The Impact of COVID-19 on Global Startup Ecosystems

After more than a year of pandemic, and after having analyzed the impact in the Travel sector globally in an internal study at Facebook, I wanted to talk here about the impact for Startup ecosystems in the world.

Although the grip of COVID has eased in the United States and Europe, the pandemic is far from over and it is therefore worth understanding the impact on startups, what this means for the economic system and what has been done or can still be done.

The Impact on Startups

We saw the first immediate impact in VC investments and the demand, followed by a consequent impact in jobs cut and spend reduction.

Capital

• Capital went down by 20%
• China drop by over 50%
• 40% of startups had capital for the next 3 months and 35% of Post Series A for 6 months
• Three out of every four startups have had the fundraising process disrupted (18% had a funding round cancelled by the investor, and 54% delayed or the lead investor become unresponsive)

What happened to Capital in the past recessions?

• A similar drop of 30% (2008 to 2009) for Series A investments in software in the U.S. Drop-in Series B investments was even sharper: 48%.
• global VC investments took one (2007–2008) and three (2000–2001) years to recover to pre-contraction levels.
• Related, technology IPOs in the U.S. dropped by 90% following the last two recessions, and tech IPOs in the U.S. have not yet recovered to pre-Recession levels, with the number of IPOs in 2019 (34) being 55.3% lower than in 2007 (76).
• During the past two recessions, although fewer dollars were invested, more companies got funded, suggesting that businesses that can become cash efficient might become even more likely to raise money following a recession, albeit at lower valuations and lower total funds raised.

Demand

• About 72% of startups saw their revenue drop,
• a decline of 32%, travel impacted -70%
• only 10% of startups expect their revenue will grow a lot.
• 40% expect it will stay about the same or grow a little,
• and a dramatic 28% think their revenue will still drop a lot further.

60% startup for an average of 33% of jobs cut

71% of startups have reduced their expenses, for an average cost-cutting of 22%.

The impact on the ecosystem

Tech startups and their ecosystems have become crucial to recover

The world’s transition to a digital economy and global crises always accelerate the adoption curve of new technologies.

See Zoom, Slack, and Shopify during COVID.

• The jobs they create are more sustainable because are better adapted to our economic future.
• With the highest number recorded of unemployment insurance requests in the US (3.3MLN people in a week), the economy needs startups now even more than usual because net job creation in the economy comes from new young companies (10%), especially those that scale when older firms are net job destroyers
• Startup jobs are cheaper to save than traditional small business jobs by government programs — about 41%
• Tech companies have impressive job multipliers. for every high-technology job, five other jobs are created in the service economy

We have already seen in the wake of the Great Recession, startups contributed strongly to the economic recovery. 2.6% year job growth in the “Computer Systems Design and Related Services” industry vs. -1.2% in the economy. The 2.6 growth rate is higher than that of large sectors including healthcare.

Value impact of startups

startup ecosystems has increasing returns to scale due especially to network effects.

As the number of startups in the ecosystem grows, the whole economic community related to the ecosystem: talent, universities, startup support organizations, produces more value.

A 3x larger ecosystem creates about 5x more economic value (Porter’s cluster theory). This also means that if you lose about 20% of startups, you can expect to lose about 27% in value. If you lose 40% of them, which is the figure for startups in the red zone globally, and you’re risking shaving off over 50% of the economic value produced by your ecosystem.

And indeed the opposite applies. Reducing the number of startups would slash the value of an ecosystem exponentially.

Returns for investors

Startups funded during the Great Recession had slightly higher exit multiples over total money invested than those funded during economic expansions

VC returns for recession-year startup investments were, at 13%, higher than for all but one of the years in the decade, from 1997 and on, with startups including Facebook, LinkedIn, Palantir, and Dropbox.

Other opportunities

lower negative impact on the environment

stronger focus on inclusion

fair access to the amazing value that tech ecosystems create.

Startups provide competition to entrenched players in virtually every industry. Without startups, technology, finance, healthcare, and other fields would be stagnant. (e.g. FinTech)

And when startups do bloom and become important industry players, that adds more prestige and value to the ecosystem in which it operates. (e.g. Amazon and Microsoft in Seattle)

What the government should do

Government relief programs typically have strict eligibility rules and emphasize companies with revenue, profitability, and collateral.

