Defying Gravity How ambitious businesses can achieve growth in the age of uncertainty
part 2: expanding international horizons
contents 3 4 5 9 11 15 17
About the study An introduction from our managing partner A mid-market facing downward pressure Businesses take measures to deal with Brexit pressures Leveraging international opportunities New horizons Find a way forward for your business
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about the study Our Defying Gravity report series will help to explain how medium sized businesses (MSBs) can achieve high performance in complex and uncertain times. Research is based on interviews conducted in 2017 with 500 leaders of UK MSBs across a representative range of industry sectors.
about Foresight
about Mills & Reeve
Foresight is forward looking and insightful content produced by Mills & Reeve. Designed to help our clients better understand the key issues they face, it offers broader commercial acumen in addition to legal expertise.
Mills & Reeve is a national law firm with more than 500 lawyers and 900 staff across six UK offices. We’re one of the most successful law firms in the UK as a result of our highly commercial approach, the deep relationships we develop with our clients, and the quality of our people and culture.
A “medium sized business” is defined as having a turnover of between £10 million and £300 million while a high growth or high performance business is defined as having achieved turnover growth above 20% last year. Participants were CEOs, CFOs or Board Directors. You can find out more at: www.wearedefyinggravity.co.uk
We’re the only firm to have been named in the Sunday Times 100 Best Companies to Work For 14 years running, and 97% of our staff would recommend Mills & Reeve as a good place to work. You can find out more at: www.mills-reeve.com/whoweare
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an introduction from our managing partner We are living in increasingly complex and uncertain times. As the impact of Brexit threatens to destabilise the economy and political landscape, and globalisation and disruptive technology bring rapid change, how are businesses meeting the challenge?
We set out to understand how these businesses can achieve high performance in challenging times, speaking to 500 mid-market leaders who shared their growth and investment plans, international expansion strategies and innovation priorities.
The mid-market is the unsung powerhouse of the UK economy, with pre-referendum studies forecasting that MSBs are set to be the fastest growing segment of the economy over the next three years. Our own research reveals the impressive resilience of the UK’s middle: two thirds of MSBs (66%) grew turnover last year, at an impressive average rate of almost 20%.
Our campaign, Defying Gravity, explores the issues that leaders are facing and possible steps to success through a series of reports and roundtable events. This second report in our series examines the impact of the EU referendum on the mid-market and finds that leaders are preparing for life beyond Brexit by also looking to countries outside Europe.
But can the mid-market continue to defy gravity in the face of deteriorating market conditions? And how has this unstable external landscape impacted mid-market leaders’ confidence in their ability to invest in and generate growth?
Despite very real and recent hurdles, it is encouraging to see mid-market leaders remaining defiantly ambitious about growth, determined to beat market conditions and to hold their position as the driving force of the British economy. More than four in five (83%) mid-market businesses plan to increase turnover in this financial year (2017/18) by a confident average of 22%. Defying gravity indeed!
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At Mills & Reeve, we want to champion these MSBs and help unlock new opportunities for growth to help them achieve their full potential. As a mid-market business ourselves, we understand the landscape and experience many of the same challenges as the leaders we spoke to. In 2015, our Full Scale Ahead report explored paths to growth for mid-market businesses and the question of whether to scale or sell. Now, following a period of upheaval and disquiet, there are many other considerations on the minds of mid-market business leaders. We would like to thank everyone who participated in our study. I hope their insights help you to find a way for your business to defy gravity in these challenging times. Claire Clarke Managing Partner Mills & Reeve
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a mid-market facing downward pressures Our study reveals defiant ambition in the UK’s mid-market. However, far from being bullish about their operating environment, mid-market business leaders are concerned about a number of gravitational factors pulling them down.
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a mid-market facing downward pressures More than half of business leaders do not believe that the UK economy is “strong and stable” and two thirds express frustration that the economy in its current state presents hurdles to growth.
...the pound’s fall in value following the Brexit vote is having a significant impact on the day-to-day trading of British businesses. Two thirds of MSB leaders believe that while major corporates have the resources to navigate turbulent times, economic uncertainty will disproportionately affect the mid-market.
Brexit is exerting substantial downward pressure, with the referendum outcome and uncertainties surrounding Britain’s future trading relationship with the EU already hitting the pockets of mid-market businesses.
falling demand following the Brexit vote, rising to 69% of companies that have suffered a decrease in turnover. Over half of MSBs have experienced increased issues with late payment since the referendum.
In particular, the pound’s fall in value following the Brexit vote is having a significant impact on the day-to-day trading of British businesses, increasing the price of imports and narrowing margins. Although a weak pound is good news for exporters, dramatic currency fluctuations can make it difficult to manage foreign exchange risk, and over half of leaders feel that currency volatility is damaging their business.
