(bright music)
- [Batia Wiesenfeld] This is Batia Wiesenfeld
and I wanna welcome everyone
to another session of our
Faculty Insights on COVID-19.
Today we have a focus on small business
and entrepreneurship, and we have with us
Manasa Gopal from our finance department
and Deepak Hegde from management
and Manasa has been doing
some terrific research
on financing for small businesses.
And Deepak, of course, is running
our Endless Frontier Labs,
which is a really exciting new accelerator
for tech-based startups and
has been directly involved
in helping startups in New York
through the Berkeley Center
where he also is the director figure out
how to navigate this situation,
the coronavirus calamity.
And so we have some real expertise
and it's clear that COVID
is directly impacting
the small businesses and
entrepreneurial ventures.
So Manasa, I wonder if you
could share your screen
and begin with your presentation,
then we'll turn it to Deepak
and then open it up to questions.
Please remember to put your
questions in the Q and A box.
- [Manasa Gopal] It's great to be here, Batia,
thank you for organizing the session.
I think as you mentioned, clearly,
COVID has had a huge
impact on small businesses.
And in my talk, I largely want to focus
on the extent of damage due
to COVID on small businesses
and potentially talk about how we can aid
small businesses in getting
through this crisis.
And the reason the focus
is on small businesses
is because aggregate economic recovery
is gonna be very closely tied
to how small businesses perform.
And the reason this is, is
because small businesses,
which are defined as firms
that have fewer than 500 employees,
are actually 97% of all
businesses in the U.S.
and nearly 3/4 of these businesses
actually have fewer than 10 employees.
So we're talking about
very small businesses
that contribute a huge
fraction of the U.S. economy.
Not only are they large in
terms of the number of firms,
but actually they contribute nearly half
of all of U.S. employment.
Basically aggregate employment
is gonna be very closely tied
to how small business employment moves.
And this is also because small businesses
not only contribute to
aggregate employment,
they contribute towards new job growth.
So annually, about half of the new jobs
that are created in the economy
come from small businesses.
So really all of this just makes the point
that if you want aggregate
economic recovery,
we need to really focus on how
small businesses are performing.
And this is important because if you see
in the last few months, small businesses
have been largely affected
by the effect of COVID.
So in the one month
after COVID was declared
a national emergency, the revenue
of small businesses fell over 45%.
Okay, so we've seen some initial recovery
in the past month and a half,
but it's no where close to
what the pre-COVID levels were.
So revenues at small businesses
are now still over 26% below
what was the average pre-COVID.
And while revenues have gone
down at small businesses,
the costs that small businesses face
have not fallen at the same rate.
Okay, so what this means is that earnings
at small businesses have taken a big hit.
So by April 15th, the earnings
at small businesses were 60%
below the average level in other years.
And again, even though we
see some sort of recovery,
we're still almost 40% below
where we would want to be.
Right, so as revenues fall
and cost stay the same
as earnings drop at small businesses,
most of this loss has been transferred
to the employees of small businesses.
So maybe if you look at hourly employment
and small businesses, this
is again, dropped over 60%
in just one month after COVID
was declared an emergency
and still it's right
now at the end of May,
about 40% below the levels we would like.
Now the reason all of
this is a big problem
for small businesses is
they're not really equipped
to handle these large shocks.
The smaller businesses
don't have much cash on hand
to be able to accommodate large drops
in revenues and earnings.
Nearly 3/4 of small
businesses when surveyed
at the end of April said they have less
than two months of cash in
hand for operational expenses.
And if we expect that
this crisis will continue
for a few months, which seems
like most small businesses do
so almost 90% of small businesses
believe it'd take them over two months
to get back to normal operations.
And for a third of them,
it's over six months
to get back to normal operations.
We need to find some way to
compensate small businesses
for this loss that they're facing.
And typically firms rely on banks
for access to financing.
But what we've noticed in the past
is that especially in recessions,
it becomes very hard for small businesses
to access traditional
sources of financing.
So if you just look at the last recession,
small business lending fell
by over 40% after 2007.
And in the last 10 years,
as the economy has grown,
as overall bank lending has
grown way past, 2007 levels,
the lending to small businesses from banks
is still not recovered to
the levels they were at
pre-financial crisis.
