Market Shock — After Brexit for startups

London’s startup investor community rallies after the country’s referendum to exit the European Union. That sentiment also largely fails to reflect the mood of finance. Large banks make plans to relocate office to European cities like Dublin, Frankfurt, and Paris. International markets slowly digest a new European financial geography, where London no longer holds passporting rights. I’ve personally heard of $600M in private equity investments held since Friday at 9AM.

Startup entrepreneurs know investors rarely say no. They either come in, or defer to non-distinct future moments. Presently, they bargain with the future. Recommending the UK government negotiate favourable terms with Brussels. Calling on the Treasury to directly replace losses from European structural funds. Recommending an absent government cut corporate tax when it’s unclear where interest rates will go and what foreign appetite remains for British sovereign debt.

My goal here is to dispel delusion and approach Brexit from an entrepreneur’s point of view. You’re a lean team building a product, and you’ve just had a market shock. What happens now?

First and foremost, take stock of what has happened. Far from neologisms about making hay while the sun shines and positive thinking. The average company takes 5–10 years from inception to exit. You’re somewhere in that journey. Your company’s environment has now completely changed. For you, maybe nothing changed or maybe everything changed.

Five whys: Brexit Edition

I want to bottom out what I see, and consider the environment in which I now build my business. What does the new environment offer? What are the limitations? What does it mean?

1) Britain voted to exit the European Union.

2) Massive civic and structural fractures exist between London and the rest of the country.

3) The UK became a two-speed society, with unbalanced distributions of education, income, health care, housing, representation, and wealth.

4) London – operating in a vacuum – reaped substantial gains as the hub of European and transatlantic finance, media, and technology. Many of those gains went offshore and failed to be shared with the rest of the country.

5) Breakdown of class compromises underpinning the United Kingom’s liberalised capital markets and social democracy.

The country (and the world) continues to unpack the social dislocation that occurred on Thursday, and subsequent impacts, consequences, and opportunities. There’s very little agreement exiting the European Union offers prosperity and continues the record growth story seen here over the past three decades. Rather, the current sentiment looks to now find the opportunities within this future condition.

Summary: Britain voted to exit the European Union because of deep domestic structural problems, not because exit offered profound economic opportunity. Those are not problems solved in two years, five years, ten years. Brexit resonates into Britain’s future for at least two decades.

If facist or populist factors destabilise Europe in the meantime, when Britain finally re-emerges in a generation, it is highly unlikely that London returns to such a position of dominance on the world stage as it enjoys today.

For each business — and each entrepreneur– the answer will be different. Ultimately, now that Britain has fundamentally changed as a market, you must consider that new landscape. What that means for your own fortunes.

As startup technology companies, many of us produce IP that works in different markets around the world. Startup ecosystems are on the growth agendas of most countries. You may have mobility options others do not. You may either desire to move markets now, or you may be courted to move market later.

You must consider the UK’s new market position; if this is the best market for your business. You may decide to ‘keep calm and code on’, or you may decide to move back into the European Union, or go for the largest markets of China or the United States. Most press, from financial to tech, speaks of long-term trends. What will happen when “Britain keeps most of the venture capital, and Europe keeps most of the talent.”

In the meantime, London’s startups must account for variable change and entrepreneurs decide where businesses thrive on the basis of Fiscal This Year and Fiscal Next Year.

Market

First and foremost, consider the exit’s TAM, SAM, and SOM effects. If investment-backed, market size determines investment attractiveness and whether current / next round targets can be met.

Whether or not Brexit changes market size depends on three factors – nature of product, direct buyers, and market environment. There’s a lot of nuances here and it deserves a deep think.

Unchanged/Improved Outlooks

Mainly product-based startups born global. Enterprise. Social networks. AI.

1. Enterprise infrastructure software application. Potential global market of 10,000 companies. Primary sales channels are direct and partner resellers. Average seat license cost of $200.
2. Network orchestrators / social networks / network marketplaces. Potential global market of 100M customers. Primary channels to market are app stores, content campaigns, and P2P marketing.
3. Research and data-based products / AI. Cracking problems based largely (strictly) on data, and scalability is not a factor. Think Magic Pony — where the domestic market is large enough to build and refine a product, and scale (before Brexit and after) requires becoming part of a company with a worldwide footprint.
4. Manufacturing / IoT / cleantech / biotech. Potentially a huge boom across the board as exports become cheaper with devalued sterling. The difficulty for those companies may be attracting talent on lower incomes, however simultaneously, it is likely that cost of living in London declines as companies atomise UK operations into Europe.

Changed Outlooks

Mainly services. Ecommerce. Fintech. Online/offline hybrids.

