By Joanna Wang
Research Intern, McNair Center for Entrepreneurship and Economic Growth
The economic downturn caused by Covid-19 has left no industry unscathed. However, start-ups and their venture capital (VC) partners have been hit particularly hard, and it is easy to see why. The very nature of start-up companies puts them in a difficult position during economic fluctuations. Unlike more established businesses, start-ups tend to be volatile and risky and generally do not have the financial stability to guarantee investor returns even during economic highs. Covid-19 has supercharged the natural selection of start-ups by putting strains on the supply of capital, the very resource that start-ups need to survive. The draining of VC funding has led start-ups to slash costs by laying off employees and pausing ongoing developments, yet these measures may not be enough to keep many businesses open.
The most direct impact of Covid-19 on the startup industry has been on its primary source of funding, venture capital. From the months of May to June, Covid-19 slashed the number of VC rounds in the U.S. by 44%, with seed-stage deals taking the biggest hit of 57% compared to the same time period in 2019. Almost 20% of start-ups that had a term sheet before the pandemic have since had it pulled by the investor, and 53% of start-ups are experiencing a slower fundraising process or struggling with an unresponsive lead investor. With no investors to back entrepreneurial ventures, many start-ups are grappling to stay afloat. A recent survey by Startup Genome of 1,000 start-up founders found that two-thirds of start-ups will run out of money within six months, and 40% within just three months. The number of companies identifying themselves as being in the “red zone” has increased by 40% since December 2019.
The advent of “crisis mode” has led many start-ups to rapidly downsize in an attempt to preserve their business. In tech start-ups alone, some 70,000 employees have lost their jobs. Fully 75% of start-ups have had to let go of employees, with 39% of them laying off more than 20% of their staff and two-thirds letting go of 60% or more of their employees. These job cuts are especially concerning because start-ups are one of the biggest employment and job creating sectors in the United States. A Congressional Research Service study found that start-ups account for almost all net job growth in the economy and that “young companies are the engines of job creation.” As a result, contraction of the start-up sector may have long-lasting effects on employment in the United States, keeping unemployment high even when the economy recovers.
Areas of Opportunity
Luckily, not everything is doom and gloom for start-ups. Looking back to 2008, some of today’s most successful start-ups, like Airbnb and Slack, were able to emerge and thrive even though they were still in the seed-funding stage during the recession. The same is happening now. In the past four months, as Covid-19 has transformed everyday lives, it has also created opportunities for start-ups in certain industries to capitalize on these lifestyle shifts. For example, stay-at-home orders and the race for a vaccine have boosted start-ups in e-commerce, video conferencing, software-as-a-service (SaaS) and health technology. Conversely, start-ups in industries that require in-person business such as travel and hospitality, real estate and physical retail are facing massive revenue challenges as demand in these industries has drastically decreased.
Covid-19 will continue to alter the start-up space as new sectors emerge and traditional industries fall victim to the digitalization that has only been accelerated by the pandemic. What’s important to note is that this isn’t a death sentence for the start-up industry. Start-ups need to adapt to the changing consumer environment and preserve their limited resources until the pandemic passes.