So what we have now are businesses
with a big drop in revenue,
no cash on hand to
accommodate these losses.
They can't access traditional
sources of financing
from banks that they typically might.
So they're being in some sense,
attacked from all directions.
So we need some sort of support to ensure
that small businesses can
actually survive this crisis.
And obviously this is
something I think policy makers
understood very early on.
So in late March, when
the CARES Act was passed
a significant portion of money
so around $349 billion was
earmarked for small businesses
under the paycheck protection program.
These were largely 100%
federally guaranteed
loans meant to be provided
to small businesses
to ensure that they can maintain payroll
and continue operations.
So these loans were going to
be dispersed through banks
and borrowers could borrow
up to two-and-a-half times
their monthly expenses to
cover payroll, mortgage,
or rent expenses and utilities and so on.
And these loans have
extremely attractive terms.
So only 1% interest rates on
loans for up to two years,
borrowers did not have
to show any collateral.
They didn't have to show proof
that they couldn't access
other sources of funding
just to ensure that all small businesses
could tap into these loans.
But probably what made the
paycheck protection program
so attractive was that these loans
could actually be forgiven.
So if businesses spend
the money on payroll
and mortgage and rent
and utilities and so on,
this amount would actually be
forgiven by the government.
And since the focus was
on maintaining payroll,
businesses were expected to
spend about 75% of the money
that they received on
maintaining employment.
So, as I said, obviously
the great thing about PPP
was that it was implemented early on,
but there were large issues
with the paycheck protection program
that became obvious pretty early on.
So one of the big things
was the size of the program.
As I mentioned early on, 97%
of the businesses in the U.S.
are classified as small.
So they could have
potentially been eligible
for loans through the PPP.
And there is no way $349 billion
would cover two months of expenses
for this large number of firms in the U.S.
who required the funding.
Okay, so we estimated about
$810 billion would be needed
to cover operations of small
businesses for eight weeks.
And essentially when this was implemented,
it became clear early on that
there aren't sufficient funds.
So the $349 billion that were earmarked
ran out in less than two weeks.
Now because of this, Congress passed
an additional $310 billion
for small businesses,
about 10 days later.
But what seemed to happen over time
is businesses were getting
more and more confused
about what it is they were getting into.
So in the two months
after PPP was announced,
there's been 14 sets of
different rules on eligibility
for these loans, on eligibility
for loan forgiveness.
And surveys by the National Federation
of Independent Business,
showing that basically 3/4 of
businesses actually confused
about whether their
loans will be forgiven.
And half the businesses feel like
they can actually spend
the money in eight weeks
because of shelter-in-place
and lockdown orders
preventing them from operating.
And all of this confusion led to a drop
in borrower interest for all these loans.
And the second round of PPP actually
still has about $130 billion left,
even though initially it was
thought that $310 billion
would run out in less than a week.
Now because of this drop in demand
and because of all of this
confusion at small businesses,
just last weekend, there
were some new rules
that were passed to make
the PPP more attractive
to small businesses and make sure
they actually tap into these funds.
So instead of having to
spend 75% on payroll,
like before, now firms need
to only spend 60% on payroll.
And they've been given
24 weeks to use funds
instead of eight weeks.
And the same time initially
there was penalties
to small businesses if they
were not rehiring their workers.
Now exceptions have made to that rule
if the employee refuses to be rehired.
All of this to ensure that
small businesses do tap
into the PPP and to make
sure we can rehire employees
as was the goal.
But probably the largest
issue with the PPP
was that there were no clear rules
or guidelines as to which businesses
should be prioritized in the loan program.
So it was left to the discretion of banks
to decide who they want
to approve loans for.
And anecdotally, there
is a lot of evidence
that banks prioritized their customers,
especially their larger ones
and a lot of small businesses were left,
unable to access the PPP.
And this is not very surprising
when you look at the
long academic literature
that has argued that relationships
between banks and firms
is actually very important
for access to financing,
especially in periods of distress.
So small businesses
need to have strong ties
to their banks to be
able to access funding.
And borrowers without relationships
were essentially left out.
