Student Blog — Start-ups and Venture Capital: The Uphill Battle With Covid-19

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,^[1] 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.^[2] 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.

Capital Crisis

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.^[3] 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.^[4] 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.^[5]

Slashing Jobs

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.^[6] 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.^[7] 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.”^[8] 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.^[9] 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.^[10]

Conclusion

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.