The Brexit dilemma of eco-system relocation for London start-ups
By Amelia Ann Román and Niels
Developments surrounding the on-going Brexit negotiations create uncertainty which is reflected in the European financial markets and the global economy. This uncertainty is interrelated with economic risk, and thus forces entrepreneurs to re-evaluate their risk and return trade-off schemes. Throughout this interlude, London-based entrepreneurs may well be considering pursuing their entrepreneurial opportunities elsewhere rather than remaining in the London metropolitan area. This possibility raises the fundamental question: whether European entrepreneurial ecosystems have the merits to attract the London based startups contemplating relocation due to Brexit.
What is important or qualifies as essential to entrepreneurial success in one region cannot be applied in another region. In simple terms, what goes for London is not necessarily the right recipe for successful startups in for instance Paris, Amsterdam, Berlin or Tallinn. These European metropoles are becoming unique entrepreneurial ecosystems for startups with their specific cultures, institutions, and characteristics differing from other startup regions in the world. Unique ecosystems are more than just locations; they are crucial for startups and all startups should ask themselves whether they are in the right place for their business. Because location decisions are of high strategic importance to each and every company, this question is now, of particular importance for entrepreneurs currently based in the London entrepreneurial ecosystem.
Introducing the London Entrepreneurial Ecosystem
London is known for being one of the most successful startup ecosystems globally, producing the largest output of startups in Europe (Startup Genome, 2017). Currently, the city of London hosts on average around 5,100 active startups which is the fourth largest startup output in the world, and accounts for more than twice the number of startups compared to the next biggest European ecosystem, namely Berlin, which hosts on average 2,100 active startups (Startup Genome, 2017). Overall, the London entrepreneurial ecosystem ranks first on a European level in all indices (European Digital City Index; Global Entrepreneurship Index; Startup Heatmap Europe; 2016), and ranks third according to the Global Startup Ecosystem Ranking conducted by Startup Genome in 2017, behind Silicon Valley and New York respectively. Not only is London’s startup industry the most developed in Europe (Nesta Report, 2016), but due to proximity to some of the world’s largest banks, professional venture capital funds, and technology firms such as Apple, Google, and Facebook, London’s startups have access to both potential investors and acquisition opportunities (Startup Genome, 2017). In addition, London’s cultural diversity is one of the strongest attributes that its ecosystem has to offer, with the capital’s multiculturalism acting as a key differentiator compared to other global startup ecosystems (The Guardian, 2015). Despite London being one of the most attractive ecosystems for startups globally, since the EU referendum held by the UK in June 2016, numerous sources (The Guardian; Financial Times; TechCrunch) have indicated the possibility of a great number of startups considering relocating to other European ecosystems afore and after the initiation of Article 50 of the Lisbon Treaty of the EU on the UK, more commonly referred to as Brexit.
Brexit, the Free Movement of People & the Access to Talent
London continues to be the best destination for technical talent within Europe (Balderton Capital, 2016); however, as a result of the uncertainty surrounding the current Brexit negotiations, London lost some of its technical talent to neighbouring capitals, specifically to Berlin and Paris (Atomico Report, 2017). According to a source of the Financial Times (2017), this is “[…] not because the UK is not appealing anymore but because they (i.e. talent) don’t want to invest a year and then have to leave again”. Hereby, European nationals are avoiding a move to the UK given the current ambiguity regarding visas (Inc., 2018). A study by Balderton Capital (2016) claims that London’s attraction rate could further decline as higher recruitment costs of foreign talent who need visas could become a significant problem post-Brexit. According to the Financial Times, the UK has already experienced a sharp drop in job applicants from other EU member states. Data indicates that during the first quarter of 2017, there was a 10% reduction in technical job applications from abroad compared to the same quartile in 2016 which was before the Brexit referendum (Financial Times, 2017).
The Future of European Entrepreneurial Ecosystems
A survey conducted by Balderton Capital (2016), showed 82% of the startups are concerned about access to talent post-Brexit. The study concludes that losing just 20% of its startup workforce will result in talent being dispersed across other European entrepreneurial ecosystems, resulting in there being no definitive leading ecosystem in Europe. As Brexit has the potential to shift the startup ecosystem playing-field in the EU, we argue that it is essential to research this further and ask if London startups are considering relocation due to Brexit. This naturally leads to the next question of which European entrepreneurial ecosystems stand to benefit by a possible exodus of the London startups.
A review of prior academic literature on location studies highlights several key factors to be taken into consideration regarding the situation of London startups possibly leaving the entrepreneurial ecosystem and relocating elsewhere. A company’s location decision is thought to be not arbitrary but strategic. Location decision models have often been applied to analyse the relative importance of location specific characteristics in company’s preferences of favouring one location compared to other locations. With a review of studies from before the 1980s to current studies, we find a total of 18 essential indicators. There are factors related to the cost of production, such as (1) transportation, (2) labour costs, (3) access to raw materials and external (4) economies of agglomeration, which were among the four most traditionally cited location determinant factors at the time.
