I recently wrote about the potential impact of coronavirus on innovation. If coronavirus leads to a fall in the availability of venture capital then it could lead to fewer high-risk, high-reward innovative startups getting funded and lead to less innovation overall. My concerns were prompted by a study by Ramana Nanda and Mathew Rhodes-Kropf, which looked at the relative performance of VC investments in upmarkets and downturns.
One of the authors of that study, Ramana Nanda, along with other leading researchers, has released a new working paper assessing the initial impact of the coronavirus pandemic on venture capital returns.
They found:
“… that U.S. VC activity fell precipitously during the initial phases of the coronavirus disease 2019 (COVID-19) crisis, despite government efforts to prop up startups.”
More interestingly, the decline in funding wasn’t spread evenly across the market. Instead, it appears to back up the concern that VCs will take fewer risks when funding is limited.
“In unpacking the source of this decline, we find that the number of weekly early-stage VC deals declined by nearly 38% in the two months starting March 4, 2020, relative to the previous four months. In contrast, later-stage VC has remained much more robust thus far.”
The researchers identify a few other interesting effects.
First, looking at patent data they find that the quantity and quality of VC-backed innovation is linked to the business cycle.
“The number of patents applied for by VC-backed firms, as well as the quality of those patents, is positively correlated with the amount of VC investment into startups in a given month.”
Second, they find this effect is driven by a decline in activity from VC specialising in early-stage investment. Later-stage VCs by contrast are more insulated from the wider economy.
The government’s Future Fund opens today and it aims to shelter VC-backed innovation through the crisis. This new study highlights why the case for intervention is particularly strong. However, it also raises concerns. Investments through the Future Fund can be as high as £10m (split 50:50 between investor and government). Yet startups need to have already raised at least £250,000 to qualify. If the impact is felt sharpest at that end of the market, then perhaps it should be lower.