Insights overview

The Effect of Brexit on UK Digital M&A

With Britons having voted to leave the EU, the focus now turns to precisely how – and when – the UK will exit from the… Read more

more content below

With Britons having voted to leave the EU, the focus now turns to precisely how – and when – the UK will exit from the union.

In his resignation speech, David Cameron said he would leave that task to his successor; someone unlikely to be named until October. This, coupled with the fact that the referendum was deliberately set up as non-binding, has led some Remain commentators to suggest that Article 50 notification may never be made, positing that a new Prime Minister may favour negotiation with Brussels and a possible settlement than out-and-out exit.

Even if we accept Article 50 will be invoked, it sets a two-year deadline for Brexit that can be extended (although only with unanimous agreement from the EU’s other 27 members). This means Britain could remain in the EU until Q3 2018 or longer; until such time, the UK is unlikely to make wholesale amendments to the law governing activity within the technology sector. But what may change?

Effect on legislation

The main piece of legislation governing corporate activity in the UK tech sector is the Companies Act 2006. Although some parts of the Companies Act and the secondary legislation made under it have been derived from EU directives (such as regulation around a company’s accounts, the rights of its shareholders and the disclosure of information), we would not expect to see the Government looking to make wholesale changes to provisions governing the incorporation and operation of UK private companies.

There may, however, be potential tax implications. In theory, Brexit restores the UK’s power to set its own taxes whilst stopping it from accessing the single market. The UK could, then, have the ability to make sweeping changes to the way it taxes its citizens yet be subject to additional tax liability, such as duties on importing to the EU. In practice, we believe little may change, particularly in respect of VAT and excise duties. Currently, VAT forms a large proportion of the UK tax revenues and there does not seem to be significant benefit in moving away from the existing EU-derived system (other than potentially creating further classes of reduced rate or exempt goods). Were the UK to join the European Free Trade Association, it will – like Norway – benefit from a suspension of customs and excise duties as well as VAT on goods that travel to an EU member state through the UK.

Even if certain UK taxation legislation was derived from an EU directive – such as the Parent-Subsidiary Directive and the Interest and Royalties Directive – it is likely to remain in place for the short-to-medium term. Right now, the effect of these directives is that for a group of companies with a UK parent, interest, dividends and royalties from wholly-owned EU subsidiaries will usually receive those payments free from any withholding tax. However, should the UK’s tax rules diverge from EU rules post-Brexit, this withholding tax exemption could be lost.

Effect on existing transactional activity

The financial markets tend not to like uncertainty, and so it was unsurprising to see sterling hit a 30-year low the day after the referendum and the FTSE 100 taking an 8% hit (although it rallied to the same point it started the week by close of the markets in Friday, due no doubt to the Bank of England’s statement that it will take any measures – including a £250bn injection – to secure economic and financial stability).

For UK businesses currently negotiating terms for a corporate transaction, or operating under the terms of previously-agreed metrics (such as would form part of an earn-out), term sheets and contracts should be re-examined. Do forecasts still seem reasonable in the light of currency volatility or a potential short-term recession? Do assets and liabilities need to be revalued? Could Brexit trigger any material adverse change provisions? In some cases, deals with pre-agreed valuations or financial payments may be subject to renegotiation following Thursday’s vote.

Existing finance arrangements should also be reviewed to understand how any performance dip could affect financial covenants.

Effect on the UK digital M&A market

The general view is that a healthy UK M&A sector is driven by market confidence. Many commentators are predicting a slow-down – at least in the short to mid-term – especially where deals are reliant on the buyer raising funds.

However, whilst the number of private tech M&A deals dropped slightly in the run-up to the referendum, non-EU investment into the UK has increased substantially this year compared to 2015. The UK digital sector has historically been fairly resilient to market volatility and economic change, especially in the mid-market. Whilst some large EU IPOs or trade sales (such as Telefonica) may be on hold until the dust settles, the UK digital market may be comparatively insulated.

The UK digital sector is a market which constantly evolves and is constantly disruptive. As many new players seek to challenge incumbent companies, there is a natural cycle of consolidation. UK mid-market M&A is a legitimate business model, driven by more than just a desire for growth. Strategic acquisitions can bring increased cost savings as well as an acquisition of talent, products and access to know-how and intellectual property.

That is not to say that UK digital companies won’t face challenges as a consequence of Brexit – we may see a rise in investment in the larger combined EU and European market at the expense of investment in the UK as well as reduced access to funding (with UK businesses no longer being able to leverage EU grants and subsidies). Arrangements for migration, access to talent and the removal of certain passporting regimes cannot be overlooked.

However, many will see Brexit as an opportunity. A fall in the value of sterling makes UK assets more attractive to dollar-rich investors and buyers. The UK is a leading financial centre with a strong venture capital community, a vibrant entrepreneurial culture and an expertise in agile, fast-moving technology. Corporate tax rates are favourable and the legal and regulatory environment continues to be robust. These attributes are unlikely to change in light of the vote to leave the EU.