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By Daneesh Shahar
Governments around the world are funneling money to keep the startup ecosystem alive
The novel coronavirus pandemic has quickly become this generation’s defining event. The fallout has led us to assign the pandemic to a particular tier, where it ranks among the likes of the World Wars and the Spanish Flu. As the crisis has unfolded, more and more governments have chosen to introduce stimulus packages to boost their economies. For the first time in history, startups are the beneficiaries.
Stimulus packages provide temporary relief from financial pressures through handouts, forgivable loans, or tax cuts. Historically, they have been criticized for misdiagnosing the problem they’re trying to solve or the lax enforcement of their terms and conditions. However, in the face of the Covid-19 crisis, it has become increasingly difficult to argue against them.
What’s interesting about economic stimuli during Covid-19 is that previous crisis-era governments didn’t have to consider where startups fit into the plan–after all, Silicon Valley wasn’t a concept in the 1920s. Should startups be prioritized for government aid? Are there irreversible consequences of not providing them with adequate assistance? These are the questions politicians and regulators have to contend with as they witness their economies fall apart in real-time.
National repercussions of startup struggles
Like most other businesses during this crisis, startups are struggling. However, startups’ unique process of raising capital can make them especially vulnerable to exogenous shocks. When investor funding is contingent on hitting milestones, startups fall prey to excessive cash burn and the need to boost top-line revenue figures at the expense of a sustainable business model.
A black swan event like Covid-19 isn’t typically accounted for in the budgets of young, venture-backed startups. Consequently, the pandemic has forced many to lay off their employees as quickly as they hired them.
In the early part of the U.S. lockdowns, electric scooter sharing startup Bird laid off 30% of its workforce in a single Zoom call, while apparel startup Everlane furloughed hundreds of its employees. Even the giants aren’t immune; in May, Airbnb let go of 1,900 employees, and Uber laid off of 3,700–around 25% and 14% of the companies’ workforces, respectively (TechCrunch). Such cases are, understandably, bad news for governments attempting to keep unemployment figures from spiraling.
Government responses to the crisis have varied drastically. France led the way with a €4 billion (US$4.3 billion) stimulus package announced in late March, with a twofold funding and loan offer for startups. Around €86.7 million (US$94.5 million) of the stimulus package is allocated to startup funding, softening the decline in venture capital. The bulk of the aid, €2 billion ($2.1 billion), is a liquidity support scheme; through it, startups can borrow up to two years of payroll for its employees, or 25% of annual revenue, depending on whichever is higher.
The U.S. has taken a different approach, opting to include startups under the umbrella of small businesses. In late March, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, a US$2.2 trillion relief package to protect American people and businesses, was signed into law. Under the Paycheck Protection Program (PPP), US$349 billion was set aside for small businesses to pay for up to eight weeks of payroll costs.
This massive allocation to small businesses is expected, given they’re often referred to as ‘the heart of America’ for representing entrepreneurship, grit, and the best parts of American-branded capitalism. However, due to a regulatory twist, the PPP does not guarantee participation for venture-backed startups.
Venture-backed startups are often part of a VC firm’s portfolio of companies. To the federal government, this relationship can be interpreted as an affiliation with a controlling entity; therefore, the employee count is the combined total of all the employees working at all the portfolio companies, which can easily exceed 500.
Although venture-backed startups can disprove this perceived affiliation, the process requires time. Without adequate proof, banks–which must strictly adhere to PPP guidelines for fear of not being reimbursed on defaulted loans–may be unwilling to submit a startup’s PPP application.
What do the differences in federal aid programs for startups reveal to us about how governments view startups? Musheer Ahmed, a founding member of the Fintech Association of Hong Kong, argues that the differences in approach are partially driven by a government’s economic assessment of startups.
“If you look at how the responses have been different major countries, it’s probably down to how the country looks at the startup ecosystem–whether they see [it] as a main vertical or a very important vertical of the economy,” he says.
He adds that it’s also a matter of classification and the landscape’s maturity. For example, in the U.S., where the startup ecosystem is highly mature, legislators have chosen to lump venture-backed startups in with SMEs rather than cater to them.
France’s decision to launch a dedicated aid program for startups is, therefore, a logical and expected one. The government has openly expressed interest in cultivating greater digital sovereignty through initiatives like the US$5.5 billion AI-focused startup fund announced in 2019 (VentureBeat).
Should venture-backed startups receive aid?
The problem with classification extends into the discussion on who should and shouldn’t receive federal aid. An increasingly widespread sentiment among many academics in the U.S. is that venture-backed startups should not receive federal assistance. This notion partly stems from the belief that well-funded startups, with wealthy investors and considerable resources, would take money away from mom-and-pop businesses, especially since programs like PPP operate on a first-come, first-serve basis.
This frustration with bailing out wealthy investors has its roots in the GFC stimulus, perpetuating the widely-held belief that it rewarded bad behavior from big banks while not doing enough to help average Americans. For example, Airbnb is often referred to as a startup, but it would be difficult to defend the company should it file for federal aid, considering the leverage it has for raising capital through equity or debt.
Classifying all venture-backed startups ignores differences in the capital raised, their stage, and industry. Such factors affect how well or poorly each startup is doing during the crisis, which loses meaning if having VC backing disqualifies them for federal aid.
Predictions for the future
Many of today’s most prominent startups in ride-hailing, rental platforms, and AI started after the GFC of 2008, so there is no reliable reference when making predictions about what the startup landscape will look like with stimulus packages propping up an ailing global economy. But the trends we’re seeing today do give us a clue of our post-Covid-19 world.
“Despite whatever support the government is giving, there will be a much higher mortality of startups in the next three to six months, if not already. I know of a couple of startups that have raised a significant amount of money and then had to shut down,” says Ahmed. He further explains that retaining talent in the startup ecosystem, and not losing them to corporates, will be integral to its recovery.
“The person who’s working for the startup, as well as the people running [it], have to evaluate whether they can continue burning cash and sustain their families, or if they have to do something else which helps sustain them over the next year or two,” he says.
Working for startups is often a high-risk, high reward bet. If that risk exceeds the reward too significantly, it could threaten entrepreneurship’s appeal in the long term. The stimulus package could be one answer to mitigating the effects of the inevitable brain drain from startups. Still, as Covid-19 continues to mount pressure on our economies and lives, it becomes evident that more has to be done to protect them and that some cannot be saved.
Daneesh is Jumpstart’s Journalist-in-Residence.