Brexit set to dent UK tech business valuations

 Jamie Johnson, Corporate Finance Director at Moore Stephens, discusses the impact of Brexit on the valuation of British tech companies

Investors expect Brexit to reduce the valuations of UK tech businesses in the coming year, according to Moore Stephen’s recent study of more than 100 investors in the UK technology sector, (including private equity and venture capital as well as technology companies). However, despite this, the market expectation is that significantly more deals will take place in the short to medium term due to sector consolidation.

The research shows that 51% of investors predict that valuations of UK technology businesses will drop over the next 12 months, with only 28% predicting valuations will remain steady.

44% of investors expect to see an increase in M&A activity in the coming year, while only 26% think the number of transactions will slow, suggesting that a fall in valuations of UK tech businesses is expected to lead to an increase in deal making in the coming months – as larger corporates seek to purchase innovative tech businesses at lower prices.

The survey also reveals a difference in sentiment between trade buyers and investors. Trade buyers appear to be considerably more positive than PE and VC investors regarding current valuation levels, with only 42% of trade buyers believing that valuations are currently too high, compared to 79% of PE and VC investors. As trade buyers will often offer their listed shares as consideration in a transaction, they tend to be less sensitive to higher valuations than PE and VC investors, who, by necessity, will pay predominantly in cash.

In recent months we have seen some major investments in UK tech businesses:

• In May, Japanese tech giant Softbank invested more than $500 million in London-based virtual reality start-up Improbable, reputed to be the largest Series B investment ever in Europe
• Babylon, a digital healthcare business also based in London, raised $60 million in April to allow its artificial intelligence researchers to develop an AI doctor that can diagnose illnesses without human interaction. Investors included Demis Hassabis and Mustafa Suleyman, founders of Deepmind, the AI business acquired by Google in 2014

UK still the digital destination, despite Brexit

From a digital standpoint, the UK is, and will be, one of the world’s key digital destinations and hard for investors to ignore. Investors are still looking to make deals, especially when the technology involved has significant commercial potential.

The tech sector doesn’t have the same investment characteristics as more traditional business sectors so, although Brexit may bring about a slight confidence knock, our research suggests that investors are still keen on backing UK tech companies.

For deals with VC funds, investee companies may have to compromise a little more on price to get these deals over the line, but the kind of ground-breaking technology being developed in the UK means that deals will be made, whether that’s by investors in the UK, or by US and Chinese players.

Government encouragement for investors may be key

The general view held within the market is that with Brexit comes a significant risk of the loss of future funding from VC and PE firms, along with increased competition from Europe’s tech hubs seeking to prise tech businesses away from London. To counter this potential loss of funding, Britain should encourage more US based VC firms to set up and invest in the UK, bringing with them a fresh, bullish outlook to the UK tech market.

To further encourage investment into UK tech post-Brexit, the Government should increase the level of funding available for emerging tech start-ups and continue to provide support and infrastructure through the Government backed agencies, such as Innovate UK. Investors could be further incentivised by increasing tax benefit thresholds for those that take the risk of investing in early stage tech businesses, through reliefs such as the SEIS and EIS schemes, and expanding the awareness of research and development tax credits and Patent Box schemes.

Talent development must be supported

The ability to attract and retain top talent from Europe is under real threat as a result of the expected loss of free movement of labour for workers between Britain and Europe. Should this lead to access to highly skilled workers in the tech sector being negatively affected, uncertainty will loom over Britain’s status as a favoured location for global tech companies. The Government will therefore need to find an alternative model to ensure that the influx of talent is not restricted; such as increasing the number of tech visas granted post-Brexit.

It’s noticeable that a lot of the conversation around the impact of Brexit on UK tech has been around maintaining access to international talent, but further action must also be taken to ensure that Britain continues to foster and develop home-grown talent too – be that school leavers, apprentices or university graduates. Partnerships amongst key stakeholders within the UK tech ecosystem including universities, corporates, advisers and industry experts should continue to be developed in order to promote and provide accessible courses, training schemes, apprenticeships, internships and mentor programmes.

The UK’s loss of access to the ‘digital single market’ is likely to have a considerable impact on how the tech industry is regulated post-Brexit. In order to maintain the status quo, the Government will need to be proactive in creating new domestic regulation, whilst at the same time negotiate bilateral agreements. This is the only way the UK can maintain a stable and transparent political, legal & regulatory environment for the sector.

The impact of Brexit negotiations will no doubt cause short-term waves but it’s also clear that the sector has belief in the ability of the UK to ride out the storm, and that the rich vein of talent and investment will continue to see the UK as being at the vanguard of the global tech space.

 Jamie Johnson is the Corporate Finance Director at Moore Stephens.

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