British citizens cast their ballots on June 23 in the historic referendum on whether or not to leave the European Union. The possibility of Brexit is causing significant concern for business leaders, and middle market companies appear to be particularly vulnerable. Whether it’s the depreciation and selloff of the British pound, shrinking tax revenue in the UK, slower consumer demand and inflationary pressures in the region, or a drop in investment in Britain, there appears to be much to fear from Brexit.
According to Paolo Pasquariello, associate professor of finance at the University of Michigan Ross School of Business, U.S. middle-market firms doing business in the UK or with significant UK operations may be exposed to lower revenues in U.S. dollars due to a weakening GBP, at least in the short term. Middle-market firms in the UK have more to fear since they generally have more limited access to financial instruments to hedge various forms of financial risk, especially currency risk, he adds.
The turmoil in financial markets following the UK’s exit from the EU would also make it more difficult and expensive to trade on financial products. Pasquariello adds: “Brexit is also likely to be accompanied by large portfolio rebalancing activity across European stock markets, as investors move their money out of more exposed countries and industries and into other havens.”
A UK exit from the EU could take years to unwind, of course, and significant time to define new treaty agreements. Joe Bruseulas, chief economist for RSM in the United States, admits that there are still many unknowns. For instance, the ripple effect for businesses in the UK and beyond are hard to assess, given the global reach of the UK as a major jumping off point to the European market.
Joe Bruseulas, chief economist for RSM in the United States, admits that there are still many unknowns. For instance, the ripple effect for businesses in the UK and beyond are hard to assess, given the global reach of the UK as a major jumping off point to the European market.
For now, the investment community remains wary. A joint study issued by Merrill and The M&A Advisor found uncertainty around the pending Brexit vote is having a “negative and tangible near-term impact on M&A activity, as well as high-yield and private equity investment in the UK.” For private equity, as well as the large banks and other institutional investors, many are already taking a defensive position to hedge against a Brexit possibility.
If the UK does leave the EU, private equity players might be able to find a small upside in the turmoil. David Brophy, director of the Office for the Study of Private Equity Finance at the University of Michigan Ross School of Business, notes: “Firms with cash may drive in and make some really good deals. The downside, of course, is increased volatility, which will be tough for exits. If you’re all set to exit, and the market turns sour, that could be bad.”
Gavin Williams, a partner in the London offices of the global law firm Herbert Smith Freehills, notes, that the long term ramifications of a Brexit yes vote would take even longer to become clear—whether it’s where to allocate capital or how put money to work.
For now, business leaders and the investment community across the globe are waiting for the vote, which is likely to be tallied by early Friday. The business risk is pretty clear, says Williams, but with political factors also playing into the debate, ranging from immigration to sovereignty, it’s hard to guess just where the vote will end up until the last ballot is cast and counted.
Myra Thomas is a business writer based in northern New Jersey and a frequent contributor to Middle Market Growth.