FAQ: Brexit for Non-Brits

The Impact of Brexit on Non-UK Startups.

In the wake of the UK’s vote to leave the European Union, the UK and the rest of the world have been trying to grasp what’s next for the world and what “Brexit” will actually mean for business.

To address a number of questions our U.S. entrepreneurs are asking, we have compiled our thoughts on the practical implications for international startups who are either considering coming to Europe or growing their existing European operations.

As we’ve recently written, we’re still bullish on Europe. There is no denying that the referendum result has added uncertainty for entrepreneurs, but this doesn’t change our view that a great team, pursuing a big market with an inspired product vision can create value that outweighs macro risks by orders of magnitude.

Transcript

1. July 6, 2016 FAQ: Brexit for Non-Brits
2. The Impact of Brexit on Non-UK Startups In the wake of the UK’s vote to leave the European Union, the UK and the rest of the world have been trying to grasp what’s next for the world and what “Brexit” will actually mean for business. To address a number of questions our U.S. entrepreneurs are asking, we have compiled our thoughts on the practical implications for international startups who are either considering coming to Europe or growing their existing European operations. As we’ve recently written, we’re still bullish on Europe. There is no denying that the referendum result has added uncertainty for entrepreneurs, but this doesn’t change our view that a great team, pursuing a big market with an inspired product vision can create value that outweighs macro risks by orders of magnitude. Index Ventures
3. TL;DR There are no immediate changes to the way you do business in Europe. So far, no UK laws or regulations have changed and all EU rules, regulations and trade agreements relating to the UK remain in force. They will remain unchanged for at least two years. London retains its role as a key tech hub in Europe. The importance of London may diminish over time (especially in financial services), but if this happens, it will happen gradually. For the foreseeable future – we think at least the next 5 years – London will remain the preeminent European base for startups. Be flexible as you choose where to expand internationally. London was previously the obvious choice for a European base – and it may still be for many startups. However, we advise that you also consider other locations, such as Dublin, Amsterdam and Berlin and remain nimble enough to switch locations if better choice becomes apparent. Stay focused. The whole topic of Brexit can become an unnecessary distraction. For most startups, its impact will be minimal in the short term compared to other decisions you will take for your business.
4. What Just Happened? On June 23rd, the British people voted to leave the European Union in a national referendum. 17 million people voted to leave and 16 million voted to remain; London voted to remain but most other English regions were in favor of leaving. Scotland and Northern Ireland voted to stay but, being part of the UK, they are currently bound by whatever agreement the UK government strikes with the EU. Observers attribute the result to a combination of factors including concerns about current and future levels of immigration from the EU; fear that the UK Parliament has lost its sovereignty on certain issues to the EU; and stagnating economic conditions outside of London (which some attribute to the UK’s EU membership). David Cameron, the Prime Minister who called the referendum and was actively campaigning to remain, has committed to stepping down. This has kicked off a leadership contest which will result in the appointment of a new Prime Minister on September 9, 2016.
5. What’s Next? Technically the Referendum was advisory and has no binding consequences. However the current government has committed to recognizing the outcome of a democratic process and pushing toward a formal exit from the EU. The new Prime Minister, who will be appointed on September 9th, could choose to call a general election to cement his/her democratic legitimacy. This would result in several more months of campaigning leading up to an election. While all parties are likely to campaign on the basis of exiting the EU, this is not a given. The formal process of leaving the EU is triggered when the UK government formally tells the EU and triggers Article 50 of the Lisbon treaty. This begins a two-year negotiation process to determine the terms of the separation. Negotiations will be protracted: While the UK will seek to preserve access to the EU’s single market for its goods and services, this appears incompatible with promises made by the Leave camp to curb immigration from the EU. Once a new relationship has been negotiated, the UK Parliament would still have to enact the relevant changes to UK law. There is a remote chance that the UK Parliament might not vote for the changes or may seek a second referendum.
6. What Is the Most Likely Outcome of Negotiations? The key debate will revolve around whether the UK can maintain tariff-free trade with the European Single Market while putting constraints on immigration from the EU. In our view, the most likely scenario is that the EU will negotiate from an economically rational standpoint and concede some additional controls around immigration to the UK—such as allowing the free movement of labor rather than absolute free movement of people—and still allow the UK to maintain its trade status with the EU. The worst case scenario would prevail if no agreement is reached before the clock runs out on the official EU exit and the UK loses access to the single market, reverts to WTO trading rules and places strict restrictions on immigration. We think this outcome is unlikely given the importance of trade between the UK and the EU.