1. Fintech services where the dominant market is London and the growth strategy is across European cities. Without passporting, growth plans now requires offices in Europe. If the product serves Britain, it makes sense to remain based in London. If the product serves only London, it may make sense to relocate the head office to Europe.
2. Fintech services where the dominant market is property. Proptech market adoption is driven by inefficiencies in the trade of high-value assets, usually while those assets are appreciating. Proptech’s fortunes lay on whichever property submarket they serve.
3. Fintech investment platforms are likely to be the first hit, especially in the buy-to-let sector. Increasing prices of imports combined with decreasing returns from property (see demand destruction below) may see a flight to quality as retail investors abandon higher returns for security. Further, if the Bank of England raises rates to support sterling, all bets are off. The residential financing platforms were incubated in a very specific market situation. The constituent components were 1) low interest rates, 2) limited supply, 3) the best economic prospects for 500M people who had right to free movement. If demand starts backing off, property financing platforms run redemption risks, or simply dry up.
4. Similar risks apply to P2P equity platforms, which aggregated money from around Europe and the world, and put them into startups in London. Smaller market size for London startups = smaller market for intermediaries.
5. Residential property pricing is expected to pull back between 5% in the short-term, and up to 20% in the next 24 months. The Leave campaign was not only about Britain leaving the European Union, it was also about immigrants leaving the United Kingdom. A pure form of demand destruction. Mixed bag for people around the United Kingdom, depending on whether their an owner or an occupier, or a borrower or a lender. Regardless, if asset prices cool, there’s less need for technology that more efficiently executes transactions. As demand recedes, velocity slows. Shifting from a sellers market, where buyers adopt tools to reduce price risk, to a buyers market. As margins decrease, both buyers and sellers become less interested in new solutions.
6. Commercial property is up for grabs at the moment. Some corporate demand (banks) disappears. Weaker sterling means other demand (industry, foreign companies) appears. There’s a distinct possibility that other developed/emerging markets take advantage of lower rates to expand representative offices in London to larger formal footprints. The challenge for commercial proptech is time — the gap in between finance reshuffling out, and new demand coming in.
7. Ecommerce platforms serving London customers may struggle as the city rebalances away from finance and jobs are lost. During economic disruption, people become less interested in new solutions and stick with what they know. They’ll be concerned about jobs, families, friends. Customer time spent more on community and less on consumption. As immigration was key to the leave agenda, it’s unclear what customer composition looks like in six months, one year, five years.
8. Ecommerce platforms serving national customers will struggle if the country enters either recession or austerity. While each sends customers looking for cheapest options, both also reduce net consumption and lead to cannibalisation and consolidation. Currency shifts will gradually move consumption patterns away from some imports.
9. Retail platforms struggle if domestic consumption flags, and boom on the back of increased tourism driven by sterling’s devaluation. Platforms designed to combat high retail rents face mixed fortunes as landlords turn from price-setters to price-takers. Platforms serving luxury markets and restaurants boom as tourism rises.

Point being your business serves a market — a market interdependent on other forces. If that market depends on outsized demand for residential property, the entire point of the referendum was restricting supply and decreasing market size. If that market is taking British products to consumers around the globe, the devalution of sterling increases it.

Look up and down your value chain. Look at how this affects your customers, and their customers. Look at how this affects your suppliers and their suppliers.

Team

The impact of immigration is adequately covered in the tech press. The only comment I add that Brexit impacts not only the capability of companies to employee workers in Britain, but also the desirability of Britain itself.

Britain is no longer Europe.
Cuts in European research funding affect R&D.
England becomes hostile toward immigrants.
Five years or more of economic uncertainty ahead.
Lack of clarity on the route to residency and British citizenship.
London is no longer the centre of European and global finance.
Weakened sterling decreases the multiplier affect of saving here.

The greatest detriment to talent acquisition is ecosystem damage. Better startups attracting more capital creating better startups. Beyond startups, it included the best people in European finance, media, policy, and research. London had a global network effect because first and foremost it had a European network effect. Without the latter, the former is in doubt.

The soft factors that sell talent on London evaporate. It’s not the coolest, most diverse place in Europe. Paychecks do not go as far abroad. There’s no route to European citizenship. There’s a distinct lack of clarity as to where the country ends up.

Britain voted to exit the European Union because of deep domestic structural problems, not because exit offered profound economic opportunity.

All of that affects the talent magnet.

Product

The only specific comment here is about product viability in recessions.

Many of the products in development are peak-shavers that serve boom business and consumer markets, taking fractions of transactions or making small commissions of large volumes.

If your market is primarily domestic, given the most likely outcome of Brexit is a period of oversupply, how does your product fare with lower prices and/or lower volumes of transactions?

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This was written to provoke you, your co-founders, and your teams into interrogating what Brexit means for your companies. What’s happening for your suppliers, customers, and competitors. From a place of authenticity and free from chatter and delusion. While there is always opportunity in disruption, there is also distress. The greatest opportunity in the London startup scene now for is pragmatism and decisive action by our companies.

nick@projectx.nyc