2020 is turning out to be a challenging year for startups. Many are trimming staff, and even so might still run out of money by October. With the rapidly developing situation it has been difficult to stay informed of developments, particularly when it comes to the availability of the venture capital needed to sustain startup development. There has been a lot of conjecture on the viability of startups in an unstable year, even Stimulus added our opinion to the conversation recently, but relatively few answers. So, in the wild current business landscape where markets of all types are shuttered by lock-down measures while the stock market rallies, what is actually going to happen with funding for startups this year?
To answer this question it is necessary to take a look at the past, to the two significant downturns in the digital age so far — 2001 and 2008. The causes behind those crashes were unique both from each other and to the current situation, but the recovery behaviors afterwards are useful analogues. The easiest lesson gleaned from this history is that startup funding will most likely not return to pre-2020 levels for a number of years. After the financial crisis, it took between two and three years for Series A, B, and C funding levels to return to those of Q1 2008. More dramatically, venture-capital funding of startups has still not yet been able to match the high water mark it achieved in 2000 during the dot-com bubble, although that may be more a measure of the scale of the bubble than anything else.
However, that same data indicates that during the financial crisis, seed funding for startups only took a hit until the end of the calendar year of 2008. In Q1 2009, while the Dow Jones Industrial Average was still on its way towards bottoming out on March 6th, the number of seed funding agreements had already outpaced the year prior. That number then continued to rise as the broader US economy contracted. These recession seed investments were proven to be just as fruitful as any other year, with many big names in tech today having received their initial funding in the years following 2008.
There are two causes for this funding behavior that come to mind. The first is that potential investors were cowed by the economic turmoil, and became much tighter with purse strings. Caution certainly prevailed through 2008, but the immediate jump in seed deals once the initial crisis had passed discounts this as an enduring influence. The second is that Series A, B, and C figures declined in part due to the sheer number of businesses failing during 2008–2009, compounding the effect of cautious investment behavior. Many existing startups at the time ran into trouble with lowered customer activity, particularly if they were oriented towards consumers or small businesses, and ran out of runway before they were able to demonstrate viability or pivot for new funding. Meanwhile as Startup Daily points out, significant amounts of venture capital “dry powder” had been built up before 2008 which still needed to be deployed before investment periods ran out, bolstering funding activity afterwards. This is in contrast to 2001, where the relative paucity of capital raised from the preceding years caused funding to collapse and stay low.
2018 and 2019 were banner years for venture capital fundraising, so most likely startup funding behaviors will more closely follow the pattern of 2008 over that of 2001. There will still be significant funding available even if 2020 is host to an economic contraction on the scale of 2008, though that funding will be disbursed with caution through the rest of the year. And that caution would be just as well founded as it was in the past — a majority of currently active startups are short on runway, and are turning to staff reductions regardless of their size in order to survive.
Despite the similarities, the situation in 2020 has more than a few confounding factors that will set it apart from any historical analogues. Primarily, the instability has been caused by a virus, which is an external factor that exists independently from the economy. While the crashes of 2001 and 2008 originated within the realm of finance — vaporware and sub-prime mortgages do not appear in the wild — COVID-19 is a natural phenomenon that doesn’t cooperate with the standard economic tools used to stabilize markets. It is entirely possible that stay-at-home orders and plant closures will return in the near future, becoming perennial disruptions to our seemingly stable supply chains. Supply chains which, aside from financial issues, had not had operational failures delivering needed goods during either of the previous crashes.
We talked last month about the supply chain impacts of COVID-19, including raw material shortages and labor issues. Since then, many production stoppages have either prolonged or become permanent, providing a first look at the longer-term impact of this crisis. Given that a number of US states are now reopening, despite historical experience telling us that doing so this early will be disastrous, we can expect the disruptive effects of COVID-19 on production to prolong. Transmission within even small gatherings is still an issue, which could lead to repeated plant closures as they attempt to sustain operation. The longer that production is under duress, the longer financial markets will remain unstable, and the longer investor caution similar to 2008 will last. If this situation extends past the end of 2020, any comparison to the previous crashes will have run out and we will be in truly unprecedented territory.
On the other hand, the physical nature of COVID-19 breeds optimism that it can be solved by technological means. While not in overwhelming amounts, investor funding is nonetheless being directed towards companies that could develop solutions for any of its myriad effects on daily life. No one was searching for startups to fund for innovative responses to 2001 or 2008, nor setting aside money to save them, but we are seeing both of these occur in the midst of COVID-19. This is a promising sign, indicating that availability of funding and confidence in the viability of startups haven’t taken as big of hits as might be expected during uncertain times.
Ultimately, the frustrating answer to the question of funding is that we really don’t know. There are historical precedents for some of the activity that we are experiencing now, but even if this was purely an economic reversal it would still have its own unique characteristics. However, as the trend goes negative for both startup population numbers and funding terms it is worth noting that these could be temporary reversals, and more short-lived than you might expect. While this is little comfort to the thousands of startup founders that have watched their business models collapse since March, it is good news to others still waiting to jump into the fray or that are successfully navigating the suddenly uncertain funding landscape.