And one other potential
reason that complicated this
was that banks were being
paid fees by the government
for these loan approvals and
the fees were in proportion
to the size of the loan
that was being made.
So this naturally also biased
banks to approve larger loans,
which meant larger firms
for getting these loans.
And if we actually look at the data,
this becomes clear pretty easily.
So what we see is a lot of
the small businesses in say,
the Midwest and the Southern States,
were more likely to get
loans under the PPP,
even though potentially
regions in the Northeast
were affected more by COVID.
In fact, actually there
is almost no correlation
between the severity of COVID in a state
and the share of businesses
that receive loans.
And one potential way
to target these loans
could have been to actually focus
on which businesses were more affected
by the lockdown and
shelter-in-place orders.
The idea here being that
when shelter-in-place
was implemented and everyone
had to work remotely,
some firms could continue
operating as usual,
but some of them were severely affected
because their operations could
just not be done remotely.
So there is academic
work to create indices
on the extent of the effect
of shelter-in-place orders
on different industries.
So if we had done that,
we could potentially
have targeted these loans
towards businesses that were most in need
of the loans at this point.
And one of the reasons to do that
is we see that at least on the surface,
it does look like loans
to smaller businesses
through the PPP improved
employment rates in the States.
So of course this is
very preliminary data.
So we don't entirely know, one,
if this gains are actually
going to be permanent
or if it's just a temporary
gain in employment.
Ideally we want to
ensure that these workers
are retained in the long run,
but we have to see what happens
once the PPP funds run out
and after eight weeks,
whether these employees
are going to be retained.
And we have to also identify
whether these gains are actually coming
through the PPP loan acceptance,
or because a lot of economies
are now opening up and
loosening shelter-in-place
and lockdown orders.
I want to spend maybe a couple of minutes
just contrasting how the U.S.
has responded to the crisis
compared to how other developed
countries have responded.
So I think you largely,
there have been two strands,
one like the U.S. where
they've opened up unemployment
insurance benefits to workers
who would have traditionally
not been able to tap into them.
So basically even employees
that are not actively seeking employment
can now get unemployment insurance.
The other strand which has been followed
by most of the European nations,
is actually to pay firms to ensure
that they retain their workers.
So countries like France, where
they've actually made sure
that if an employee is furloughed,
the government will cover
about 84% of the wages
as long as the firm retains its employees
and pays them benefits.
In Netherlands, again,
90% of the payroll costs
for companies would be covered for firms
that saw a small drop in revenue.
New Zealand, also similarly paid employers
a fixed amount per employee to make sure
that they will be
retained on their payrolls
and to make sure that a
certain level of their wages
were being continued to get paid.
Australia, Switzerland, Germany, Ireland,
all of them have followed
similar programs.
And what we actually see
is this has led to two
very different responses.
So the countries that spent more
on a lot of these
short-term work programs,
or to fund employers directly
to retain their employees,
have seen a much slower
growth in unemployment rate.
Compared to the U.S, where by far
there's been the largest
growth in unemployment rate,
because the funding was not directed
through employers to retain employees.
So this, I think largely
leads to the question
of what the goal of such a
program should have been.
And so if the goal is to make sure
that workers are retained
on employer payrolls,
and to make sure that
when the economy restarts,
these businesses can restart
operations immediately,
'cause you don't spend time
rehiring and retraining workers,
then maybe we could
potentially have directed money
to firms instead of to employees,
to unemployment insurance benefits.
So I'm gonna hand it over to Deepak now,
but I'm happy to answer any
specific questions at the end.
- [Deepak Hegde] Great, good afternoon, everyone.
And thanks a lot, Manasa,
for your presentation
and thank you Batia for your introduction
and for leading the faculty
insights series with Viral
I've learned a lot from the series
which has helped crystallize
all of our thoughts
on really important
matters during a period
of unprecedented uncertainty.
So thank you, I'm very
excited to be contributing
to the conversation today.
Manasa talked about COVID's
impact on small businesses.
And I will be focusing on
COVID-19 impact on new businesses,
which typically are also born small.
So of course there may be differences,
but what I am going to
be talking about now
is going to be COVID's impact
on a subset of the companies
that Manasa touched on during her talk.
