The European Commission’s Joint Research Centre (JRC) has published a paper on the Coronavirus economic crisis and its impact on venture capital and high growth enterprises, authored by Professor Colin Mason.
High growth enterprises (HGEs) make a major contribution to economic growth. They are innovative, many are technology based and they make a disproportionate contribution to job creation. HGEs typically go through a ‘valley of death’ in which their costs exceed revenues as they develop their product, achieve market traction and scale-up. For many HGEs, access to venture capital – from venture capital funds, business angels and increasingly equity crowdfunding platforms – is therefore critical, providing a financial ‘runway’ that provides them with the opportunity to reach profitability. The economic crisis created by the COVID-19 pandemic is expected to result in both an immediate and longer-term contraction in the supply of venture capital. This will have a significant negative economic impact over the longer-term. Investors will focus on supporting their existing investee companies and therefore are much less likely to consider making new investments. Moreover, the financial capability of investors to make further investments may be constrained as investors in venture capital funds pull back and business angels experience a decline in their net worth as a consequence of the decline in financial markets. This raises concerns, first, that many HGEs will fail as they run out of cash and, second, that potential high growth start-ups that emerge from the crisis will not be able to raise pre-seed and seed capital.
The immediate focus of government intervention has been to support the small business sector with measures to support their liquidity. A key focus has been the provision of loan guarantees to enable banks to lend to cash-strapped businesses. However, this type of support is not appropriate for HGEs; moreover, the eligibility rules for such schemes often excludes such firms. HGEs require other forms of financial support. These include co-investment schemes, tax incentives for business angels, convertible debt instruments and grants and other non-dilutive forms of finance. Developing agile government procurement processes is also a significant lever for government support to technology businesses. Many of these support measures already exist but require modification to increase their reach. The effectiveness of some new initiatives has been compromised by poor design. The increase in financially constrained HGEs and investors may result in an increase in acquisition activity. Governments should therefore also consider the need for greater scrutiny of the takeover of emerging technology companies by foreign companies because of the risk that key knowledge assets will be transferred to other geographical regions. More generally, Government needs to ensure that entrepreneurial ecosystems remain intact. Finally, governments must also ensure that the contraction of VC investing does not widen existing geographical disparities in venture capital investing and, as a consequence, high growth firms.