What Does a Recession Mean for Start-Ups?
Michael Buckworth, Managing Director of Buckworths
As it is announced that the UK economy has entered recession and the country’s GDP has nosedived by 20.4% between April and June, start-ups like many businesses throughout the country, face a testing time. We asked Michael Buckworth, founder of Buckworths, what UK start-ups need to do to survive.
Funding and cashflow
Funding is vital for high growth start-ups and most funding comes from equity investment. During the 2008 banking crisis, investment in start-ups boomed as investors looked for alternatives to the depressed and highly volatile stock market. The risk of investments in early stage businesses is reduced by qualification for the Enterprise Investment Scheme (EIS) which gives investors an income tax credit of up to 30% of the amount of their investment, and a tax free exit. Start-ups raising capital from UK angel investors really need to qualify for EIS and that requires the business to be structured in the right way from the get-go.
However, start-ups with significant COVID related debt should be aware that EIS monies can only be used for growth and not for working capital purposes, including repayment of historic debt. We have argued that the Government must introduce a temporary tax relief scheme similar to EIS but without the emphasis on growth capital to help SMEs raise investment to pay off debt incurred during lockdown. Such a scheme may encourage angels to fund businesses where EIS is not available and help avoid a raft of loan defaults over the next couple of years.
Prepare for Brexit
As UK businesses focus on surviving the effects of the pandemic, many may well have forgotten that the Brexit transition period is due to end in just 4 months. A cliff-edge return to WTO trading terms after several decades of EU free trade looks increasingly likely as the EU and UK negotiating teams seem deadlocked over issued such as State Aid and access to UK fisheries. Such a result would cause significant disruption to supply chains, increased bureacracy and unwelcome tariffs on imports and exports. Whereas a year ago, supply chain businesses had sufficient financial resources to be able to stockpile, that may not be the case anymore as they have been battered by the impact of lockdown. For start-ups dependant on the free movement of goods, preparing for delays and additional complexity is crucial.
Innovation and execution
As large numbers of people are made redundant, many of them will become entrepreneurs. As a start-up community, we should welcome this influx of new ideas and skills. However, inevitably that means more people competing for limited resources. For start-ups to succeed they will need to continue to innovate -staying ahead of the curve in developing new products and functionality – and they will need to execute efficiently.
Entrepreneurs have been able to get away with poor execution over the recent boom years for UK start-ups. Investors have been forgiving of precedent legal document that isn’t fit for purpose and founders have generally been able to raise further investment to deal with pivots from ill-executed business plans. These deficiencies cost money in the long run and as belts are tightened, investors are likely to become less forgiving. Start-ups need to get the right advice early and not cut corners in the hope that things will work out in the end.
Looking for the win
Recessions provide fantastic opportunities for start-ups. Established businesses are focussed on survival and not innovation, leaving start-ups to fill the void. Economic contraction leads to an increased emphasis by government on growth sectors resulting in better grants and tax reliefs for the start-up ecosystem. High unemployment results in large numbers of skilled people looking for work which means start-ups can hire the best talent.
As the UK enters recession, founders should be prepared but optimistic. The UK start-up ecosystem has weathered many storms – the 2008 banking crisis, Brexit, COVID – a mere “mega recession” won’t bring it down.
Michael Buckworth is the managing director of Buckworths, the only law firm in the UK market working exclusively with start-ups and high-growth businesses. Buckworth set up the firm in 2011 as the UK start-up ecosystem began to take off in order to provide expert quality advice to entrepreneurs working in the UK market. 9 years later, Buckworths have worked with over 1,200 start-ups and advised on 497 investment rounds.