So why care about startups, right?
Startups are well known as the
engines of economic growth.
Between 1980 and 2010
startups defined as businesses
less than a year old
generated 2.9 million jobs
every year in the United States.
This was 1/6 of the gross jobs generated
by all the establishments and nearly all
of the net jobs created
in the U.S. economy.
The implication of course, is
that cohorts of older firms,
typically exhibit net job declines
and startups are essential to add jobs
to the economy as they have
done over the past 30 years
or so for which we have this data.
The second reason to care about startups
is they disproportionately contribute
to research and innovation
as well as productivity,
growth in the U.S.
If you take many examples,
such as the airplane,
the railroad, the
automobile, electric service,
telegraph, telephone,
computers, air conditioning,
and so on, each of these were started up
by innovative young and new firms
and ended up fundamentally
transforming consumers' lives,
but also became platforms
for many industries
to enhance productivity.
A one staggering
statistic is that in fact,
85% of the R and D
spending in the U.S. today
is conducted by VC-backed startups
born between 1974 and 2015.
So really startups at
the moment of founding
as well as through years of their growth
add disproportionately
to R and D innovation
and productivity growth.
Third, startups are known
to enhance reallocative efficiency.
What that means is that startups exhibit
and are put off dynamic.
Innovative and successful
startups go rapidly
and become a wellspring of
jobs and economic growth,
or they can quickly fail
and exit the market,
allowing capital to be put
to more productive use.
So startups really enhance
the ability for resources
to flow freely to where
is most beneficial.
In an economy where
reallocated efficiency is high,
more productive companies grow
while less productive firms
contract or possibly exit the economy.
A great example of startups
and reallocative efficiency
is actually the medium
that is facilitating
our conversation today.
Zoom was born in 2010
when getting Eric Yuan,
then the lead of Cisco's WebEx group
was deeply dissatisfied with WebEx.
For those of you who have used WebEx,
you will know that the
WebEx conference service
required you to sign up and
then identify the system
that you were signing up from
which really slows things down.
And too many people on the
line would have to strain
the connection leading to
choppy audio and video as well.
And obviously the service
completely lacked modern features
like screen sharing for mobile and so on.
So Yuan really wanted
to improve the product
that Cisco, the WebEx
team that he was heading,
but he was really not prioritized
within the company at all.
And this led of his starting Zoom in 2010,
the company IPO'd in 2019,
April and today after COVID
the company enjoys a market
cap of about $58 billion,
nearly more than the combined market cap
of three of the U.S' the largest airlines.
highlighting how quickly startups
can seize on opportunities
as well as grow in response
to what might turn out to be
a different set of ideal circumstances
in the face of changes
such as the pandemic.
So three main reasons why we
need to care about startups.
what has COVID done to startups?
So what I'll do as Manasa implicitly did
is peer back into looking
at how entrepreneurship,
the formation, financing, and
performance of new businesses
was impacted by previous recessions,
primarily the great
recession of 2008, 2009.
And then produce some
very preliminary data
on COVID-19's impact on startups.
And we will bring these
two things together
to understand in what ways
COVID-19's impact on startups
compares or contrasts with
the experience of startups
during the previous recession.
And based on these, we'll try
to quickly try and speculate
about what the future might look like
for startups and entrepreneurship
in light of COVID-19.
So the great recession of 2008, 2009,
so a 20% decline in new firm formation
from about 700,000 in 2007
to about 560,000 in 2010.
This was by all means one
of the sharpest declines
seen in the history of the United States,
other than during the
depression of the 1920s.
You will also see that
although there was a recession
following the burst of the
internet bubble in 2000, 2001,
the impact in terms of
new businesses started,
the impact was not that high relative
to the Great Recession of 2008, 2009.
We also look at another measure
of activity, startup activity,
which is venture financing.
Venture capital in the United States
accounts for a large proportion
of the successful startups.
And what we can see here is
that during the recession
of 2008, 2009 venture financing
dropped from about $45 billion in 2008,
to $31 billion in 2009,
a 31% drop in one year.
