Will Brexit put paid to the sector giving the next generation of British businesses a leg up?

James Codling
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The industry hasn't been through a credit cycle – so the recession threat from a Brexit is crucial (Source: Getty)

Today's vote, should it be to exit the European Union, is likely to have far reaching consequences – some potentially negative, but some potentially positive – for the alternative finance scene here in the UK.

This market accounted for £3.2bn of investment into startups, scaleups and the “S” in SMEs in 2015, and is now an important part of supporting the next generation of British businesses.

The majority of the platforms have only operated in periods of relative growth and market stability, setting up in the aftermath of the 2008 crash and benefiting from the resulting fallout in banking and financial services.

Their business models have never been tested during a downturn, and institutions like the Bank of England and the IMF have said that our country would go through at least a short-term period of painful readjustment following a Brexit vote.

Read more: People expect poor economic conditions immediately after Brexit. But they expect long-term gains

That’s why, for continued investment in the UK’s small businesses and the health of the alternative finance industry, I think it is critical that we remain in the EU.

Plain speaking

Let’s not deceive ourselves: the alternative finance industry is, very honourably, trying to support the riskiest end of the investment spectrum. This could either be small businesses that are unable to get credit from the banks at a sensible rate, or the startup and scale-up scene where our great hopes for the future are still unable to find all the investment they need and have to be boosted by tax breaks to encourage investment.

It is, sadly, this part of the market that will see the most contraction, the highest rates of defaults and take the biggest hit to shareholder value in any period of economic uncertainty.

For the platforms that are channelling this investment, the macro economic shock of Brexit will have a couple of immediate consequences for them.

The first is the behaviour of private investors who are the life blood of this market. The “crowd” is at the heart of the alternative finance model, which has been predicated on an individual’s willingness to invest in riskier assets to chase yield in a benign interest rate environment.

Economic uncertainty and potentially further austerity will make us as consumers look much harder at what we’re investing in, and our ability to monetise our investments should we need to do so.

This might not be so much of an issue for the ultra-wealthy, who cross borders anyway, but for ordinary investors with jobs and families there would almost certainly be a flight of capital to safer and more liquid asset classes as we have seen in previous recessions.

Second, the consequences for the business raising through these platforms cannot be underestimated. In the P2P space, any downturn will have an impact on the credit quality of loans, push up defaults and stretch platforms’ stress tests to the limit.

We will see a contraction of investment across the market and a number of platforms with lower quality credit portfolios potentially exit the space.

In equity crowdfunding, uncertainty will result in less liquidity being available for this market and a general flight to quality resulting in less businesses getting funded. Investors will almost certainly look to shore up the liquidity position of their assets that are performing well and pull back on support for those that may be in the greatest need.

Compounding the situation will be the fact that the alternative finance industry has itself been investing in future growth, hiring staff ahead of revenue and profit.

The impact of the above will require them to reassess their growth plans, business models and hiring policies to deal with the changes they are seeing in their own industry. The P2P loan space has been quicker to partner with the institutional market and may therefore be able to weather the downturn better than equity crowdfunding.

Silver lining

However, there are also some potential benefits that could come from a Brexit. Leaving the EU will have an impact on valuations, which is arguably a good thing for what is a relatively frothy market at the minute. Valuations coming down may help to encourage investors back in because possible returns would be more attractive.

Read more: Eleven reasons voters will make the positive choice and vote for Brexit

In the longer term, free of European rules around state aid, it is likely that the UK could be more flexible in terms of supporting these ecosystems with tax breaks. Protection of SEIS and EIS would in theory be more straightforward.

However, there are those in government and in certain parts of the civil service who don’t understand the necessity of such breaks, so who knows if there will be continued appetite to support these vital schemes, particularly if government finances come under pressure.

I, for one, will be eagerly awaiting the final result tomorrow morning.

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