The UK votes to leave the EU and concern spreads throughout both its technology companies and the investors backing them. So went one argument made by ‘Remain’ advocates prior to the referendum, and not without justification. The overwhelming feeling this morning around the Silicon Roundabout and countless other British tech hotspots will be one of disappointment and uncertainty.
Is there good reason for trepidation? Fears about the potential consequences of a Brexit on British tech companies did not, after all, translate into a catastrophic fall in investment into these businesses in the first half of 2016. M&A activity in this area of the UK mid-market continued at a steady rate, within the wider context of a global slowdown relative to 2015’s record-breaking levels. In fact, those areas of the Communications, Media and Technology (CMT) sector currently in particular vogue – notably FinTech, software, and enterprise comms – seemed almost immune to the political risk. Only in June did we start to witness a conscious deferral of deals by buyers until after polling day.
Given the apocalyptic rhetoric that surrounded much of the referendum campaign, this may seem difficult to explain. After all, an ‘Out’ vote threatened to pull up the drawbridge in a way inimical to the increasingly borderless nature of the global technology industry and throw up barriers to the recruitment of the highly-skilled continental Europeans heavily represented across the workplaces of British start-ups. But the global drivers of investment in the CMT sector proved to outweigh the short-term impact of the threat of Brexit.
Now that the UK has voted to leave the EU, we are faced with a new paradigm of British companies trying to attract cross-border investment whilst headquartered definitively outside of the European Union. Brexit previously only weighed on M&A volumes as a threat; now we will discover whether an actual departure from the EU will prove an immovable object before the irresistible force of investment into the global CMT sector.
In the wake of this major change of circumstance, I’d like to take a closer look at the likely impact of Brexit on three anonymised and illustrative examples of UK companies. By considering the consequences of Thursday’s vote for each of them, we can better understand its implications for UK CMT companies more widely.
First up, a semiconductor start-up based in one of the UK’s second-tier cities. This company designs and sells (whilst outsourcing the intermediary step of fabricating) a variety of microprocessors to be embedded in electronic devices to connect them to the Internet of Things. It has raised over $50m in venture capital (VC) funding across a number of investment rounds since its foundation.
To fund the development of new generations of chips, the company will need to hold further fundraising rounds, which is where Brexit may prove to be an obstacle. Departure from the EU will deny British companies access to the capital allocated to VC funds by the European Investment Fund, on the proviso that it be invested in companies from EU member states. On the other hand, the European VC market pales in comparison with that of the US, and semiconductor companies in particular are increasingly looking to Asia for equity finance. Tellingly, the company’s latest investment round was raised in part from a German conglomerate’s VC arm, but also from an American corporate and Chinese multinational.
In all likelihood the greater issue arising from Brexit will be attractiveness to VC investors, rather than access. A company whose exports to continental European clients become subject to the imposition of tariffs is a less investible proposition. But again there’s a flipside: 40% of the company’s sales in 2015 came from the American and Asian markets, while a substantial proportion of the 60% accounted for by Europe is likely to have come from the UK. Moreover, the World Trade Organisation, whose established standards will represent the bare minimum for Britain’s replacement trade agreements, liberalised tariffs on semiconductors and other next-generation IT products in 2015 through an expansion of its long-standing Information Technology Agreement.
It’s therefore difficult to imagine that the barriers thrown up by Brexit will by themselves deter investors from backing this semiconductor company. This is particularly the case given the sharp burst of forward momentum the impending Internet of Things revolution is likely to impart to it.
The stakes in Thursday’s vote were higher for the second company, a London-based, private equity-backed software provider to the insurance industry.
Financial Technology, or FinTech, is the subset of the CMT sector in the UK for which the potential consequences of a Brexit received the most extensive public airing, by virtue of how these companies’ fortunes are closely tied to those of the financial services sector. The prognosis was bleak. London owes its position as a global leader in FinTech in part to ease of access and its position as the world’s foremost financial hub. Accordingly, the supposed post-Brexit shift of financial services operations from London to Paris or Frankfurt was predicted to have a negative knock-on effect on its ‘enabling’ technology suppliers – if less so their ‘disruptive’ counterparts.
Many treated these predictions of the City of London’s decline with a degree of scepticism, remembering the prevalence of similar warnings when Britain opted against joining the single currency. But the London insurance market served by our second company is already ceding global market share to centres like Singapore, a process likely to be accelerated by any loss of ‘passporting’ rights to other EU member states. As this second company generates the vast majority of its revenues in the UK and Irish markets, a shrinking domestic customer base may constrain future growth prospects. Moreover, rather than benefiting from an end to Solvency II, the EU’s newly-instituted and burdensome regulatory regime that some insurance firms will be glad to escape, the company may even see its software suite designed for compliance with these new regulations become less commercially viable.
In the medium-term, however, the company will adapt to these changes, as the nimble, mid-market tech businesses of today are perfectly equipped to do. In terms of attracting future injections of capital, the strength of the dollar against weakened sterling may even encourage far-sighted American corporates to bid for the asset, which remains a leading player in the undisputed global centre of FinTech excellence, and others like it at a knock-down price.
The appetite of American investors for UK CMT businesses in the face of Brexit is an even more important consideration for the third and final example. A British provider of detailed energy-sector data and analysis, this media company was owned by private shareholders until recently, when the backing of a US investment group only one month before the vote valued it at over a billion dollars. The forward visibility of its revenues and the rapid growth of sector-specific media companies catering for corporate clients rendered the outcome of the EU referendum a virtual moot point. The deal provides a textbook case study in how global CMT investment trends can override short-term obstacles.
Brexit will have a detrimental short-term impact on UK CMT companies and their investment prospects. But what risked being lost in debates about new trade barriers and regulatory systems was that much of the investment into the sector globally is driven by ongoing, fundamental changes in how we work, behave, and live. Thursday’s vote will not affect these underlying drivers. When tech companies and investors in the sector come to reflect on Britain’s departure from the EU referendum, it will be better thought of as a speedbump rather than a roadblock.