Two decades later, this was expanded on with major production factors such (5) access to the labour market, and (6) market size. Also (7) taxes was found to affect the firm’s choice of location during the final evaluation of alternatives. Research expanded on traditionally cited factors affecting location to include factors such as (8) quality of labour, (9) business climate, and the (10) quality of life. Other studies analysed the potential effects of (11) energy costs (electricity and natural gas), all of which were at the interurban level.
Numerous scholars have since identified that (12) knowledge spillovers from universities are a key source of promoting firm innovation and performance. Startups which are active in the high technology sectors are influenced in their location decisions by the opportunity to access knowledge generated by universities. Another significant challenge to be faced by entrepreneurs, especially those concentrated in technology startups, is (13) access to capital. These startups have little evident history of their performance and often hold ambiguous technologies, thereby creating financial concerns in how to signal the company’s value to potential venture capitalists. Startups that are located in large metropolitan areas are best positioned to benefit from the facilitating access to venture capital. This notion is supported by research that highlights that technology startups are typically located in major urban centres.
An additional factor that has an impact on location decisions, is the possibility for entrepreneurs to recognize opportunities. Three social sources of information, namely through (14) mentor assistance, (15) (in)formal networking events, and (16) participation in professional forums, were found to have direct and positive effects on opportunity recognition by entrepreneurs.
Location decisions involve uncertainty by nature, and (17) uncertainty avoidance, which seeks to capture societal attitudes toward risk, ambiguity, and unpredictability, and thereby support beliefs and behaviours that promise certainty and conformity. This creates an interesting dilemma for current startups in London’s entrepreneurial ecosystem, as both (re)location decisions for companies and the Brexit create uncertainty.
One reason why entrepreneurs should consider their home regions as the prime location for their new ventures lies in being able to leverage their social capital, which refers to the range and depth of an individual’s social network, the strength of which is determined by the frequency of interaction with a large number of long-lasting acquaintances. In addition, social factors, such as (18) proximity to family and friends, weigh up to 4 times more in location decisions made by entrepreneurs compared to economic factors.
The European Digital City Index
The model which used as a guideline for this paper is the European Digital City Index (EDCi) of 2016, which describes how well different European cities support digital entrepreneurship and startups (Nesta Report, 2016). The EDCi provides information about the strengths and weaknesses of local ecosystems and describes what ecosystem indicators are most valuable to attracting and retaining startups (Nesta Report, 2015). The EDCi index of 2016, is comprised of 10 themes, subdivided into 40 individual indicators. The literature on location decision making is the guide for choosing which of the indicators is used in our analysis. Each of the 18 location determinant factors have been assigned a number corresponding to its order of appearance in this paper, with (1) transportation being the first, and (18) proximity to family and friends as the last location determinant factor covered in the theoretical framework. Only the Index indicators that have an established direct or indirect correlation to location determinant factors are applied.
These 18 general location determinant factors cover multiple individual indicators from the original Index. Next, the consequent weighing of these location determinant factors are subject to alterations. The weights of the individual location determinant factors are categorized under low (0.333·), medium (0.666·) and high (1.000). One last location determinant factor was added (18) Proximity to Family & Friends, which is left as a qualitative variable. The total of 60 European ecosystems is used to create the tailored index. The raw data collected by the Index underwent several processes in order to be able to answer the research question.
Interviews with startup founders
The target population is defined as all the active startups that are registered in the London metropolitan area, where a startup is, an entrepreneurial venture designed to search for a repeatable and scalable business model and is valued under $1 million. The sample frame used is the Tech London online platform. In addition, a background check was conducted, using the online data platform Crunchbase and the Company House platform operated by the UK government.
The primary data of the London startup entrepreneurs, was collected through structured interviews via telephone. The final sample size was determined by the number of successful interviews recorded within 100 interview attempts. After the two unstructured interviews, 100 structured interview attempts were made, the outcome of which represents the total sample size of fourteen in-depth interviews.
This section illustrates the most important findings of the ecosystem ranking which were generated using normalized values. The overall ranking is discussed, followed by how further improvements to the ranking are considered to establish the most likely scenario.
Table 1 shows how the original ecosystem ranking from the EDCI differs from the tailored ecosystem ranking using the 18 indicators from the location theory. The main differences being Vienna and Tallinn.
Table 1: Adjusted Top Ecosystems based on Normalized Values
|Original Ecosystem Ranking EDCi – 2016
|Tailored Ecosystem Ranking
Grey=Considered Alternatives to the London Ecosystem
Ecosystem Ranking Adaptations
Apart from the inclusion of the Taxation Cost location determinant factor and its corresponding medium weight, no alterations have been applied to the original weights of the Index.
