The NVCA’s report warns startups of a capital crunch.

The National Venture Capital Association (NVCA) issued a  white paper on the likely impact of the evolving COVID-19 economic crisis on the U.S. startup ecosystem.

“The U.S. startup ecosystem has rapidly entered a new chapter of what will be a turbulent period over at least the next several quarters,” wrote the NVCA. “The U.S. economy has essentially shut down, leaving many venture-backed startups living in a state of uncertainty far beyond the normal challenges of launching a successful business.”

Business closures and job losses

The NVCA observed that 300 startups across the country have already laid off approximately 30,000 employees

“Fasten your seatbelts…This is likely just the tip of the iceberg for what will be tough times for startups over the coming months,” said the NVCA.

It quoted a VC’s prediction that 80% of startups will slash headcount by 10% to 50% of employees over the next two to four quarters.

“The reality is that companies will shut down—at a higher rate than what is inherent to this risky industry—and there will be waves of layoffs.”

Declining investment

With the economic uncertainty from the pandemic looming over the VC industry, one big source of funds is likely to dry up – the so-called “non-traditional” startup investors.

These include corporate venture capital groups, family offices, PE investors, and sovereign wealth funds. These entities are likely to “rebalance away” from high-risk and illiquid investments such as in startups.

“Existing capital reserves by venture capital (VC) investment funds will not be nearly enough to sustain operations in the startup ecosystem,” the NVCA warned.

As a result, investment funds would be scarce when they are needed the most – for the creation of new ventures and employment to bedrock the recovery from the pandemic.

Dry powder

The report observed that while the $120 billion of dry powder that the VC industry started 2020 with was a substantial war chest, it was not enough to weather the COVID-19 storm.

The report quoted VC investor Jon Sakoda’s analysis that VC investors allocate half of their dry powder for existing portfolio companies and the other half for new investments. By that reckoning, and based on the current pace of investing, the NVCA estimated that industry dry powder will only last four quarters.

Again, a downturn causes a decline in exit activity such as IPOs and M&A. This will place further strains on dry powder.

Lessons from the GFC

The report made several comparisons with the 2008 global financial crisis (GFC).

• VC fundraising fell by nearly 60% from 2008 to 2009
• Total deal value for investments with participation from non-traditional VC investors, such as corporate venture groups and PE firms, fell by 29% and 36% respectively from 2008 to 2009
• [Exits] While VC-backed IPOs numbered 90 in 2007, the number fell to 13 in 2008 and 11 in 2009
• [Exits] Disclosed M&A value during 2008 and 2009 fell by more than 50% compared to 2007

These are worrisome trends should they repeat in the current crisis.

A leaf from the startup rescue playbooks of France and Germany

What should the U.S. do? France and Germany have set up startup rescue packages of $4.3 billion and $2.2 billion respectively. By that measure, the NVCA estimates that a U.S. aid package should amount approximately $40 billion to $60 billion.

“Aiming for more of a soft landing rather than a hard crash for the startup ecosystem over the next 12-24 months will have a major impact on the country’s economic recovery and the future of innovation and jobs,” the NVCA recommended.

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