The Brexit Impact on EU Startups

Britain has voted to ‘take back control, British start-ups need to understand what this means to them and their organisations?

The debates and hustings have been and gone, the ballots have been counted and the country has spoken: Brexit is now a reality in Britain today. As Prime Minister Theresa May said on the steps of 10 Downing Street, “Brexit means Brexit”. However, the ambiguity surrounding Brexit has helped to create a lot of uncertainty in the business community due to the vagueness surrounding the future of the British economy, British commerce and wider socio-economic pressures. In such a climate, it is crucial that knowledge, analysis and comment about Britain’s SME future is set forth to help budding entrepreneurs to understand what this means for their businesses. Start-ups account for a great deal in relation to GDP, employment and tax revenue for Government. We need to understand how Brexit will affect the start-up sector in the United Kingdom. This article will move beyond the hubris and hyperbole of Brexit and explore the post-Brexit landscape by understanding accession countries and the reverse model experience of exit and how this will impact Britain’s SME start-up sector.

Red tape: Brexit realities and hyperbole explained

The narrative surrounding a British exit from the European Union was partially based on the issue of regulation and a freedom to trade further afield. However, the EU as a market is a large part of the UK sales channel for goods and services. That being the case we need to understand some realities. Brexit isn’t instant, it requires a two-year process of disengagement set out in Article 50 of the Lisbon Treaty. We do not yet know the terms of exit. Whilst there will be a lot of market volatility and political uncertainty, for two years from when Article 50 is triggered, the UK will still be a constituent member of the EU – so all the same rules and regulations apply.

What we need to understand is what will happen after the two-year period. There is a myriad of questions that need answering. Bureaucracy is often cited as a core reason for leaving the European Union. However, start-ups in countless sectors following the Brexit negotiations conclusion and British exit from the EU will find a new regulatory environment. As Europe is a large trade partner and a massive market for British goods and services. Regulation will play a large part in export terms. Since the Department for Exiting the European Union has only just opened its doors, we are perhaps experiencing a dearth of fact-based information relating to Brexit because we have yet to understand the Brexit experience facing Britain?

Accession to the EU: Does this offer a reverse indication of what Brexit could unleash on UK SME start-ups?

In order to understand what could happen to the United Kingdom, we should look at a possible outcome and apply a reverse interpretation of accession countries SME experiences. This could help us to better understand Brexit and how this could impact the UK economy and beyond. The European Union started life as a six-member club offering free trade on coal and steel. It morphed over the decades to include 27 members and created a raft of laws, a currency and global diplomatic reach to help improve the prosperity and security of member states. However, there is a mismatch between countries who have joined compared to older, more economically well-off member states. This segment will explore accession to the EU and the impact on start-ups.

Case Study Evaluation

The purpose of this evaluation is to better understand the patterns of growth emanating from EU membership and the levels of growth thereafter. The 2007 EU Enlargement, saw Romania and Bulgaria join the European Union on the 1st of January 2007. According to the European Commission, “The European Union has brought huge advantages to all Europeans – stability, prosperity, democracy, human rights, fundamental freedoms, and the rule of law. These are not just abstract principles. They have transformed the quality of life for millions of people. The benefits of the single market for consumers in the EU are obvious: economic growth and job creation, safer products, lower prices, and greater choice in crucial sectors like telecommunications, banking and air travel, to name but a few” (1). The economic boost EU membership brings is the purpose of this analysis.

Case Study A – Romania 2000-2010

Start-ups and SMEs are the “engine of the European economy” (2). In Romania, this is no different. According to the World Bank, Romania’s per capita GDP grew from 1,668.2 US$ in 2000 to 8,297.5 US$ in 2010 (subject to a 10,136.5 US$ high before the world economic crisis 2007/08 (3). Again, if we look at GDP growth, and place the world economic crisis into the context, we can see significant growth levels during the same period; from the low of 2.4% in 2000 to its nadir in 2008 of 8.5% falling post banking crisis to -0.8% in 2010 (4). During the same period, according to Dr Emilia Herman, startup growth exploded during this period; In 2000 Romania had 295,589 start-ups registered by 2010 that number was 523,501 (2). The country undertook a series of reforms in order to pass integration rules along with a change into the service and knowledge economy. Employment and tax receipts, even if we include the banking crisis fall, grew by a healthy margin during this period. EU enlargement and Romanian inclusion helped to create 1 million new jobs and grew the economy by nearly 10% during this period.

Case Study B – Bulgaria 2000-2010

Bulgaria invested heavily during the late 90s to change its economy away from an agrarian/heavy industrial sector dominance into services, especially Information Technology (5). According to the World Bank, Bulgaria’s per capita GDP grew from 6,344 US$ in 2000 to 15,084.3 US$ in 2010. Bulgaria’s experience differed widely from Romania in that the global financial crisis didn’t impact as much on Bulgaria’s economy in per capita GDP terms. However, if we look at World Bank data surrounding annual percentile growth in GDP we can see a very different picture. Bulgaria started the millennium in 2000 with 5% growth levels and ended the decade in 2010 with 0.1% growth levels. However, the mean average during the same period was 5.85% according to the World Bank (6). According to Stanislav Ivanov and Craig Webster, the growth of start-ups was gigantic. According to the duo, in 2000 nearly 678,293 start-ups were registered with the government and by the end of the decade that number had nearly doubled to 1,18 million (5). The growth levels in Bulgaria were hit badly by the banking crisis but policy changes and investment in technology saw a massive increase in start-up activity during the period and after enlargement.

