UK Technology SMEs and International Trade
According to Tech Nation’s Unlocking Global Tech(1) report, released in September, the UK’s digital tech exports in 2019 totalled £23.3 billion. Moreover, this figure is projected to grow by more than £8 billion over the coming five years to reach £31.45 billion by 2025.
These “digital tech exports” include software services, telecoms, tech consultancy, ecommerce and cybersecurity. And positively for the UK economy, the country’s tech trading surplus, which currently stands at 55%, increased by 68% between 2015 and 2019 – rising from £8.7 billion to £12.8 billion.
The report underlines the UK’s position as one of the world’s digital powerhouses. It also demonstrates the importance of reducing trading friction for tech companies, particularly small and medium enterprises (SMEs), that want to expand into global markets.
It is a timely issue. On 31st December 2020, the year-long Brexit transition period will end, at which point the UK will leave the legislative and regulatory framework of the European Union (EU), including the Single Market.
Given the importance of the EU as a trading destination for UK services firms, including technology companies, this will be a significant moment; according to the Office for National Statistics(2), UK exports of services to Europe hit £95.2 billion in 2018, which represents 51.4% of the country’s total.
Many UK tech businesses will be considering – or reconsidering – what the opportunities for exporting their services will look like in 2021 and beyond once they lack easy access to EU nations due to being outside of the Single Market (unless a UK-EU trade deal is agreed to that effect).
Now is, therefore, an opportune moment to assess the practical and financial considerations for UK-based tech SMEs that are weighing up their options for overseas expansion.
International opportunities aplenty
Regardless of Brexit, there are vast opportunities for UK tech SMEs to grow their businesses by exporting their wares internationally. The aforementioned Tech Nation study found that Britain is second only to the US when it comes to the number of high-growth, scaling and established tech businesses that are primed for international trade – the report states that the UK has over 7,000 firms(3) with the potential to export their digital products and services.
While Europe and the US have traditionally been the primary targets of UK tech firms when exporting, there are also notable opportunities in other global markets such as India, Japan, Brazil and China. While themselves renowned as prominent exporters of products and services, these four topped a list(4) of countries that have seen the greatest increase in their digital imports over the past two years. That is to say, India, Japan, Brazil and China are importing more and more tech services from other nations, including the UK.
Once the UK exits the Single Market, more British tech businesses may look beyond the EU for export opportunities. However, they must be well prepared when doing so.
Understanding the local market
One of the most important elements of expanding into a new global market is having an in-depth understanding of the territory. From taxation and regulation through to language and culture, there are many obstacles to establishing a customer-base outside of the UK.
It is essential, then, tech SMEs take time to study prospective markets. Not only must they ensure there is significant enough demand for the technology they are offering, but they must also consider the ease of doing business in that region or country.
StartupBlink is one of several organisations that charts the ease of doing business in different parts of the world. Such lists can guide British tech firms towards potentially attractive and accessible markets.
Thereafter, business leaders must invest time and resource into exploring the viability of certain markets in greater depth. Trade tariffs, barriers to entry, market fit and potential strategies must all be carefully considered.
Studio Graphene is a London-headquartered agency that designs and builds technology products for both startups and corporates. In 2018, it opened a branch office in India, adding a site in Portugal last year – and while the majority of its clients are UK-based, it has worked with companies across Europe and the Middle East, particularly in the United Arab Emirates (UAE) and Qatar.
Ritam Gandhi, founder and director of Studio Graphene, explains: “Having developed a strong team and portfolio of clients in London, it seemed only logical for us to expand our reach and begin offering our services to businesses internationally.
“Firstly, we researched which regions were experiencing significant growth in terms of their numbers of tech startups. Consulting with people who knew the regions, we then established the types of businesses and products that were in demand, ensuring we had the experience and expertise required to deliver on projects in the space. This is what led us to focus on the UAE.
“Thereafter we relied upon our existing network of contacts to open doors for us,” Gandhi continues. “Having heard positive things about GITEX, an annual tech trade show in Dubai, we also flew some of the London team over to attend, network and raise awareness of our offering. Over time, this has led to us winning multiple UAE-based clients, which has really helped us to grow the agency without having to rely solely on UK companies.”
For those businesses who are – or who are keen to start – exporting internationally, a common question will be whether to establish a branch office or a subsidiary company in the overseas region or country. This will likely only become a pertinent point once the business is doing a high enough volume of international sales to warrant having a base outside of the UK.