Interestingly, deal count,
which is generally considered
as indicative, or at least correlated
with allocations for startups,
new allocations for startups,
more or less stayed the same
at about 5,800 to 5,900 deals per year.
What this meant is that in
light of the last recession,
overall funding contracted,
but deal activity
measured by their
frequency remain the same.
This basically means that the average size
of the deal contracted, so
VCs were effectively writing
smaller checks for startups
in light of the contraction.
So that was kind of the primary
effect or the last crisis.
We can also look at another
measure of startup financing,
which is startup financing at the seed,
or Series-A stage,
generally startups bring on
their first round of
institutional investors
during the seed or the Series-A stage.
And what we see here as well
is about a 30% drop in
seed stage financing
from 2008 to 2009.
What you also see, however,
is that the number of deals,
seed and Series-A stage deals dropped,
which meant that very likely the companies
that were seeking financing
for the first time
during this period where the most hit
through the contraction of VC financing.
So obviously the rate of startup financing
and formation came down
during the last recession.
Obviously we care deeply
not just about the rate
of startup formation, but also
about the quality of startups.
So a key question then is
does startup quality goal
up during recessions?
One argument for why the
startup quality might go up
is basically because during slumps,
there might be a positive
selection effect, right?
If you assume that VCs
can somehow disconnect
between really high potential startups
and less high potential startups,
then if they have less money to deploy,
they're gonna go out for the best deals.
So basically maybe it's
going to be the best startups
that are able to survive and
thrive during recessions.
And if that is the case,
we should actually expect
startup quality to go up.
But on the other hand, there is the larger
sort of economic environment
that really depresses the demand,
makes it maybe hard to
access the sort of talent
that might, because they fear uncertainty
and don't want to take risks,
are less likely to work for startups.
And the general freezing
of the capital market
might also mean that
startups may not be able
to raise the funding to
invest in their plan As,
further sort of effecting their quality.
So basically it's kind
of an empirical question
and there's not a whole
lot of good research
on whether a startup quality
goes up or down during recessions.
Many, obviously those who
are particularly excited
by startups, suggest and
point to the examples
of companies like these,
Dropbox, Groupon, Uber, WhatsApp,
which were all born
during the last recession
to suggest that maybe
the quality of startups
that come out during recessions
is going to be particularly high.
There are also other great examples.
Microsoft was born during
1975, Disney during 1943,
General Motors during
1908 and General Electric
during 1890, all times of deep downturns.
So we really don't know.
So this is kind of a one hypothesis.
And recently there was
about three weeks ago,
The Economist put out
an article that spoke
to this particular aspect
and the article suggested
that almost 500 of today's
biggest listed firms in America
whose origins date back as far as 1857,
a majority of them seem
to have started their life
in expansionary years
than during the sessions.
So basically of those founded since 1970,
more than 4/5 that survive
on the Fortune 500 today
were born during expansionary times
rather than during recessionary times.
This then suggest that
perhaps the folklore
that startups born during recessions
tend to be a high quality does not hold up
to a closer scrutiny with a larger sample.
There's some recent evidence
also being put together.
My colleague in the finance department,
Sabrina Howell which looks at
patents taken out by startups
during recessions and suggest that patents
taken out by startups
that are backed by VCs
during recessions tend
to be less important,
less technologically impactful
and less closely related
to fundamental science.
Also more in line of then of The Economist
sort of hypothesis that
there is a pullback
in startup quality during
recessionary times.
So it seems like overall
the wave of evidence
imperfect as it is, seems to suggest
that startup quality actually declines
during discretionary times.
There's also a third
key effect on startups,
which is the deduction of activity
pursued by startups
during recessionary times.
And what we see is that at least during
the Great Recession '08, '09,
there was a big contraction in startups
that were pursuing
information technology ideas.
So basically, typically the
number of hovers around 50%.
50% of the venture financing
goes to IT companies,
but during the recession,
that number came down
to about 35% and hovered
between 34% and 40%, okay,
and then gradually started picking back up
as the economy expanded.
So it seems like at these
during the '08, '09 recession,
there was a pull back on IT investments
even as a relative
proportion of VC funding.