The future

Could the reverse happen to the UK? Could we see a 5-10% decrease in GDP due to Brexit? In the UK there are 5.2 million SMEs operating today (7). By applying the above enlargement model in reverse we can see a negative trend occurring. Could his happen to the UK? There are interpretative issues with this model. The UK is a more enhanced and stronger economy than Bulgaria and Romania. It has been a more developed economy with a stronger and longer-term basis in law and order, security of property and sound taxation. However, negative consequences can and will occur. A myriad of names from OECD, World Bank, HM Treasury, the Bank of England, Oxford Economics and PWC all argued during the referendum campaign that a vote for Brexit would be a vote for economic insecurity and possible recession. Yet, the nimble nature of start-ups could be the one saving grace for the sector at large. According to published data, venture capital firms since the Brexit result have invested $200 million into UK start-ups (8). This confidence, in part, is due to the ability of start-ups to weather change due to the nimble structure and deployment of services and products. Start-ups and freelancers alike can profit during downturns. Research has found that Brexit could help start-ups increase revenues as mid-size companies look to external sources to complete in-house tasks (9). The Bulgaria-Romania model could happen, but right now we do not know enough about Brexit. All we can do is evaluate options and understand the future timetable for exiting the European Union.

However, there are measures available to entrepreneurs that can mitigate the impact of Brexit on start-ups. The ICAEW argue that founders should monitor the European currencies market. Planning for sales should be a top priority. By focussing on the market, over the short-term, founders can make sure outlays don’t hasten beyond a set budget. Taxation planning is crucial. Until Article 50 is triggered and the negotiations complete no changes will happen – furthermore tax is a ‘state competence’ which means it is not set at EU level. Therefore, the domestic and transnational impact could come from Brexit contagion causing EU states and Britain to upwardly revise the tax rates accordingly to overcome any short-term Brexit issues. However, the long-term issue will be VAT. The EU-wide VAT laws will mean planning will be crucial once Britain leaves the EU. What the ICAEW argue is that founders should begin planning on setting up a Non-EU MOSS (Mini One Stop Shop) scheme application with the Irish tax authorities.

Tariffs or free trade? We do not know the terms of Brexit. Therefore, in the short term, the issue will surround futureproofing organisations. Do you focus on the domestic market, do you retain EU markets and plan for tariffs based on WTO rates of 3-20%? Or do you look further afield to the USA, Japan or China? The Government is hoping to cash in on any surplus talent by investing in infrastructure and outsourcing government services. This could be a great opportunity to look at the domestic market and tender for local authority or government contracts? Why not have a look at the Government’s Contract Finder Service?

So far we have learnt that venture capital firms are still investing. According to the FT, VC firms have invested nearly $200m in UK technology start-ups since Brexit occurred. Fears over FDI are real. However, there needs to be a realisation that government-to-government FDI differs wildly from VC FDI. Therefore, whilst working in the supply chain on big intragovernmental projects like Hinckley C, with the French and Chinese governments, which has just been placed on, could result in massive rising costs for founders. However, post-Brexit, funding from VCs into tech start-ups and bio/science firm start-ups are on the increase which could be an untapped potential for new founders.

Which industries will succeed under Brexit conditions? In periods of uncertainty, there are organisations that will flourish. For example, management consultancies, political or market intelligence services will be very popular with leading executive officers of organisations facing unprecedented change. Recruitment agencies and streamlining consultancies will be sought after services by businesses learning to re-adapt to the post-Brexit environment. Domestic tourism will see a mini revival as the pound continues to fall against the Euro and the Dollar which makes staycations more cost-effective. British luxury goods will become cheaper on the international stage and this will help increase exports of such items. Rolls Royce, Bentley and Burberry have already started to look at new opportunities. Engineering, manufacturing and trade businesses can look forward to cheaper exports and increased global sales.

However, agriculture, retail, hospitality and leisure sectors could lose out from immigration quotas. Free movement of people helps agriculture and hospitality businesses. The argument that Britons won’t pick fruit or wash dishes for the minimum wage will create a problem for these businesses. It all depends on the passporting rights we get from the EU during the negotiations. However, financial services and banking are a big part of the UK economy. If we fail to get the right agreement, we could see a wholesale divestment from the City of London. This would be catastrophic to big and small business alike. Start-ups trading with big city institutions account for 25% of their spending. This means small start-ups could lose out a big potential client pool. The risks of Brexit also decrease staffing / talent pools. As the closure of the EU freedom of movement principle will make it harder to gain talented employees for businesses across the UK.

These small steps which include monitoring the socio-political terrain, focussing on currency markets, looking at new domestic markets and understanding the positives and negatives of Brexit can help founders understand the potential pitfalls surrounding Brexit. Diligent planning and a bit of luck could go a long way and help founders create innovative and disruptive start-ups in this challenging post-Brexit era.