There are pros and cons to both approaches.
Setting up a branch is typically an easier, faster process, which also ensures a greater degree of control can be maintained over the new international operations.
Businesses will sometimes establish a branch office as something of a steppingstone – a new branch is opened in a foreign market to provide a base from which a company can learn about the opportunities and challenges of doing business in that area. All the while, the UK-headquartered team has a direct say on decision making, personnel, budgets and so forth.
A downside to establishing a branch office is that it will provide no liability protection for the UK-based parent company. As the branch is not a separate entity, just a new overseas office, the parent company must answer for any legal issues that arise. There will also be important taxation considerations – even though the branch is still a part of the UK company, any profits it generates may incur tax in the country it is located.
The downside to branch offices are, conversely, among the benefits of establishing a subsidiary company. Namely, as its own entity it will be liable for its actions and the taxation on its profits. The original UK company, therefore, does not have to worry about itself being directly impacted by such issues.
A subsidiary company can also open new opportunities with creditors. A bank, for example, might be more comfortable with – or insist upon – lending money to a local entity, rather than a UK-company with a branch office in that country. Private investors might also share this stance.
A drawback of a subsidiary is that, as a separate entity, it may require multiple government registrations and may need to maintain a minimum level of capital to operate. There will also likely be local regulations and legislation that, as its own company, it must fully abide by.
To decide which option is best, due diligence must be undertaken which covers key issues, such as: the company formation process; taxation; regulation; and liability. But again, this is only likely to become relevant once international deal flow from a particular region or country becomes significant enough to warrant a UK tech SME considering having a base or new entity in that locale.
Investment and navigating fluctuating currencies
From a financial perspective, there are numerous considerations for tech SMEs that export internationally.
For one, they might require investment to take this step; it can take significant resource to build a customer base in another country, let alone launch a new branch office or subsidiary company. Marketing, sales, development and account management – new personnel might need to be hired and trained across all key departments if a business is going to be able to offer its digital services to a new market, which will invariably result in both capital and operational expenditure.
Tech SMEs should, therefore, assess what forms of credit or investment are available. It is worth speaking with their bank as a first port of call – they are well positioned to advise on credit lines, or point them in the direction of suitable grants, loans or forms of investment.
One stream of financial support worth noting comes from the government’s export credit agency, UK Export Finance, which seeks to ensure finance is available for UK businesses looking to export.
Another major challenge is to navigate fluctuating currencies. The dramatic events of 2020 – COVID-19, Brexit negotiations and the US Presidential Election, to name but a few – serve to highlight how the political and economic landscapes will have a direct bearing on the value of different currencies. For a business that is headquartered in a country that utilises one currency but is selling into one or more countries using different currencies, this can be problematic.
A tech SME’s profit margins could fluctuate in line with currency exchange rates, potentially causing cashflow issues and making financial forecasting extremely difficult. However, products are available to overcome this problem: businesses can avoid speculation and secure their margins through a fixed rate or forward exchange contract, which will better protect them from currency fluctuations.
Again, speaking with one’s bank is a useful first step to assess how they can help.
Specialist guidance is on hand
The act of expanding a tech business outside of the domestic market can seem daunting. Indeed, that is why many SMEs opt not to focus on international growth in favour of keeping their operations and sales within the UK – only around 10%(5) of UK SMEs export at present.
However, for those SMEs that are keen to explore the opportunities available for global exports, the opportunities are vast. Estimates have suggested that by trading their goods and services internationally, the typical exporting SME adds over £287,000(6) to their annual revenue.
Furthermore, it is important to remember that there is assistance on hand from both the public and private sectors.
For example, the government offers guidance to UK firms keen to export, ranging from general advice through to specific insights about global trading partners. The Department for International Trade exists to help British businesses take the bold step into international markets and offers useful resources to that end. Local Chambers of Commerce can also assist.
There are also consultants available to help walk businesses through it. Crucially, tech SMEs should not overlook the support that could come from existing service providers, including their banks.
At Lloyds Bank, our international trade support includes foreign exchange products, currency accounts, payment solutions and more. A business could benefit from these products when looking to trade internationally or when raising investment in a foreign currency. Further information can be found in International Trade.
For more information about how Lloyds Bank supports UK tech businesses, visit our website.
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