The mid-market is clearly feeling the pinch, and businesses are concerned about what the future holds. Nearly two thirds (60%) of mid-market leaders say that single market access is ‘critical’, and a similar proportion are concerned that failing to reach a deal with the EU would cause significant damage to their business. Whether a deal is reached or not, MSBs are bracing for impact: 61% expect that the administrative burden of regulatory or legislative change will cost their business significant time and money.
On top of this, businesses are dealing with declining demand and cash flow issues caused by late payment. More than half of businesses have experienced
59% of mid-market leaders do not believe the UK economy is “strong and stable” www.wearedefyinggravity.co.uk
64% are frustrated that the economy keeps presenting obstacles to their growth
57%
of mid-market leaders say that currency volatility is damaging for their business
66% believe that economic uncertainty will disproportionately affect the mid-market 6
a mid-market facing downward pressures In addition to direct financial consequences, the implications on human resources of Britain’s EU exit are causing concern. The labour market is already tight, with almost half of mid-market businesses (48%) worried that they currently lack the talent and skills to supercharge their growth. This rises to 60% of businesses that have experienced a decrease in turnover. More than half (55%) of MSB leaders fear that a Brexit talent exodus is a serious threat, with leaders expressing equal concern over the recruitment and retention of both low cost labour and employees with specialist skills. There are significant variations by sector. Technology companies are the most likely to fear a future shortage of specialists, with 67% of leaders concerned that the UK’s departure from the EU poses a serious threat to recruitment and retention.
Technology businesses, like many other sectors, recruit heavily from the EU to ensure they have staff with the high-level IT skills they need.
The impact of Brexit on recruitment and retention by sector Brexit is a serious threat to recruitment and retention... Automotive
...of the specialist talent my business needs
50%
More than half (55%) of MSB leaders fear that a Brexit talent exodus is a serious threat. There is reason for some optimism, however, as the Government is aware that the UK’s flourishing tech sector needs to be protected. Technology companies will be hoping that the Government can come to post-Brexit arrangements with countries beyond Europe, so that technology specialists from nations like India, China and the USA can be granted UK visas more easily. Good post-Brexit deals should allow British companies to bring the right people in for the right jobs, although growing the UK’s domestic talent pipeline will also need to be a key focus.
Education
46% 51%
Financial services
...of the low cost labour my business depends on
62% 51%
Food and agribusiness
66%
59%
Health
52%
55% Overall
Insurance 52%
70%
Manufacturing
49%
55%
41% Professional services
60%
Real estate
56% 41% 50%
Sport
57%
66%
Technology
67%
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52%
55%
65% 7
a mid-market facing downward pressures MSBs are also worried that Brexit will divert politicians’ attention from other critical issues, with 61% concerned that Brexit will distract Government from supporting regional development and infrastructure. Businesses in some regions appear more alarmed than others, with business leaders based in Northern Ireland, London and Yorkshire registering the highest levels of concern.
Businesses in some regions appear more alarmed than others, with business leaders based in Northern Ireland, London and Yorkshire registering the highest levels of concern.
Three-quarters (74%) of mid-market leaders agree that MSBs need targeted policy support.
Although the Government does currently provide assistance for exporting SMEs, British businesses will need further hands-on, practical support to help them navigate trade in a post-Brexit world.
Scotland 60%
70 - 79%
50 - 59%
60 - 69%
40 - 49%
North East 58%
Northern Ireland 72%
North West 56%
Yorkshire & Humberside 70%
East Midlands 48%
74%
West Midlands 58%
Wales 58%
East of England 60%
London 70%
POLI CY
Three-quarters of mid-market leaders agree that MSBs need targeted policy support.
Businesses concerned that Brexit will distract Government from supporting regional development and infrastructure (against average of 61%)
South East 65% South West 68%
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businesses stay positive to deal with Brexit pressures While the mid-market is far from blindly optimistic, leaders remain confident in their own ability to succeed against the odds. Indeed, it could be argued that mid-market leaders have no choice: growth is not a luxury but a necessity, with well over half (59%) of companies focused on growing turnover to maintain profitability.
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businesses stay positive to deal with Brexit pressures Over 80% of mid-market business leaders are aiming to grow their turnover this financial year (2017/18) by an average of 22%, with a corresponding increase in their workforce.
Two thirds of companies that achieved high turnover growth last year have focused their strategy on the upside - capitalising on opportunity. Despite market challenges, leaders are confident that they will achieve their objectives: of those that plan to grow this year, nearly two thirds (62%) would be willing to bet their house on meeting their growth target. Offensive and defensive strategies have a significant impact on mid-market performance. Two thirds of companies that achieved high turnover growth last year have focused their strategy on the upside - capitalising on opportunity while nearly half of businesses with low to no turnover growth last year are focusing on managing downside risk.
