 

In particular, the prospect of no deal should scare investors. Businesses appreciate a stable environment, and no deal would maximise uncertainty. For many businesses a bad deal would actually be better than no deal, because then they can at least get on with it. Only time will tell, but the signs at the moment are not good.

 

 

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