Governments need to act to support startups and bail them out in the same way they are doing for traditional industries and small businesses

This is especially true for ecosystems that are not at the very top and do not have the decades of experience, talent, and capital to draw upon during times of crisis.

The top ecosystem (Silicon Valley, New York, London, and Beijing) will continue to stay top after the crisis because they have talent, experience, and capital. But emerging ecosystems risk the lose the progress made in the past 10 years.

The first goal for policymakers should be to increase capital in the hands of angels and Series A funds by about 100%.

The second goal should be to save 80% to 90% of existing VC-backed startups, and especially those at Series A and B.

and avoid that seed and Series A drop in the next two years (and we lose an entire generation of founders)

39% of startups globally are not receiving assistance

31%, reported that they would like to see grants to support company liquidity, instruments to boost investments (17%) and support for employees (15%)

However, Typically, government grant schemes are complicated and slow

Governments should instead shift to equity investment using existing funding structures to quickly deploy capital, guarantees for equity investors, and demand generation programs to future proof our ecosystems.

The 6-month worth of cash to VC-backed startups by funnelling government funds to VCs through a Fund of Funds

letting VCs distribute the funds to their portfolio startups.

Consider also that some startups are more covid resilient (e.g. healthcare with contact tracing, food delivery, online education etc).

The Coronavirus Aid, Relief, and Economic Security (CARES) Act offers an Employee Retention Tax Credit — a refundable payroll tax credit to encourage and enable employers to keep employees on their payroll. The tax credit is equal to 50% of the first $10,000 of qualified wages that employers pay each employee.

Or the U.K.’s Coronavirus Future Fund. It specifically targets U.K.-based pre-revenue and pre-profit companies that rely on equity investment and provides government convertible loans ranging from roughly $150,000 (£125,000) to $6 million (£5 million). Future Fund loans are subject to at least an equal match in funding from private equity investors.

VCs are not in the business to save startups. From the Great Recession, only 5% who received Series A had a follow-up. This is because VC firm’s incentive is to achieve high returns above 20% and earn their carry (share of the excess returns), and they do this by investing only in the startups offering the highest return potential.

Israel’s Yozma program succeed at multiplying the number of Series A investments in the mid-1990s. The program capped the returns of the government money by allowing the VC firms to redeem the capital at predefined, relatively low returns. This increased the return of participating VC firms, motivating them to invest in more than only the very best startups because the program allowed them to earn a return on the government’s money from a much lower return threshold than the normal “20% carry” formula did.

Preserve the talent from going to a big corporation or other ecosystems (e.g. Silicon Valley) or having to leave because of visas:

UAE extended all visas expiring march, 1 2020

Denmark is covering 75% of salaries for companies that do not cut staff

Germany is offering to cover around 60% of the new salaries for employees reduced from full to part-time).

Specialisation also needs to be preserve. It is important to have a vibrant startup community to ensure that patent creation and R&D make their way efficiently into commercial use. sub-sectors such as Artificial Intelligence & Big Data, Advanced Manufacturing & Robotics, and Blockchain, have a lot to lose if their promising startups don’t survive 2020.

Replace domestic and global demand temporarily, especially in regions where technology is not as in-demand.

support programs such as accelerators and mentorships (even switching to a virtual model)

Non-VC Backed​ Startups must be funnelled to startups through angel investors. But because angels have not been vetted by the private sector as VC firms have, the government needs angel investors to first invest their own money to signal to the government that the startup is truly offering good potential.

Co-investment, matching program where the government follows a private investor.

A higher co-investment ratio is mandated by the situation.

Angel investments shall be matched at a ratio of 3 to 1 rather than the normal 1 to 1 ratio. New Zealand is a good example.

Match seed-stage investments by institutional investors at a lower ratio of 2 the 1 and a maximum total deal size of two times the normal median seed round in the ecosystem

Series A investments would be matched at a ratio of 1 to 1, with a maximum total deal size of $10 million.

Note: Most of this article is based on a search by Startup Genome, then supplemented with personal considerations and other data found on the web.