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This article was published on April 29, 2020

Report: Coronavirus may lead to ‘mass extinction’ of tech startups worldwide

If governments do nothing

Report: Coronavirus may lead to ‘mass extinction’ of tech startups worldwide
Yessi Bello Perez
Story by

Yessi Bello Perez

Former Senior Writer, Growth Quarters

Coronavirus will have devastating effect on startups, causing a drop in venture capital funding across the world, eradicating many businesses altogether, and making government intervention necessary.

That’s according to Startup Genome’s ‘Governments, Don’t Let your Startups and Scaleups Die’ report, which states that the recent drop in venture investments in China will help predict what will happen in Europe and the US.

“While it took four quarters for the US Series A and B venture investments to drop from their peak by 30 to 48%, a few weeks ago we had already documented a drop of 50% of Chinese Series A investments.

[Read: Chinese startups are being starved of venture capital — which should worry the West]

“Because of their importance on the Asian venture investment landscape, the Chinese VC contraction impacted many other Asian countries before COVID-19 affected their economies directly.”

This contraction caused in venture capital investments is much faster and deeper than in normal recessions because coronavirus disrupts processes themselves — making it impossible for investors to meet startups like they normally would.

According to the report, economists say the return to normality will reveal a deeper recession.

This strongly suggests that the investment contraction is likely to lead to a mass extinction of tech startups precisely at a time when their importance as engines of economic recovery and sustainable job creation is heightened.

“Now is not the time to let venture capital investors prune startup ecosystems by 50-70% — the drop we believe might happen without any government intervention,” the report states.

“Preventing a massive number of premature bankruptcies is exactly why governments all over the world have stepped in to protect SMEs from bankruptcies, and why they must do the same for tech startups,” it adds.

Startup cash reserves are already low — and it’s only the beginning

According to Startup Genome’s study which surveyed almost 1,500 respondents, some 65% of companies — including 34% of Series A+ startups have less than six months worth of cash.

“For companies that previously raised external funding, six months is a red zone when one of the founders starts focusing close to 100% of his or her time on fundraising,” the report warns.

“When equipped with good growth numbers, they can usually make it. In the current context, where 52% of startups have seen their revenue drop by 20 to 100% (barely four weeks into the economic crisis), VCs have greatly reduced and slowed down their investments.”

[Read: VCs spent a record €8.2B in Europe in Q1 2020 — but coronavirus dampens future expectations]

This, the report continues, makes this crisis a double whammy of capital crunch and demand drop.

“Altogether, it is clear that without government intervention as much as half of our startups might fail unless they lay off most of their employees, endangering their future ability to recover, let alone grow.”

If this were to happen, the report warns it would have a significant knock-on effect on the wider economy.

“Such a large reduction in the number of startups means contemplating a major setback for local startup ecosystems and the local economy for two key reasons a) the accelerating returns to scale of startup ecosystems — and on the flip side, the accelerating losses when the economy gets smaller, and b) the impact on your national and local talent pool,” the report claims.

Coronavirus can heavily impact the tech talent pool

The report notes that 74% of startups have already had to let go of full-time employees, with 26% had to let go of 60% or more of their full-time staff — despite the fact we are still at the very beginning of the economic crisis.

As the coronavirus crisis deepens, and if startups aren’t supported, this lack of care will impact local economies’ talent pools for years to come. “More than one would expect from layoffs in traditional industries,” says the report.

Tech employees, the report states, are a highly productive talent pool.

Layoffs would not only eradicate productivity in the short-term, it may also encourage these employees to seek work elsewhere, opting for tech giants in places such as Silicon Valley, New York, and London.

This, the report adds, means that the impact of unemployment among tech startup workers is three-fold.

First, you lose the productivity of these employees today.

Second, you might lose the productivity of these employees in the future as we explained earlier—because they might leave to work in Silicon Valley or elsewhere, or in another industry and become less valuable to startups and hard to win back.

Third, the best we have estimates suggest that for every high-tech job, five additional jobs are created in the service economy — losing your high-tech jobs will lead to ripple effects much beyond your startup ecosystem.

[Read: Coronavirus threatens flow of US capital into European tech startups]

Finally, the report highlights how some of today’s most well-known tech companies — including Facebook, LinkedIn, Palantir, and Dropbox — were funded during the Great Recession.

All of these companies, though, are based in the Bay Area. “The Silicon Valley ecosystem is not about to let its most promising startups die. Do not make that mistake in your ecosystem.”

Governments need to do something about it (and fast)

For venture capital-backed startups, the report asks governments to design an immediate flow of government money to startups, not to expect VC firms to lead and spread the money, not to trigger new terms, provide greater flexibility in terms of use of funds, and align its incentives with investors.

For non VC-backed startups, the report says that government money must be funneled to startups through angel investors,

“Because angels have not been vetted by the private sector like 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,” the report concludes.

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