Now the other sort of effect
is on the differential impact
of recessions on different
startup ecosystems,
the big ecosystems in the United States,
the one in orange here,
which is Silicon Valley,
the best close broadly.
The second largest ecosystem right now
is actually the New York ecosystem
that is indicated here in blue
to include the New York DC belt
And then the Boston, New England,
ecosystem now is the third largest
in terms of overall venture activity.
And what we find here
is that interestingly
during recession, at least you know,
there is a pull back in
activity that happens
in maybe the Northeast.
It seems like the '08, 2010 recession
particularly impacted New York,
the New York region startups
and the New York region as well as
in the new England region,
the difference being that New
York seems to have recovered
handsomely in the expansionary years,
whereas Boston seems to
have more of a difficulty
in regaining its place as effectively
the second largest ecosystem
in the United States.
So it seems like very
likely through the channel
of sectoral investments,
recessions also have an impact
on the geography of startups.
So overall, what we have learned
then from past resessions
in particular, the 2008, 2009 recession,
is that recessions lead to a decline
in startup funding rates
about a 20% to 30% decline
in the past great recession,
a decline in average startup quality,
a decline in IT startup investments
and possibly a decline in
Northeast startup investments.
So now we can turn to kind of
COVID and with a little data
we have tried to see whether,
and to what extent the patterns we see,
the data reflect what happened
during the previous recession.
So here's a new firm formation,
particularly this is new firm filings
by those who are likely to take
employees on their payrolls.
The type of startups that generate jobs
and we care about.
What you see here was
an unprecedented decline
in new firm filings from about
30,000 per week in week nine
to 19,000 per week in
week 10 of this year.
This was basically the first week of March
when corona's effect was
kind of really starting
to kind of kick in.
And you see kind of the
unprecedented nature of the decline.
It's not even anywhere
comparable to the declines
even during 2009, okay.
So there was about a
four to five week period,
when the declines persisted
really record levels in terms of the hit
to start up activity.
And then eventually the good news
is over the last two to three weeks,
we have started to see a pullback
where we are actually seeing
a return to the numbers
as was the case, during the
expansionary year 2019 May.
So right now were at a point
where it seems like we have recovered.
The second aspect then is venture funding.
And if you look at
venture activity as well,
we see a decline here from about
13 and a half billion dollars
to $11 billion in April.
So it seems like much of the
activity was out in April,
not in March, obviously
because startups get
into conversations early
and it takes about a month
given the due diligence,
et cetera, for activities to close.
So likely the reason why
you don't see an impact
in March numbers for VC funding
is that most of these
deals were essentially
kind of closed at during previous months
or at least committed
during previous months.
You see a sharp decline in April,
but then a very handsome
pull back in May, okay.
And this data is basically
hot off the press.
So it is current until end May
and we are seeing a very good recovery.
There is however, a decline
in the number of deals,
which very likely means that
VCs are effectively writing bigger checks
for existing companies and are probably
not investing in new deals
at least relative to
what generally happens
during expansionary
periods or normal times.
This is confirmed when they
look at funding numbers
for seed stage companies.
There, you see a sharp
decline in new deals
from 343, the month of March to 223
in the month of April holding steady
in the month of May as well.
So it seems like there's a
contraction in new firm financing
seed financing that doesn't seem to have
really recovered even in the month of May.
Although there also you see a slight
sort of uptick in the overall figures,
if not in the deal numbers.
In terms of the sectoral
allocations what you see here
is kind of a rather remarkable
and stands in contrast to the effect
of the previous recession,
where IT investments
were among the first to be hit.
You can see here that IT startups
that are pursuing IT-based ideas
have actually maintained
the relative share
and even grew the relative share
when the contraction happened massively
or all contraction of VC
funding happened massively
April growing their shared 48%
which is really kind of remarkable.
May numbers, it seems like IT investments
have kind of decreased, but usually
there's some sort of re allocations
and refining that gets done by Pitchfork
likely many of the companies
that are being categorized
as B to C here are tech-enabled
and a likely to end up as
the IT investments here,
but at least when the decline
was the sharpest in April,
you see that IT drew it's
relative share of financing.
