Governments, Don’t Let your Startups and Scaleups Die

Startup Genome | JF Gauthier and Arnobio Morelix | Apr 2020

Governments dont let startups and scaleups die 1 - Governments, Don’t Let your Startups and Scaleups DieThe Importance of Well-Designed Startup Funding Policy in Times of Crisis

Policy makers leading advanced startup ecosystems around the  globe have  spent far too  much time and  invested far too  many resources to  watch  the  COVID-19 crisis wash  it all away. To avoid this fate, an aggressive emergency policy response is required. Building  on  the  world’s  first  global  startup survey  on  the  impacts  of the  COVID-19  crisis on startup operations and  liquidity, this report dives into the  critical capital and  financing issues facing startups at  this period of  time. Drawing on  Startup Genome’s proprietary  research base as  well  as  the  insights  compiled  from  the  analysis  of previous  periods  of economic  uncertainty,  this report explains both the  rationale for a venture capital injection policy and  explicit actions that  should be undertaken now related to the  design and  operationalization of such  policies.

This  report  stands  as  the  third  emergency  policy  response  report  for  global  startup  ecosystems,  alongside  our  earlier  Global  Startup Survey  on  COVID  Impact  and the Global  Policy  Knowledge  Base as well as our ongoing Research  Series.

See:  NCFA Open Letter: Government should collaborate with Fintechs

Key issues from this funding policy white paper:

1) Tech Startups Are Key to Economic Recovery

  • Last year, the global startup economy was valued at $2.8  trillion and  growing over  10 percent per  year, about three to four times faster than the  rest  of our economies.
  • With the  world’s  transition  to  a digital  economy,  technology  startups and  their ecosystems have  become more important and  the  jobs they  create more sustainable, because they  are  better adapted to our economic future. The current crisis has accelerated the  digitization of the  offline economy, making tech  companies even  more important.
  • In the wake of the  last crisis, startups contributed strongly to the  economic recovery. By 2011,  employment in the  ‘Computer Systems  Design  and  Related  Services’  industry  had  grown  by 2.6  percent per  year  from  pre-recession  level,  while  in  the overall economy job creation was negative, at -1.2 percent. The 2.6 growth  rate  is higher than that  of large sectors including healthcare.
  • Startups funded during the Great  Recession had  slightly higher exit multiples over  total money invested than those funded during economic expansions, and  VC returns for recession-year startup investments were, at  13  percent, higher than for all but one  of the  years  in the  decade, from 1997  and  on, with startups including Facebook, LinkedIn, Palantir, and  Dropbox.

See:  The Impact of Coronavirus on Funding Innovation

2) Drop in Private Investments, Death of Startups

  • In the   crisis  of  2007-2009,  which  might  well  prove   to  be  milder  than the   one   we  have  just  entered,  venture  capital investment deals dropped 30  percent (2008 to  2009) for  Series A investments in software in the  U.S. Drop  in Series B investments was even  sharper: 48 percent.
  • While it took 4 quarters for the U.S. Series A and  B venture investments to drop from their peak  in 2008-9,  a few weeks  ago we had already  documented  a  drop  of  50%  of  Chinese  Series  A  investments.
  • Our global startup survey revealed that 65 percent of all companies, including 34 percent of Series A+ startups, have less than 6-month worth  of cash  and  74 percent of startups have had  to let go of full-time employees, with 26 percent of them having to let go of 60 percent or more of their full-time staff.
  • Because size matters—ecosystems that are 3 times bigger produce 5 times more economic value—governments must act to prevent a massive extinction of startups and  dispersion of their high-value talent pool.

See:  How Regulation Crowdfunding Stood up to the First Weeks of Coronavirus

3) Cost-Benefit of Policy Investments in Startups

  • Governments stand to make money by injecting six months worth  of cash  in tech  startups. Even if we assume a negative 10 percent return on the  equity, the  cost  per  job saved will be 41 percent lower for startups than for SMEs, respectively costing $14,766 and  $24,928 per  job saved.
  • Startups offer a higher job multiplier because of the  higher wages  they  pay, their higher rate  of exports and  of FDI (foreign direct  investment)  from  international  investors. They  are  also more “future-proof” as  we  globally transition to  a  digital economy.
  • The sum  of exits—a proxy  for economic value—was $322  million for a typical sample of 10 U.S. Series A startups funded in 2006  or 2007.

4) Defining Your Goal as Government

  • The first goal for policymakers should be to increase capital in the  hands of angels and  Series A funds by about 100 percent.
  • The second goal should be  to save 80 percent to 90 percent of existing VC-backed startups, and  especially those at Series A and  B.

See:  How Governments Should Use Crowdfunding to Battle the Economic Impact of #Socialdistancing

5) Key Policy Principles for Supporting Startups

  • Depending on whether startups could qualify for SME payroll support programs, allocate 12.5 to 25 percent of all early stage investment made in local startups in the last eight quarters (ending Q1 2020) to a policy relief fund.
  • Extend 6-month worth  of  cash  to  VC-backed  startups by funnelling  government  funds  to  VCs  through a Fund  of Funds structure; then letting VCs to  distribute the  funds to  their portfolio startups putting their unique expertise and  intimate knowledge  of  each startup to  work—and  that   without asking VCs to  co-invest, but  rather letting them do  so  at  their discretion.
  • In  addition  to  the  specific  guidelines  above,  there are  five  key principles  governments  should  follow  in  supporting  their VC-backed startups:

○   Design for Immediate Flow of Government Money to Startups

○   Do Not Expect VC firms to Lead and  Spread the  Money

○   Do Not Create a New Instrument or Trigger New Terms

○   Provide Great  Flexibility in Terms of Use of Funds

○   Align Investor Incentives with Those  of the  Government

  • To increase venture capital investments during the crisis and  recession, match Angel investments at a ratio of 3 to 1 (three parts public to one  part  private funds), seed-stage investments by institutional investors at a lower ratio of 2 to 1, and  Series A investments at a ratio of 1 to 1.

 

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NCFA Jan 2018 resize - Governments, Don’t Let your Startups and Scaleups Die The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org

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