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Over 80% of mid-market business leaders are aiming to grow their turnover this financial year (2017/18)
Finding the right balance can be difficult and mid-market businesses are already taking measures to ride out the EU referendum storm. More than half of MSBs have increased their cash reserves since the Brexit vote. Half of mid-market leaders are reducing investment in preparation for Brexit, and 54% are postponing or cancelling acquisition plans. The majority of mid-market businesses (60%) are also changing their pricing strategies in preparation for Brexit. As MSBs feel the pinch caused by currency volatility and cash flow issues, this is being passed on to customers in the form of price increases. However, the most common move from MSBs in response to Brexit is to look to increase investment in exports beyond the EU, with nearly two-thirds (62%) of mid-market business leaders identifying a clear requirement to widen their horizons.
What are MSBs planning to do in preparation for Brexit? 62%
Increase investment in exports beyond the EU
60%
Change pricing strategy Expand or re-organise supply chain beyond the EU Reduce growth targets Increase investment in operations beyond the EU Postpone or cancel acquisition plans
59% 58% 57% 54%
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leveraging international opportunities While Britain’s scheduled exit from the EU is causing some concern among MSBs and having an impact on performance, it’s also encouraging companies to look further afield for growth.
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leveraging international opportunities Ambitious mid-market leaders are looking beyond Europe to defy domestic market gravity and preparing to leverage opportunities for international expansion. MSB exports Currently, MSBs have limited international scope, making them vulnerable to British market uncertainty. On average, only a quarter of turnover comes from exports, with high performance businesses reporting 28% of revenue generated by exports.
The top five target countries for international exports are the USA, Canada, China, Australia and Japan.
MSB international operations Businesses with greater international exposure seem to be reaping rewards. On average across all mid-market businesses, 21% of turnover is generated by international operations. This rises to 27% for the highest performing businesses, and drops to 16% amongst businesses that have experienced no change in turnover. The top five target countries for international exports are the USA, Canada, China, Australia and Japan. Meanwhile, more than half of MSBs are increasing their investment in operations beyond the EU, rising to two-thirds of high performance companies. Indeed, expanding operations internationally is one of the top five reasons that businesses intend to increase their investment in growth.
Supply chains are also being overhauled in response to Brexit, with nearly twothirds of MSBs expanding or reorganising their supply chain beyond the EU. But although the prospect of Brexit is encouraging mid-market businesses to look beyond European shores, the EU will always remain an important market for British businesses, even if trading relationships undergo significant changes. Among businesses that are increasing activity in Europe this financial year, France comes out as the most popular
In terms of key European export markets, however, Germany leads the way: 44% of the businesses that expect European export growth this financial year name Germany as a key focus, with France coming second (34%).
% of turnover accounted for by international operations across mid-market businesses Average across all MSBs
21% www.wearedefyinggravity.co.uk
location, with 25% of MSBs choosing it as a destination for expanding operations within the EU, followed by Germany at 24% and Austria and the Netherlands both at 19%. Mid-market businesses are perhaps keen to secure a foothold in a nearby European country before the UK’s exit from the EU.
The highest performing MSBs
27%
MSBs with no change in turnover
16% 12 12
leveraging international opportunities Focus on China Investment from China into the UK remains at encouraging levels despite the burden of currency exchange restrictions in China to prevent capital flight. China is still one of the largest economies in the world and continues to offer huge trading potential for foreign businesses establishing themselves and seeking investment in the UK. Whatever final format Brexit takes, China appears largely unperturbed about the impact it will have on future trade relations with the UK. There are clear signs that the existing strong trade relationship will continue. China remains keen to invest in the UK’s technology, infrastructure, education and healthcare sectors.
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Three key things a UK mid-market business needs to think about when looking to trade with, or set up in, China: 1. If you are looking to establish a subsidiary in China in partnership with Chinese investors then you should consider an equity joint venture or contractual joint venture. This provides the advantages of shared investment and easier access to local markets although possibly less control of the business and protection of its assets. Alternatively, if you are intending to enter the market independently, consider the benefits of a free trade zone, for example in Shanghai, and the use of a wholly owned foreign enterprise or a representative office. This gives you full control and better asset protection but probably fewer local connections or distribution networks.
2. What governing law do you want to adopt for your project and documentation? Chinese law is probably more convenient for dispute resolution but English law may be more appropriate if your project is multijurisdictional. Remember that English law judgements cannot be enforced in China other than through arbitration.
