What will Brexit mean for London's digital entrepreneurs?

Market access

A vast majority of startup executives - in common with other globally oriented industries - prize their access to the EU's single market. They see no reason why startups, selling apps, software and other such services, should limit themselves to one market; digital technologies need not be constrained by geography. Software and code, unlike many other exported goods, does not maintain a physical presence, meaning territorial limitations to their sale archaic to say the least.

Most tech entrepreneurs also have international ambitions, hoping to emulate the success of their forebears that have 'gone global', such as Facebook and Uber. By eliminating tariffs and significantly reducing non-tariff barriers, including mismatch of regulatory standards, the UK's membership of the single market has done much to facilitate the growth of the domestic tech industry. Indeed, research indicates that a significant proportion of customers and suppliers of London's tech firms are based in Europe. Post-Brexit, a range of policy organisations, such as Coadec and techUK have argued that continued membership of the single market is absolutely vital for the industry's very survival in the UK.

If the UK does not remain in the single market (which is looking increasingly likely), the next best option would be a comprehensive free trade agreement (FTA) with the EU, like CETA (the EU-Canada FTA).

However, CETA does not fully cover the services industry; this is the key issue which London's startups face. London's startup ecosystem is dominated by companies in 'fintech' (financial-technology), media and digital advertising and marketing (i.e. services firms). Studies show that negotiating a free trade agreement covering services is much more difficult than one covering just goods. Unless the UK stays in the single market or negotiates an FTA with the EU which comprehensively covers services, trouble lies ahead for London's startups (and also, in all probability, for the wider UK economy, which is 80% services).

The fintech sector, in which London is presently a global leader, is particularly at risk, due to the potential loss of 'passporting' rights. Often discussed in the context of banks, 'passporting' rights enable financial services firms to do business in any EU or European Economic Area (EEA) member state without being authorised and licenced by that state, so long as they are based in the EU or EEA. This enables financial services firms based in London to export services and products freely throughout Europe.

One such firm is TransferWise, the highly successful money transfer service, founded by two Estonians, which depends on 'passporting' rights for large chunks of its business. Removal of these rights, a real possibility if the UK left the single market, will mean firms such as TransferWise will incur significant regulatory and financial burdens. This perhaps explains why the co-founder, Taavet Hinrikus, considered moving the firm's headquarters elsewhere in the wake of Brexit.

Simply put, Brexit could make it much harder for London-based startups to operate in the European market. Although much of this depends on the nature of future UK-EU relations, a situation in which tech startups are negatively impacted looks increasingly likely. One could argue that the UK might negotiate a whole host of FTAs with other countries which would be able to cater adequately for the globalist ambitions of British startups. However, these would not come into effect for a number of years and would have to cover services much more extensively than most FTAs currently do in order to be of any use. Such a comprehensive set of far-reaching agreements would also raise the question of why Brexit was necessary in the first place, since they would almost certainly entail allocating regulatory powers to a body above the nation-state.

Funding

One of the most obvious challenges faced by new startups is access to capital. In London, funding comes from a range of sources: venture capital firms (VCs), angel investors, accelerators and crowdfunding. The fact that London is a global financial hub is, in consequence, extremely handy for its tech entrepreneurs. Indeed, one of the reasons why London tops the European Digital City Index is because of its high scores on 'access to capital'. VC funding has been increasingly significantly year-on-year in London for the past few years.

Less acknowledged, but no less important, is the start-up financing provided to the tech sector directly from European coffers. One very specific risk accompanying Brexit is the loss of access to the European Investment Fund (EIF), which provides funding to VC and private equity firms. Between 2011 and 2015, the EIF committed €2.3bn to 144 UK-based funds and has indirectly supported over 27,000 UK companies, many of which are early-stage tech firms. The EIF is therefore a major player in the funding ecosystem for London startups. The case of Deliveroo, the food delivery company founded in 2013, illustrates the role that the EIF plays. So far, Deliveroo had raised $474.59m from various VC funds, many of which are directly funded by the EIF.

Given the prolonged squeeze in UK public finances, highlighted in the recent Autumn Statement, it would be difficult for the UK government to adequately replace the funding of the EIF. Indeed, as with many other policy areas, the worry is not that the European funds are conceptually irreplaceable, but rather that future UK governments will have neither the capacity - not the inclination - to provide the level of investment currently offered by Brussels. At this stage, it is unclear whether the UK funds would still receive EIF funding post-Brexit. The EIF does engage in some non-EU countries, such as Israel, although these tend to be negotiated on a case-by-case basis. Of greatest import may be the fact that, unlike many forms of EU-funding, the EIF generates revenue by financing London's VC firms. Nonetheless, it is difficult to imagine the funding situation improving post-Brexit, not least due to the two years of uncertainty likely to ensue.

Final thoughts

Brexit is likely to have a significant impact on the startup ecosystem in London. It is highly likely that the UK's new trading relationship with the EU, as well as any new immigration regime, will negatively impact on established tech firms and deter digital entrepreneurs from setting up base in London. Although future scenarios that may benefit startups are identifiable - for example, a move to a more skills-based immigration policy - politically these options would seem to have already been ruled out.

London will, of course, remain a global hub for tech and entrepreneurship post-Brexit. While Brexit will damage the startup ecosystem, it will not destroy it completely. London is likely to remain a global financial centre with a vast array of funding options for entrepreneurs. It will continue to have a highly skilled and international workforce and will remain a centre of innovation, science and academic excellence. Moreover, entrepreneurs are resilient, adaptive and positive; many of them will view Brexit as an opportunity, rather than a threat, although this may not accurately reflect objective analysis of Brexit's likely effects. Like the animals in a changing ecosystem, Brexit will force London's startups to adapt in order to survive.
 

• Oliver Patel is a Research Assistant at the UCL European Institute.

This article first appeared on openDemocracy and is reposted here with permission.