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Brexit: The dilemma facing UK tech startups

investment in the UK

Robert Siegel, lecturer in Management at Stanford Graduate School of Business and partner at XSeed Capital (US), explores the impact of Brexit on the UK tech startup scene

Much has been said in the aftermath of the UK’s referendum on EU membership about the potential impact of the outcome in favour of ‘Leave’ on the technology startup scene in the UK.

In particular, there has been speculation that the ramifications of the UK’s putative exit from the EU might constitute a substantive threat to London’s position as the pre-eminent technology startup hub in Europe, with cities such as Berlin, Amsterdam, Stockholm, and Tel Aviv all potentially vying to take up that mantle.

UK tech industry airs concerns as official Brexit talks begin in Brussels

Indeed, the Dublin commissioner for startups, Niamh Bushnell, circulated an email shortly after the announcement of the outcome of the referendum extolling the “new opportunity to attract Europe’s serial or first-time entrepreneurs to set up shop” in the city, already home to the European headquarters of the likes of Twitter, Airbnb, and Slack.

The implications

It’s certainly a possibility that a London outside the EU might lose some of its lustre as elements of the self-reinforcing halo effect of the established ecosystem are diminished.

On the one hand, founders of new startups may think twice about moving to London, or may even not bother leaving stable jobs and ‘starting up’ at all; on the other, startups already embedded in the capital may not be equipped to uproot themselves and move to the continent.

But ultimately it is far too soon to say. There is, however, another area in which a discernible impact on the UK’s tech startups is already being felt, anecdotally at least: the availability of investment capital.

An appetite for investments

Investors’ appetite for speculative investments in technology startups had been on the wane for some time before the outcome of the referendum was confirmed, but the solidifying prospect of Brexit has been a catalyst for considerable uncertainty and volatility in the markets.

There have been suggestions that any slowdown in investment in UK technology startups may be delayed on account of venture capital firms’ having raised record sums in the first quarter of this year and their ‘needing’ to invest that capital.

They do not, of course, have to spend that cash now, nor at least not in the UK; they could slow their investment rate, or simply take their cash piles to deserving startups in other markets.

The thesis that there will in fact be no ‘lag’ in the reduced availability of investment capital would seem to be supported by the fact that venture capital investment in European tech startups fell by more than a third during the second quarter of this year.

Looking for an exit

This reduced accessibility of capital investment may cause many startup founders to look more seriously for opportunities to exit; in fact, as the market for funding slows and remains uncertain with the full timetable for and scope of Brexit still unknown, selling may even become a necessity for some.

With less outside capital available, a greater onus will fall on entrepreneurs to make their startups self-sustaining. But, especially for early-stage or fast-growth companies, this can be much easier said than done: in the early stages of a firm’s life, a startup may lack the customer base or monetised business model to keep growing without external support, while fast-growing startups often need injections from investors to maintain momentum and meet operating costs as they scale towards consistent profitability.

In either scenario, founders face potentially having to stall growth and, feeling that they may not get the opportunity to ignite again, may thus consider that cashing in their chips may be a good idea.

Another consideration for founders, however, is that, while a lack of available investment capital may increase appetites for M&A, it does so primarily because it creates a buyer’s market in which acquisition valuations are pushed down.

Buyers are not stupid: if a startup cannot attract funding from investors in the open market, they become more susceptible to acquisition offers that might otherwise be considered to constitute a ‘lowball’ based on valuations made in the pre-Brexit climate.

Making the right decision

Entrepreneurs will face having to decide whether the various trade-offs are worth it.

For some, it will make more sense to tighten their belts, look to ride out this period of investor uncertainty while sustaining growth as best they can, and target renewed acceleration once the situation has become clearer and investors have warmed up again.

These will have to accept the possibility that valuations may never fully recover to their (perhaps somewhat ‘frothy’) pre-referendum levels.

For others, however – in particular those whose businesses may not be sufficiently well established to tolerate a period of entrenchment – it may be a better choice to court acquisition offers and exit now.

It will not be an easy decision for an entrepreneur to take – but it may prove pivotal to the long-term success of the business, whichever way they choose to go.

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