As lockdowns ease and early signs of an uptick in infection rates spark fears of a resurgence in the coronavirus, the current crisis continues to disrupt startups and the wider entrepreneurial ecosystem.
Startups have been among the hardest hit businesses
Startups and entrepreneurial ecosystems, valued at $2.8 trillion and growing at over 10% per year, are a vital part of our global economy. In addition to providing a significant source of employment, they are paving the way for a digital and more sustainable future. Yet, these businesses have been among the hardest hit by COVID-19. As sales orders have collapsed and production has ground to a halt, investors are retracting their funding, bringing R&D, marketing and other efforts to a standstill. The initial figures are startling — since the start of the crisis, 74% of startups have seen their revenues decline; over 70% of start-ups have had to lay off or furlough staff in order to reduce costs and sustain cash balances.
While startups are, at their core, risky enterprises, they are especially vulnerable during a crisis because they do not have ample cash reserves to absorb protracted reductions in revenue. A new company looking to grow its user base will often operate at a loss (sometimes for years), relying on venture capital to finance its operations. As investments from venture capitalists dry up, common considerations such as ‘How long will this crisis last?’ can often turn existential — a three-month extension to lockdown could mean the difference between a startup’s survival and its demise.
A survey conducted in April shows that over 65% of startups now have insufficient cash balances to support their operations for more than six months (considered the acid test for a startup’s funding needs). The difficulty in securing funding has been most notable in China, where ‘Series A’ venture investments have fallen by around 50% since December 2019. This is a significant drop — but also a more rapid one than observed during the Global Financial Crisis of ‘08/09. In Europe and the US, where coronavirus has had a delayed, but no less pronounced impact, the decline has been more moderate. Yet the trajectory in China suggests that the full effects of COVID-19 on the venture capital industry are yet uncertain.
Appropriate policy response is key
The policy response thus far has been systematic and widespread, as governments around the world have unveiled large stimulus packages to support businesses and prop up their economies. Yet, many of these measures have focused on traditional businesses and small to medium enterprises (SMEs) — with only 27% of countries announcing policy measures targeted towards startups. Startups often operate at a loss and do not meet the profitability criteria to qualify for short-term aid. This has meant that startups have received limited resources to help them weather the crisis.
The importance of appropriate policy measures cannot be overstated. Estimates by Startup Genome suggest that, without government intervention, as many as half of all startups may fail during the current crisis. Such a finding is particularly concerning in light of the strong network effects of startup ecosystems in fostering talent and promoting skill-sharing. The failure of one startup can have outsized effects on the wider cluster, dispersing talent and eroding positive externalities.
Government measures need to be appropriate and tailored to the companies they are intended to support. So far, government aid has mostly taken the form of short-term grants and loans, with a focus on increasing loan availability and providing more favourable lending terms. These measures are likely attractive to startups in providing liquidity, but may be less fiscally sustainable in the long run. In May, the UK government launched a £250 million co-investment fund that provides convertible loans to startups, subject to matched funding from private investors. Such measures may better align incentives for investors and businesses, as well as reduce the public burden. Scenario analysis shows that, even assuming a ‘worst-case’ scenario, the cost of supporting a startup under a co-investment scheme can be 40% cheaper than investing in a comparable SME. Under a ‘base case’ scenario, the investment could in fact be profitable for the government.
Opportunity amidst uncertainty
Despite the challenges for startups, there are new opportunities emerging from this crisis that will be instrumental to the recovery of the wider economy. It is becoming increasingly clear that those companies most able to stay adaptable and agile — that is, the innovators and improvisors— are best equipped to navigate through this crisis.
An interview conducted by Bain & Co with leading CEOs identified the following emergent theme:
“We can’t go back to the way we were. Instead, we must become a more adaptable, learning organization, competing not only with scale, but also speed. We must rediscover business building — to disrupt the status quo and step confidently from this crisis into a much-changed, new world.”
Lessons such as these are only now being embraced by traditional companies, but they can be traced back to the very DNA of startup enterprises. By their nature, startups are flexible, adaptable and creative businesses, thriving off innovation and a disruption to the status quo. As we alight in the aftermath of the COVID-19 crisis into a “much changed, new world”, startups will need to embrace their competitive advantage and lead the way in capitalising on shifting business and consumer trends. In rebuilding and redoubling efforts on the most promising ideas and products, they can begin to pave the way for the ‘next normal’.
Of course, there are other, more practical reasons for placing our bets with entrepreneurs. During the past Global Financial Crisis of ‘08/09, startups contributed to the economic recovery by creating employment in the technology sector when jobs in the wider economy were in decline. This is no coincidence — jobs created by startups are often better aligned with the future trajectory of the economy and therefore more sustainable. Today, with an increasing number of startups operating in the technology sector, the role of startups in job creation is likely to become more important than before.
Entrepreneurs have also performed a critical social function in past crises, supplying the necessary resources to support recovery efforts and leveraging social capital to address societal goals. Today, these efforts are being repeated. To name a few examples — members of the Portuguese tech community have created a platform for dispersing information amongst healthcare workers; a self-driving rental car startup is working with emergency essential service providers to branch out its business; an innovation community in Europe has created an alternative material to produce face masks. Entrepreneurs have increasingly sought out opportunities for collaboration in catering to the current demand. As startups become more socially conscious, serious progress looks set to be made towards building lasting and innovative solutions to today’s most pressing problems.
Forging the path ahead
Looking ahead, it is vital for all business leaders (and not just entrepreneurs) to recognise the importance of conditioning their businesses for future crises, both amidst and beyond COVID-19. Conventional financial metrics such as profitability and growth have quickly unravelled during this crisis, and they are likely to become further de-emphasised in favour of resilience and sustainability as companies shift towards ‘qualitative’ growth.
Entrepreneurs should take this time to consolidate, invest in and improve their products, and repurpose their businesses in anticipation of widespread change. Governments should commit the necessary resources to ensure that the most promising startups do not fail. Rather than defining winners and losers, this is a chance for all economic agents to pool their knowledge and resources towards developing new solutions. By leveraging our combined creativity in overcoming shared hardships, we are well placed to begin sustainably and inclusively rebuilding our economy.