Two weeks into lockdown, many startups are on the brink. Unable to qualify for the Government’s Coronavirus Business Interruption Loan Scheme (CBILS), early-stage businesses will soon need a liquidity injection. In a piece for Sifted, I argued that we need urgent intervention and set out what that might look like, and as an organisation, we are a founding partner of the Save Our Startups campaign.
The key call by the Save Our Startups campaign is for an equity-based solution for startups to complement the debt-based solutions on offer for most businesses. On Twitter, it has provoked a debate between VCs and startup founders over the form that support should take.
Some argue that the limit of government intervention should be co-investment. In other words, only investing public money when investors have skin in the game. Others are calling for a not-for-profit Runway fund where the BBB would invest directly in early-stage (i.e. who have raised less than £5m) in the form of convertible notes that convert to equity at the next funding round.
The former approach has clear advantages and in a normal recession, it would be a better option. It would free up capital and talent from failing businesses, while providing liquidity for the best bets.
But this isn’t a normal recession. As Sam Bowman and I argued, a couple of weeks ago, there are key differences. The supply-shock is temporary. Mike Bird, from the Wall Street Journal writes: “It’s not like a meteor obliterated our productive capacity. It will come back”. The aim should be to freeze the economy in place to make the recovery as quick as possible. This is broadly the approach the government has taken intervening to ensure as many businesses as possible stay afloat.
The slight complication is that many of the startups in question will fail anyway. As Matt Clifford writes: “Most startups do die, even in boom times. Jobs and capital are lost. It’s desperately sad - I have to deal with it all the time - but it’s a fact of a well functioning ecosystem. If we pour £Bs into propping up doomed companies, we’re storing up huge problems down the line.”
Here I think Matt is overplaying it. The funding proposed would only be enough to keep them afloat to their next funding round. The loss-making nature of the businesses in question all but guarantees we won’t be left with zombie startups. For the non-viable businesses, there would still be a reckoning when the market recovers. The key risk is that the funds are wasted.
But in the absence of funding for startups in the short term, many will take advantage of the Job Retention Scheme or cut staff altogether. If this is the case, then the net cost to the taxpayer of bridging funds is limited.
But the cost of losing a generation of startups is large enough that we should be comfortable with losing some money on any intervention. Just as we are comfortable to lose some money on defaulted loans.
So why isn’t a co-investment approach sufficient? Many funds lack the ‘dry powder’ to reinvest. If you are backed by a VC with more funds to invest, then you will survive. But if you’re backed by angels or an EIS fund, then you may have real difficulty in going back for more investment. Angels, for instance, may themselves run businesses and prioritise saving them.
This wouldn’t be a huge problem if the VCs in question funded the lion's share of high-growth early-stage businesses. But that doesn’t seem to be the case. Data from Beauhurst shows that of the 1,634 early-stage deals raising between £100,000 and £2,000,000, the 20 largest VCs were only involved in 23 of them. Many of the rest will have relied upon EIS funds, Angel syndicates, and crowdfunding that are unable to reinvest. Co-investment may save the very best prospects but a lot of startups will be left out.
Some have talked about the ability of the startup ecosystem to recycle talent and capital but it can’t do that under current circumstances. Most investors will be risk-averse until the lockdown is over and workers will be extremely unlikely to change jobs.
There might also be a general deterrent effect. In the event of hundreds of startups going under in the next few months, while other sectors are insulated with government support. More people may choose the security of a large company over starting a new business.
If that’s the case then it’ll mean a slower recovery and a less dynamic economy for years to come.