May 15 (Bloomberg) -- Coffee houses hold a special place in London’s history. During the late 17th century, they were the birthplace of Lloyd’s of London and the London Stock Exchange -- two institutions that helped make the square-mile City of London a global financial capital.
Today, just north of where one of the City’s ancient gates once stood, the latest chapter in London’s economic history is being written in a new generation of coffeehouses, Bloomberg Markets will report in its June issue.
At Shoreditch Grind on the Old Street roundabout, a gritty traffic circle, and at Ozone Coffee Roasters, a few blocks away, bearded young men and nose-ringed women huddle around laptops and discuss ideas for startup companies.
The surrounding offices, many of them in converted warehouses, are so crammed with technology startups -- at least 300 -- that the area has been dubbed, in mock seriousness, Silicon Roundabout.
Increasingly, that nickname is losing its irony: Established technology players are moving in. Google Inc. recently opened Campus London, a kind of clubhouse for digital entrepreneurs, not far from the roundabout.
Inside, techies hobnob in the bustling cafe and attend lectures and other free events; they can gain access to hot desks, printers and conference rooms operated by another company, TechHub, for a 375 pound ($560) annual fee. Springboard and Seedcamp Ltd., European tech incubators, rent space on two of Campus’s floors.
Following Google’s lead, Microsoft Corp. and Cisco Systems Inc. are opening their own Campus-like innovation centers close to the roundabout, while Amazon.com Inc. has put its first engineering center outside the U.S. a few blocks west. There, hundreds of developers work on Amazon’s video-streaming services.
Taking in the adjacent neighborhoods, the government estimates there are now more than 1,300 digital or media startups in the once-dreary hinterland of East London.
Welcome to the “flat white economy.” The term was coined by Rob Harbron, an economist at the London-based Centre for Economics and Business Research in winking reference to the Australian-inspired espresso-and-steamed-milk drink popular in East London’s cafes.
Encompassing media, Internet and creative businesses such as film, music and advertising, the flat white economy accounted for 4.5 percent of British gross domestic product in 2011, up from 2.8 percent in 2008, according to the latest U.K. government analysis.
The flat white economy is a rare bright spot in an otherwise dismal economic landscape. Having emerged from a double-dip recession in the summer of 2012, the U.K. economy has struggled to find its footing. GDP grew a meager 0.3 percent in the first quarter of 2013.
A policy of harsh government spending cuts is only starting to be felt three years into Conservative Prime Minister David Cameron’s government. Unemployment, at 7.8 percent in January, remains high. In February, rating firm Moody’s Investors Service stripped the country of its vaunted Aaa bond rating.
In contrast to the caffeinated buzz of Silicon Roundabout, the mood in the City remains downbeat five years after the onset of the global financial crisis. Here, pinstriped men and women trudge to work at dawn through the half-light of a British spring, past steel and glass towers full of empty desks.
Financial services, the dominant industry in London since the 1980s, has been in decline, slipping from more than 10 percent of British GDP in 2008 to 9.4 percent in 2011.
“We don’t expect employment in financial services to grow very fast even as the economy recovers,” Harbron says.
The British government is desperate to find sectors to fill the hole.
“The main drivers of growth over the past 10 years were property, financial services, consumer debt and government borrowing,” says Rohan Silva, 32, a senior policy adviser to Cameron. “We have got to move the economy to a more resilient footing: life sciences, green tech and digital technology.”
Yet even as the flat white economy gains ground, venture capitalists say it will take time for London to rival more-established tech hubs such as Silicon Valley, Boston’s tech corridor or Tel Aviv.
“None of the European tech hubs compare to the U.S. or Israel,” says Hussein Kanji, a London-based angel investor.
Startup founders in London were “less ambitious” than their U.S. counterparts and were 31 percent more likely to target smaller markets, according to a 2012 report by Startup Genome, a website that analyzes tech entrepreneurship.
London companies also struggled to find seed investors willing to put $500,000 to $2.5 million into startups, the report said. As a result, by the time they had found proven markets for their products, these companies raised on average 81 percent less capital than their equivalents in Silicon Valley.
City Meets Tech, a group whose co-founders include James Rowsell, chief executive officer of Cantor Fitzgerald Europe, has been trying to get bankers involved in seeding fledgling tech companies. The group organizes pitch days that introduce startups to investors from London’s financial community.
It’s an uphill struggle, says Steve Karmeinsky, a startup consultant and co-founder of City Meets Tech.
“If you are a broker making 100-million-pound trades a day, the idea of putting 30,000 or 40,000 pounds into a tech startup seems too difficult,” he says. “It’s easier to go and buy your second Porsche.”
The rap on London has long been that its business culture isn’t supportive of entrepreneurs -- that failure carries too much stigma.
“I think most of that has changed,” says Ben Holmes, a partner at Index Ventures in London, a firm that has a 350 million euro ($455 million) early-stage fund. The cost of failure has fallen.
“For just tens of thousands -- or even a few thousand pounds -- you can build and test a prototype,” Holmes says.
The recent recession also lowered opportunity costs: With young graduates hard-pressed to find jobs, would-be entrepreneurs have little to lose on a startup.
And, while there’s still a gap in seed funding, overall venture capital has become more plentiful, though still lagging far behind the U.S. In 2012, the U.K. was the most active European hotbed, with $1.8 billion raised, up from $1.4 billion in 2009, according to Ernst & Young LLP.
Holmes says London now has all the ingredients of a successful tech hub except one: an initial public offering or acquisition with a valuation of $1 billion or more. In the world of venture capitalism, the $1 billion exit is seen as an important milestone for a tech center, cementing its reputation and creating enough millionaires to seed another round of startups.
