Investments safe from Brexit

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Investments safe from Brexit

Britain’s small to medium-sized enterprises are in rude health, currently accounting for at least 99.5 per cent of the businesses in every main industry sector and contributing an impressive £1.9tn to UK GDP annually.

Their success has been due in part to their ability to meet the rapidly changing needs of UK consumers, who increasingly require flexibility across many aspects of their lives.

With no Brexit deal yet in place, this disruptive approach and ability to adapt will also serve SMEs well as the UK enters an era of unprecedented change and uncertainty following its divorce from the EU.

Regardless of whether we end up having a hard Brexit or a soft Brexit, SMEs will remain the lifeblood of the UK economy and a significant provider of jobs and growth.

The growth of mobile technology and the ‘gig’ economy has revolutionised the way Brits buy products and services.

However, support for growing companies is not always widely available, with traditional lenders remaining parked on the sidelines.

The venture capital trust structure is ideal for supporting Britain’s start-ups. Not only does it help fund the UK’s entrepreneurial spirit, but early exposure to promising businesses can generate exceptional returns for investors.

Innovation generation

The growth of mobile technology and the ‘gig’ economy has revolutionised the way Brits buy products and services.

This has created a Darwinian dynamic where static, established firms are losing sales to innovative young start-ups whose disruptive models can quickly adapt to an increasing need for flexibility.

This trend has been evident across the range of consumer-facing sectors we focus on, and we have been making the most of it through our investments.

For example, in the health and fitness space, pay-as-you-go brands like KXU and Boom Cycle have become popular alternatives to traditional gym chains as weak consumer spending has hit conventional monthly payments.

KXU lets customers book fitness classes and spa treatments whenever they wish. Boom Cycle offers studios at sites across the capital where Londoners can book individual or multiple fitness sessions to suit them.

Likewise, in the services sector, the rise of the gig economy has led more and more tradespeople to switch permanent employment for a freelance approach.

This allows them to work as little or as much as they want. Apps and websites like RatedPeople.com have arisen to meet the increasing demand for DIY platforms that match homeowners and tradesmen on the most convenient terms possible.

It is not just retailers that are changing either; flexible working has allowed many to exchange the traditional 9am to 5pm working window for around-the-clock employment at their own convenience.

Temporary and co-inhabited office providers like Second Home are becoming a significant force as flexible working replaces the need for a permanent office, and many firms avoid committing to London on Brexit fears or want to avoid being tied to lengthy and expensive permanent office contracts.

According to a recent report by Cushman & Wakefield, in central London alone, flexible workplace providers accounted for 21 per cent of office space in 2017 and the pattern is beginning to be replicated across the UK’s major cities.

This rise of disruptive SMEs has been unwavering in the face of the UK’s imminent divorce from the EU, where a lack of progress has thrust almost every area of the British economy into uncertainty.

Indeed, according to the National Federation of Self-Employed & Small Businesses, there were a record 5.7m UK private sector companies at the start of 2017, of which 99.9 per cent were SMEs employing a total of 16.1m people.

Brexit flexibility

Alongside their ability to adapt to changing consumer trends, these nimble enterprises are also far better placed to adapt to any regulatory and fiscal changes that arise as a result of Brexit than their larger counterparts.

For example, uncertainties around how the divorce will play out have thrown into question everything fromthe property sector to the airline industry.

What is more, due to their broadly domestic focus, SMEs, on the whole, enjoy some insulation from the macro and currency issues that have defined the performance of the internationally-diverse FTSE since the referendum.

Regardless of their favourable positioning post-Brexit, the reality is that not all young organisations will be a success.

All this suggests the rise of UK SMEs is due to continue, with more and more small business arising to steal market share from sector stalwarts struggling to adapt to changes in both consumer behaviour and the UK itself.

Not only does this create more competition and choice for consumers and us as investors, but it also means that SMEs’ contribution to UK plc could become even more significant as we move forward.

Regardless of their favourable positioning post-Brexit, the reality is that not all young organisations will be a success.

We often like to quote the old saying ‘the lemons usually ripen before the melons’ – write-offs always come first, with winners sometimes taking their time to bear fruit. Quality VCT managers will be able to spot far more melons than lemons.

First of all, any investee firm must have an ambitious and passionate management team with a strong vision for their brand and a robust knowledge of its market. Founders should also have financial investment in their business, as ‘skin in the game’ demonstrates long-term commitment and ensures shareholder alignment.

Potential holdings should be generating £1m or more in run-rate revenues, and to possess an established brand or the potential to develop one.

We always ask ourselves whether the young company we are looking at is offering an innovative product or service that is driving change in its sector and could take market share away from larger, more established rivals.

Finally, we look at a potential investment’s supply chain and consumer base. The critical question here is whether it can realistically deliver the plan it has presented with and whether it is already engaging with customers.

Naturally, many entrepreneurs will overestimate the value of their business.

Once a good VCT manager has finally invested, they will work tirelessly with their holdings to ensure they become a success.

Firms often require additional experience and support as well as follow-up investments where further capital could accelerate an existing growth strategy. Indeed, some of the £52m we have raised since 2013 has been injected into existing holdings.

Ultimately, when a holding is generating revenues of around £15m, its funding circle will have opened up considerably, and it will be ready to ‘fly the nest’.

When this happens, many will consider exiting so they can use the proceeds to invest in new young businesses and begin the cycle again.

Andrew Wolfson is managing director of Pembroke VCT