7. What’s the Immediate Impact on the UK Economy? Compounding uncertainty about future trade relationships, the new Prime Minister and a potential referendum in Scotland will undoubtedly delay long-term corporate investment decisions and may impact consumer confidence. This has led economists to predict a large negative impact on UK GDP, driving the economy close to or into recession in 2017 and a material (though lesser) impact on EU GDP. The British Pound has fallen sharply against the dollar and could fall further if confidence is not rebuilt. The UK has a large current account deficit which makes the GBP very vulnerable to material changes in foreign direct investment. On the flip side, the weak British Pound will make London cheaper for international firms who hold dollars as their main currency.
8. Does Brexit Present Any Opportunities for Startups? The fall of the British Pound has made the UK a cheaper place to do business for companies earning in foreign currencies. Property prices and rents are also expected to fall. Many incumbent players may falter finding it too difficult to adjust to rapid changes in the environment, creating opportunities for more nimble companies to take their place. Lots of talented employees – especially from financial services companies – who won’t want to relocate as their companies shift headcount to the EU, will suddenly become available to startups. The government may become even more business friendly to counter incentives for UK companies to move abroad. This may in turn create better business conditions for startups.
9. Should London Still Be Top-of-Mind for your European HQ? Before the Brexit vote, we would have advocated wholeheartedly for London as a European HQ. In the past, the vast majority of US companies have based their European operations in London. Today, we recommend that companies also consider Amsterdam, Berlin and Dublin, in addition to London, for their European bases. This is especially important for companies in heavily-regulated industries – such as financial services – who may no longer be able to conveniently passport their status from the UK across the EU. On the whole, London will continue to be a dominant city in Europe’s tech scene for the foreseeable future, as it is Europe’s largest English-speaking hub, filled with a highly-experienced, educated and creative workforce from around the world. Given the uncertainties, however, companies who have or will choose London will need to remain flexible so they can make adjustments as the negotiations progress.
10. How Will the Brexit Vote Impact Hiring into and from the UK? There will be no immediate change until negotiations with the EU are completed which will take at least two years. Existing rules on employment and freedom of movement will remain in force until then. We consider it unlikely that any subsequent changes will affect your existing non-UK employees working in the UK. Most economists predict that once the UK officially exits the EU, there will be some limitations on migration, but the impact on hiring highly skilled and highly paid employees will be minimal. It will, however, present an additional administrative burden on companies relying on talent from abroad. Companies should base themselves in a cities where they can attract the most relevant talent. For many, this will remain London, but this could change and require London as a talent base to be re-evaluated regularly.
11. What Does Brexit Mean for Fintech Businesses? In our view, Brexit presents the highest risk to fintech companies, who stand to lose the valuable passporting which allows them to offer innovative financial services across the EU from the UK. We also expect that many wholesale financial activities such as securities exchanges and other institutions clearing transactions denominated in Euros will shift to the continent. We expect that fintech companies will have to register both in the UK and the EU and will want to have a statutory presence in both regions. Possibly the greatest economic impact of Brexit is that London’s dominant position as a financial services capital will be diminished over the long term if the EU insists that key clearing hubs be located within the EU. However this will take years to materialize. Nevertheless, in the short term, London remains a very appealing base for fintech startups that can draw on the talent, capital and infrastructure that have concentrated there over the decades of being one of the world’s great financial centers.
12. What Events Might Cause Us to Change Our Reaction to Brexit? If several major financial services companies begin to leave London and move to the EU. If many major corporations move their operations to the EU. If in 2018 negotiations begin to run out of time without an extension granted, and the UK looks destined to revert to WTO trading rules. If negotiations lead to a severe curtailment in the free movement of labor. If a deteriorating perception of UK’s openness and political climate begins to deter talent from coming the UK even before the outcome of the negotiations. If other countries in the EU launch other referendums and populist anti-EU parties in Italy, France and the Netherlands gain momentum.
13. What Does This Mean for Index? As we’ve done for the past 20 years, we will continue to support entrepreneurs with global ambitions wherever they are; inside or outside of the EU. Brexit hasn’t changed our investment strategy. We will be working directly with our companies to help them make any necessary adjustments in the short term and advise on longer term plans. We will continue to provide all necessary support to companies expanding to Europe. This includes helping them navigate the rapidly changing environment and assessing Brexit’s impact on every part of their business, from hiring and office space, to tax and legal arrangements. On behalf of the Index family of companies, we will work with both the EU and UK governments to advocate for minimal disruption of the transformative businesses that are driving their economies.