Under the Access to Capital theme, the two most important sources of capital were already expressed in terms of the highest weights. The remaining Availability of Crowdfunding location determinant factor is not as popular as the other two sources of financing, and was provided with a medium weight. Thus, if any weight adjustments are to be made, it would have to be within the Access to the Labour Market theme. Within this theme, only 3 out of the possible 6 location determinant factors could be considered subject to weight alterations. Finally, it can be argued that the level of English Language Skills would be a factor that all London startups would consider before relocation to an alternative European ecosystem. Consequently, the weight increase of the English Language Skill location determinant factor altered the ranking to produce the newest ranking as seen in Table 2 with the top five rankings.
Table 2: Final Ranking London Alternative Ecosystems
Analysis from the interviews
With the use of data from the interviews with the London startups, we now ask if London startups are considering relocation to another entrepreneurial ecosystem, and if so, to which European ecosystem. The sectors in which the startups operate are: Blockchain Technology, Platform Technology, Cloud Computing, Consumer Electronics, Cyber Technology, Educational Technology, Insurance Technology, Real Estate Technology, and Transportation.
Brexit and the London Startup
The opinions on Brexit depend on countless factors such as the startup’s core business, their target market, the nationality of their staff, and how the company sees its future, to name a few. Those that were eligible to vote, voted against Brexit. But a positive outlook prevails. One entrepreneur said that “Brexit is no real concern for my startup operations as the main focus lies on providing an online platform”, thereby implying that it is different as compared to providing a physical product regarding possible exports, “[…] and because the platform is only active within the UK”.
When asked why the entrepreneur voted against Brexit he mentioned that although it did not affect his business per se, he did not want the added uncertainty that Brexit would create. This startup raised just shy of half a million British Pounds end of May, 2018. This response in provided some insight into why entrepreneurs still have positive outlooks despite Brexit. Three-quarters of the interviewed startups said that they have their main target market in either London or the UK alone, and feel they are less affected by international economic and political factors than those who are exporting their products or services abroad.
The London Startup and the Access to Capital
Despite the large increase in the total amount of funding capital for the London ecosystem last year, the startups biggest concern is the access and availability of capital. Two reasons were named. The first by an entrepreneur who said that “[…] the individual investors (such as Business Angels) have become more risk averse because of Brexit, […] and rightfully so”. The entrepreneur, who has already set up 3 startups, stated that in his opinion, where microcredit is less widely available compared to a couple of years before, corporate investing has become a lot more popular among startups nowadays. One startup mentioned receiving a loan from the European Investment Bank (EIB) to help with the experimentation to implement Blockchain technology in education. The co-founder of this startup pointed out that “many UK startups before us have received funding help from the EIB” and that “a funding gap will be created if the EIB decides to withdraw future funds from the UK because of Brexit”.
The London Startup and The Retention of Talent
The interviewees worried about the retention of foreign talent. (Co-)founders mentioned either the visa system, the access to talent or the retention of talent as a major concern post-Brexit. One consolation for London startups currently employing EU talent will be that the settled status will grant EU nationals (and their family), who have spent 5 years in the UK, the same rights as UK citizens after Brexit. However, as startups are relatively young companies, the question remains if this limit of 5 years will suffice to retain their staff.
The London Startup and Relocation Decisions
Asked if they considered initially developing the company in any alternative ecosystem beside London, half of the entrepreneurs stated they did. Each founder mentioned alternative entrepreneurial ecosystems where the entrepreneurs had a previous residence, for either work, personal or educational reasons. The logic behind this supports earlier findings that entrepreneurs will locate in regions where they are able to leverage their social capital.
The London Startup and The Proximity to Family & Friends
The last question asked was whether the effect of relocation on family and friends played a role. Almost all of the entrepreneurs mentioned the effects that relocation would have on their family and friends. Several entrepreneurs acknowledged that proximity to family and friends played a factor in the relocation decision making.
Our analyses point to Amsterdam being the most likely recipient of any entrepreneurial refugees leaving London followed closely by Dublin, Paris, and Berlin. Glued to the city of London by their family and friends, most London startups do not have the time nor the financial means to consider possible relocation to another European ecosystem. For most London startups, the value of their social capital simply outweighs that of the possible benefits derived from relocation. For London startups considering relocating their HQ, chances are that they will relocate to an ecosystem where the founder has a previous history, either private, educational, or work related, or simply has a well-established network in the area. The startups are of course, basing their answers on the current situation. Few are able to conceive the economic impact of a Hard Brexit as the probability increases; hence their optimism and their tendency to trust in the stability of their home market of London. The uncertainty may be prolonged if an extension of Article 50 is granted.
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