What will Brexit mean for London's digital entrepreneurs?
19 December 2016
Oliver Patel, Research Assistant at the European Institute, offers three reasons why the Brexit vote is worrying for London's tech community.
On virtually every measure available, London is Europe's startup capital. London is home to the most successful, vibrant and dynamic ecosystem of tech startups on the continent. Nesta's European Digital City Index ranks cities based on their attractiveness to digital entrepreneurs. For two years running, London has topped the ranking by a significant margin.
Nearly 40% of Europe's 'unicorns' (tech companies with a value exceeding $1bn) were founded in London, including 'asos' and Zoopla, as well as many other notable success stories, such as Deliveroo and TransferWise. Due to its financial prowess, London boasts a plethora of funding and investment options for entrepreneurs. In 2015, digital firms in London raised a total of $2.28bn, up 69% from 2014, and much higher than any other European city. It is fair to say that London has become a major global player in tech and entrepreneurship.
Many entrepreneurs and investors are worried that Brexit could undermine the success and progress which has been achieved in the last few years. In fact, it is difficult to think of a constituency more resolute and united in its opposition to Brexit than the startup community in London. Entrepreneurs and startup policy groups have been extremely vocal in their opposition to Brexit. Indeed, a 2016 survey by Tech London Advocates found that 87% of more than 2,450 tech professionals, entrepreneurs and investors were in favour of remaining in the EU, with only 3% wishing to leave. This finding echoes the results of similar polls as well as the dominant pre-referendum discourse within the community.
The reason for the tech community's opposition to Brexit is not difficult to fathom: London's startup community represents, in its everyday activities, much of what the Brexit campaigners are opposed to: it is international, open-minded, forward-thinking and embraces globalisation. Moreover, a high proportion of workers in the sector are EU nationals - around 20%, according to one source - meaning the industry has a substantial stake in maintaining close association with the EU.
As with other sectors of the British economy, the impact of Brexit on London's startups will depend ultimately on the nature of the future relationship between the UK and the EU secured in the years to come. Whilst the shape of any future deal remains unclear for the time being - event to members of the British government - it is not difficult to identify those areas where the greatest battles will be fought between the tech industry and the Brexiteers: immigration, market access, and EU funding.
For years, London's entrepreneurs, many of whom do not possess UK citizenship, have been complaining about British immigration policy. In this respect they are not dissimilar to the Brexiteers. Unlike advocates of the leave campaign, however, the tech community has been pushing for liberalisation of the restrictions on migration into the UK, complaining that hiring workers from overseas is too difficult even with the freedom of movement between EU member-states. Time and time again, access to talent is highlighted as the greatest challenge facing startups.
Indeed, according to available date, the UK does have a discernible IT skills shortage. And since the demand for skilled digital jobs far outstrips the supply of skilled domestic labour, startups have understandably started to look abroad for talent. Onerous immigration procedures, especially for non-EU citizens, have hampered their ability to fill these roles and thereby undermined their capacity for expansion.
It is reasonable to assume that Brexit will have a major impact of the UK's immigration regime. Despite Theresa May's impressive silence on the UK's negotiating position, there is much to suggest that an end to freedom of movement in its current form will be the UK's top priority and will constitute something of a 'red line' in the forthcoming negotiations. It is unclear at this stage whether any agreement on single market access without freedom of movement will be possible, although it is potentially a moot point, given May's unwillingness to agree to maintain free movement. Nor is it particularly clear what will be the status of EU nationals currently living in the UK after Brexit, or what the effects of Brexit on UK migration policy will be in general.
Whatever the outcome, though, it is difficult to see any way in which Brexit will make it easier for startups to hire the talent they need. Any hope that Brexit will lead to a more open migration policy for non-EU nationals are likely to be rapidly dashed. The current political climate, the perceived status of the referendum result as a protest vote against migration, and the continuing government commitment to reduce net migration all augur against any relaxing of immigration restrictions.
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.
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.
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.