“In terms of a trade deal it is conceivable that a UK-China agreement could be one of the first to be announced postBrexit. But would a quick deal be a purely political expedient? Will the desire to show a quick result be at the expense of a more considered approach given the challenges around getting a decent deal on trade in services?
3. When receiving investment into your UK-based business avoid potential delays to your project by investigating your Chinese partner’s source of funds as soon as possible. This will ensure they have a ready access to cash in a way that complies with the necessary Chinese government regulations.
“Ultimately a UK-China trade deal is not likely until the UK resolves its post-Brexit relationship with the EU. That is a lot of red tape to scrabble through before any deal can be struck.”
Nick Finlayson-Brown, head of the China desk at Mills & Reeve, said: “The effect of Brexit remains uncertain. Some believe a hard Brexit could release the UK from the economic shackles imposed by Brussels and actually allow the forging of much closer and stronger economic ties with China. Others argue it will weaken the UK’s role as a back door into Europe and so its allure could actually wane.
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leveraging international opportunities Focus on France France has always been prized for its excellent road, rail and air infrastructure. This, combined with its strategic geographical location for trading between northern and southern Europe, as well as with Africa and the Middle East, makes it an excellent choice for consumer goods businesses wishing to keep a foothold in the EU post Brexit. Not to mention its proximity with the UK via Eurostar. Meanwhile the choice of Paris as the new home of the European Banking Authority following Britain’s withdrawal from the EU in March 2019 demonstrates that France is now perceived favourably within the business community.
Three key things a UK-mid-market business needs to think about when looking to trade with, or set up in, France: 1. When starting a business in France you must decide whether to establish it as a branch or a subsidiary. Establishing a branch is relatively easy and inexpensive, but if you intend your business to develop, it is generally advisable to create a subsidiary to allow for the segregation of assets between the subsidiary and parent company. Subsidiaries may also apply for government support, for example France’s very favourable research tax credit, which is calculated at 30% of annual research expenditure on R&D operations carried out in France. On the other hand, losses by subsidiaries cannot be offset against parent companies’ profits, and operating through a subsidiary will involve some legal constraints such as the requirement to appoint a statutory auditor.
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2. One of the main hurdles to overcome when setting up a business in France is obtaining the necessary authorisations if the relevant business is regulated. In such cases, particular attention should be drawn to possible qualification requirements for the local managers. The impact of Brexit on such requirements will have to be watched closely. 3. Certain acquisitions in sectors considered to be “sensitive” require prior authorisation from the French Ministry for Economy and Finance. This applies to acquisitions of a controlling interest in a French company and all or part of a business line by a foreign investor.
“However, the election of Emmanuel Macron has dramatically changed this perception as a number of laws have been passed to make life easier for businesses. The ‘Macron Laws’ were introduced to simplify the French Labour Code in September 2017 and built on the labour law reforms that have been undertaken in recent years aimed at simplifying the labour code and introducing far greater flexibility for businesses.”
Anne Frechette-Kerbrat, co-head of the UK desk at FIDAL, said: “Over recent years France’s attractiveness to foreign businesses was severely hindered due to our employment laws and the associated costs. Put simply we were not seen as business friendly.
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new horizons The outcomes of the Brexit negotiations are still extremely uncertain, but what is clear is that the UK’s trading relationships with Europe and the rest of the world will be dramatically reshaped.
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This is encouraging and suggests that Brexit may have prompted a necessary expansion of horizons. Future economic growth will be driven almost entirely by the emerging markets rather than by our closer neighbours, so businesses that are willing to look beyond Europe can expect to see returns. However, it’s critical that the Government pays close attention to the needs of mid-market businesses as it builds new international relationships and negotiates new trade deals. In particular, politicians need to take into account leaders’
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...it’s critical that the Government pays close attention to the needs of mid-market businesses as it builds new international relationships and negotiates new trade deals.
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In this climate of uncertainty, mid-market businesses are feeling the pressure, but they’re also seeing immense opportunities, with more than 60% looking to increase their investment in exports beyond the EU.
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new horizons
concerns about recruiting the people they need to keep their businesses competitive following Brexit. Britain’s scheduled exit from the EU is bringing significant challenges, but it’s clear that mid-market businesses have ambitious aims both here and abroad. Business leaders who are able to see the opportunity in Brexit are likely to be rewarded for their efforts. Tom Pickthorn Head of International Mills & Reeve
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find a way forward for your business Get in touch to discuss the right international strategy for your business. Call us on 0344 326 0000 or email letsdefygravity@mills-reeve.com You can also find out more about the research and case studies referenced in this report, register for one of our roundtable discussions and sign up to receive forthcoming insights by visiting our website: www.wearedefyinggravity.co.uk Follow us @rocketfuel4MSBs