Likewise maybe related
to the portraits of IT,
Silicon Valley seems to have
grown in strength COVID-19,
relative strength COVID-19
seems to have increased
the proportion of investments
that Silicon-Valley-based
startups seem to have enjoyed.
And obviously there seems
to be a halting of the march
the constant upward trajectory
that New-York-based startups
were sort of on since COVID-19
and you see a pullback
in New York numbers here.
So it seems like for a variety of reasons
Silicon Valley startups seem to thrive
even in the face of COVID.
So a summary then of COVID,
unprecedented decline
in new firm formation
in March and April with
a sharp rebound in May.
Venture funding declined
a sharply in April,
but also seems to have
rebounded back in May
in terms of the overall numbers,
if not in terms of the number of deals.
IT startups seem to have increased
their half of share of venture financing
during the downsizing.
Silicon Valley startups
also seem to have increased
their share of venture
financing during the downsizing.
What may not have been
evident in the bar charts
that I showed, because the overall share
of finance-related startups
tends to be relatively lower,
is a sharp pullback in venture financing
for financial service startups,
going down from a high of about 6% to 8%
of all venture investments to 1% to 2%
of all venture capital
investments during April.
So that seems to be a
huge pullback as well.
So overall, where we stand, it seems to me
that looking ahead,
we are right now facing
a fork in the road.
And I think too scenarios
are equally plausible
and can play out.
The first scenario is the more drastic one
where there is wave-2 to of the pandemic
with some of the numbers
in terms of job losses.
And worse, still deaths, that kind of return
to what we were seeing in late March.
And if that happens
very likely the rebound
that we saw in the data is
likely to be short lived
and you will see an unprecedented decline
in startup formation.
What you saw in early March
was absolutely kind of staggering
and if we have a few months
of that type of contraction,
I think we are looking at losing
an entire generation of startups
here in the United States.
Very likely if the patterns
from the last recession holds
under this drastic scenario,
you will also see a lower
average quality of startups.
You will see tremendous bargaining hands,
power in the hands of investors
who are willing to
deploy their dry powder.
And you will see the return
of investor friendly terms
and you will see obviously a
decrease in valuation numbers
for the startups as well.
I think relatively well
shielded will be IT startups.
And if you think about IT technology,
what it does really, the
pandemic has been unprecedented
in terms of either completely reducing
or definitely having an impact
on our ability to communicate
and what information technology does
is really reduces the
communication costs, if you will,
and that's why it's been
such a powerful substitute
in these times and we can
expect the relative strength
of IT to hold and I feel possibly given
Silicon Valley's dominance
as the place where
new information technologies get generated
as well as the likely effect
on the financial sector,
New York City's growth as probably
the fastest growing startup hub,
maybe halted and that,
but on the other hand,
the recent numbers look good.
And if we continue on
our present trajectory
where the pandemic spread is
relatively well-controlled,
then we are likely to see a quick rebound
and recovery in startup formation,
we are already seeing it in the data.
And the missing generation of startups
and ideas we suggested will kind of likely
be limited to the ones that
really have to exit the market
suboptimally because about a
month of sharp contraction.
IT startups will still continue to thrive
perhaps because of social distancing
and all other measures that will likely
held to be in place
affecting communication costs
and New York city might
be able to pull back
and regain its prominence
as the fastest emerging
hub for startups.
So that's what we have,
I'm very much hoping for a Wave-2
while not necessarily expected.
- [Batia] Thank you both so much
for such really thoughtful
and insightful ideas and data
with respect to both small business
and entrepreneurial firms.
I wanted to, just to kind of start out,
I'm wondering about some,
I'd like to pose some questions.
One of the things that
both of you highlighted
is how dependent these
startups are on financing
and, well startups and small
firms are on financing,
and Manasa really
highlighted the fragility
of these small firms.
And at the same time, highlighted the fact
that so much of our employment
is dependent on these small firms.
And I guess I'm wondering what are,
so Warren Buffet said
when the tide goes out,
you find out who was swimming naked.
It does, COVID kind of
help us to understand
a level of fragility
among our smaller firms
and perhaps among our newer
firms that is unhealthy,
or is this actually a good thing
in terms of that in fact,
we expect this sector
to be more agile, to have
this reallocative efficiency
that Deepak highlighted?
