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What is Brexit?

On June 23rd, Britain voted to exit the European Union, creating the now popular term Brexit. This is akin to Texas voting to leave the United States. Few thought it possible that the Exit camp would win, and many were shocked when they received 52% of the votes.  Those in the Remain campaign, which were mostly the younger generation, those in Scotland, Northern Ireland, and in London, feared that leaving the EU would dramatically impact the UK’s economy. A key issue at the center of the vote was the number of migrants coming into the UK. We received mixed reactions during our recent annual meeting in Europe, which included stops in London, Frankfurt, Dusseldorf, Helsinki, and Copenhagen. On one hand, this referendum could serve as a wake-up call for the EU which could result in a stronger European Union in the end.   One of our healthcare VCs commented that the UK now may have freedom to do things it couldn’t as part of the EU. Specifically, the UK may become an easier place to receive pharmaceutical approvals. But most people we talked to were incredibly disappointed by the results of the vote.  One entrepreneur we spoke to had to reassure his employees that “nothing would change for them” and a VC told us during our visit just a few days after the vote, “Brexit just brought on a recession.”   Investors from Germany feared an influx of start-ups from London to Berlin, putting pressure on an economy that is already tight on housing, causing real estate issues.

Brief Primer of the EU

There are 28 members of the European Union (“EU”), many of whom share a common currency, the Euro, which came into use in 2002.  However, a few of these members still use their own currency, such as the UK.  The important business aspect of the EU is that it enables a “single market,” which allows people, capital and goods to move freely across borders within the EU. Allowing people who are citizens of France, for example, to work in the UK has helped the EU region compete on a grander scale worldwide and has served to unite what were once 28 different, smaller, economic centers with borders between them making it hard to hire people from one country into another, or harder to transport goods and services within the region.

History has shown that some European countries have survived well outside of the EU.  For example, Iceland, Liechtenstein and Norway are part of the European Economic Area (“EEA”) which provides the benefit of the “single market”, but these countries are not part of the EU. In addition, Switzerland remains neutral, not a member of either the EU or EEA; however it has negotiated bilateral agreements to take advantage of the “single market”.

Since Britain joined the EU, the start-up ecosystem has enjoyed free movement of people throughout the EU, and potential changes in the immigration law could make it harder for those same start-ups, or any company for that matter, to hire people from outside the UK.  As a result, start-ups may move to continental Europe or to Ireland, where the government is promoting new enterprises and building a start-up ecosystem of its own.  Beyond the people and potential shift in the start-up ecosystem, the uncertainty around the future could stall fundraising for European funds and companies as investors wait to fully understand the gravity of Brexit and the full economic implications.

This change is a very complicated undertaking and will take time. First, Article 50 must be invoked. Article 50 is a provision in the Treaty of Lisbon which addresses countries that want to leave the EU. The UK must invoke the Article, then it has two years to plan its exit and to negotiate with the remaining members of the EU. At the center of these negotiations will be the UK’s access to the single market.

How does Brexit impact our portfolios?

The exposure to the UK and EU within the TTCP portfolios is minimal. First, our exposure is small as only 4% of all of our active companies are located in the UK and only 6% are in Europe.  We have seven funds with Pound Sterling or Euro denominations. The currency impact of the movement of these two currencies in the second quarter of 2016 was less than $2 million or 0.06% of total NAV.

Additionally, of the UK and EU based companies in our portfolios, median revenues are $15 million, the median revenue multiple is a respectable 3.6x, and the median company age is 9 years old. These are a balance of both start-ups and mature businesses, and, as such, we believe many of them should be capable of managing through this situation.

With the limited exposure we have to Brexit, we do not anticipate volatility in our portfolios. However, this change is significant to the mindset and the future of Europe, and now we must wait and see how the people of Britain will manage through their Brexit.