Exemplifying London’s tech resurgence is a shaggy-haired 38-year-old entrepreneur with a penchant for loud shirts and snakeskin boots named Michael Acton Smith.
Acton Smith had minor success during the first dot-com boom with a company that sold gifts and gadgets online; its most popular item was a chess set made of shot glasses.
In 2004, he convinced a group of investors to back him in an online games company called Mind Candy. In three years, the company burned through 5 million pounds developing a treasure-hunt game that flopped.
With what little cash Mind Candy had left, Acton Smith gambled on a new idea: Moshi Monsters, a site that would allow children to adopt, personalize and care for a digital creature.
After a slow start in the depths of the 2008 financial crisis, during which Mind Candy almost went bankrupt, Moshi Monsters became a phenomenon. Kids have created more than 75 million of them. Mind Candy has signed more than 100 Moshi Monsters merchandising deals ranging from stuffed animals to music.
In three rounds of venture funding, Mind Candy has received about 12 million pounds, most of it from the London office of Accel Partners Ltd., a Palo Alto, California-based VC firm, and Index Ventures. In 2011, the last year for which audited financials are available, Mind Candy made a profit of 7.4 million pounds on revenue of 29 million pounds. In 2012, revenue doubled, the company says.
Mind Candy’s first offices were in Battersea in South London. Lured by a mixture of cheap real estate and bohemian atmosphere, the company moved east to Shoreditch in 2009, soon followed by a wave of digital startups.
“We like this part of town because it is a little bit grubby,” says Divinia Knowles, 34, Mind Candy’s chief operating officer.
While average commercial rents in Shoreditch have increased nearly 40 percent to 42.50 pounds a square foot from the end of 2008, they’re still about half the price of those in London’s West End, according to real estate brokerage Cushman & Wakefield Inc.
Mind Candy occupies 2,700 square meters (30,000 square feet) on the top two floors of a rehabbed 1960s office building on Bonhill Street, less than a five-minute walk from the Old Street roundabout and directly across from Google’s Campus.
The offices feature green AstroTurf-like flooring, rainbow-colored Moshi Monster murals, a faux treehouse and even a twisting metal-tube slide so employees can swish down to the third floor from the fourth.
Nearly 5 kilometers (3 miles) to the west, inside the Georgian drawing rooms of 10 Downing Street, Cameron has been trying to give London’s growing tech hub a helpful nudge.
In doing so, he’s following in the footsteps of Margaret Thatcher, who died on April 8, says Sara Kelly, executive director of the Coalition for a Digital Economy, a trade association. The late prime minister’s privatization of British Telecommunications Plc and Cable & Wireless Ltd. in the 1980s, for example, created opportunities for smaller companies.
“Her policies made becoming an entrepreneur an acceptable alternative career path,” Kelly says.
With policy adviser Silva acting as his de facto liaison to the tech community, Cameron has pushed through a raft of policies aimed at boosting entrepreneurship, including an income tax credit of up to 50,000 pounds on the first 100,000 pounds invested in a startup and an exemption from capital gains taxes. The government also created a so-called entrepreneur’s visa that makes it easier for foreigners to come to the U.K. to start businesses.
Despite almost across-the-board spending cuts in the 2012 budget -- including 3.2 billion pounds in local government and 1.8 billion pounds in defense -- in an effort to balance the U.K.’s books, Cameron has found money for East London’s tech hub.
He’s committed 25 million pounds to improving broadband connections and pledged 50 million pounds to erect a landmark building in the middle of the Old Street roundabout with classrooms, auditoriums, shared offices and 3-D printing labs. The project is due to be completed by 2016. The government will fund one-half to two-thirds of the project’s cost, with the rest coming from private donations, Silva says.
Late last year, Silva hired Joanna Shields away from her job heading Facebook Inc.’s European operations and named her chief executive of the Tech City Investment Organisation, charged with promoting London as a tech center.
In April, Silva announced he planned to leave Downing Street at the end of June to found his own digital education startup.
Cameron isn’t the only one looking for tech to replace some of the losses from financial services. Real estate companies that once catered to banks see profits in tech startups. Tech and media companies now account for 35 percent of all commercial real estate demand in London, more than any other industry group, according to Cushman & Wakefield.
In March, Canary Wharf Group Plc, which has been developing a financial district east of the City since the 1990s, launched Level39, an incubator space for startups focusing on financial applications, or fin tech, among other areas.
Ironically, the very institution that made London a global financial center has been among the biggest impediments to making it a global tech hub: the London Stock Exchange.
The LSE’s main market required companies going public to sell at least 25 percent of their shares. This rule turned off venture-backed startups fearful of diluting existing investors. By contrast, Nasdaq’s minimum float is 5 percent.
In March, the LSE created a High Growth Segment within its main market that will allow companies to sell fewer shares -- just 10 percent -- provided they have had 20 percent annual revenue growth for three years running.
While that may help London, the U.S. retains other advantages, Index Ventures’ Holmes says.
“It is a difficult choice for many companies,” he says. “Do you go to the U.S., where there is a bigger comparable set of businesses, more analyst coverage and the valuation models are better understood? Or do you go to London, where the natural shareholder base might be?”
Fred Destin, a partner at Cambridge, Massachusetts-based Atlas Venture, says investors in London are too concerned with profits, while American investors are willing to back companies with high revenue growth long before they become profitable.
Even Mind Candy, London’s most sought-after tech ingenue, is hardly immune to the seductive wiles of American investment bankers.
“When we’ve talked about IPO, we have talked about it as a U.S. IPO and not a U.K. IPO because it still seems that the money is over there,” COO Knowles says.
Unless that changes -- and Silicon Roundabout gets its breakthrough $1 billion exit -- the flat white economy might fall flat.
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