So I guess the first question is,
is there a level of fragility
that is not appropriate?
Especially Manasa highlighted the need
to have relationships with banks.
So it sounds like it's
not just what you know,
but who you know, not
just how good you are,
but their faith in you.
So what should we be thinking about?
Should there be policy changes?
Should we be doing things differently
in terms of recognizing
that we're dependent
on these smaller firms and newer firms,
especially for employment,
and yet they seem so fragile?
- [Deepak] Great, Manasa do you
want to go first or?
- [Manasa] Okay, so I guess one
thing potentially is,
I mean, even in normal times,
I think we see that small businesses,
younger businesses fail very often.
And of course, I think at one
level that's a good thing.
You don't want resources allocated
to inefficient businesses.
I think about 10% of businesses
fail in their first year.
So there is a large reallocation,
even in normal times.
I think the question is if a lot of this
largely depends on say something
like the relationships that you have,
which take a while to form,
then it is not evident that
these are worse businesses
but potentially just businesses
that don't have the right connections yet.
'Cause it takes a while for
banks to start initiating
credit relationships
with smaller businesses.
Be it in terms of giving credit lines,
having accounts, having normal term loans,
banks tend to do that for
firms that have existed
for a while because they like knowing
that these businesses will stick around.
So you need to have sufficient
history of good cash flows
to be able to access financing
and how good a firm you are
takes a while to establish that history.
- [Deepak] Great, so just to
add to what Manasa said
Batia your question of
whether, kind of the fragility
that we are seeing in the data,
particularly with respect to
the U.S. is it good or a bad?
I think it's a great question.
And really in my view, at least it depends
on the reasons for the downturn.
I think we see job losses
during downturns, it is natural.
It's the process of creative destruction.
But many of the downturns
are precisely brought about
because of inefficiencies in the system
and basically the downturns
that play the role
of reaching the market back
to a new, better equilibrium.
And if you take the downturn
of 2001, 2000 to 2001,
that was on the back
of a massive inflation
in values of software startups,
even while there was no pathway for them
to be creating the type of value
that was being suggested by
the stock market valuations
of these companies.
We saw a downturn, we saw
a reallocation of capital
and arguably that wasn't good.
Likewise during 2008, 2009
there were some excesses
on the financial side and that there were
other inefficiencies as well
which got corrected immediately, arguably,
at least in the long run.
And probably then the fragility in fact,
led to the creation of
a more robust system.
I think COVID-19 has been
fundamentally different
in the sense that what
has been brought upon us,
has not been viewed in any
fundamental inefficiency
economic inefficiency,
but it's a health shock.
And so it is less clear then that policies
that at least keep this fragility
or at least do not do anything
to address it will have the same benefits
as might have happened
during other recessions.
And I'll leave it at that.
- [Batia] Yeah, that's very helpful.
Let me pose two questions that
came from my partner, Viral.
And so those two questions are
should we be thinking about the decline
that you highlighted
Deepak in the startups,
the COVID related decline,
as just mothballing
or is it possible that some of this
is really a permanent loss?
And you kind of highlighted
these two different directions
where it seemed like you were suggesting
that what happens in the
next couple of months
is going to determine those two.
So that's kind of the first question.
And then the second one is, is
it not just about financing,
but also COVID related
disruptions in productivity?
And I feel like that one,
we could actually see that being
just as relevant to small businesses
and maybe some of the
ones that are failing
might be in industries where it is
for example, more hospitality,
more restaurants, et cetera,
in industries where it's
going to be really hard
to become productive back again
and so what are those
two different effects?
Maybe the first question, Deepak,
you might start out with
the second question,
Malasa might start out with.
- [Deepak] Okay, great.
So thanks a lot from
Viral, the question about
whether what we are seeing
is kind of mothballing,
or this a permanent loss, right?
At least up until now, at
least based on my conversations
with the VCs, it very
much seems to be more
along the lines of what you
call it mothballing, but why?
So VCs are saying, we are still interested
in looking at startups.
We want to be kind of chatting with them
we want to have our radar
so we will be very cautious
but we are not closed for
business is what they're saying.
Okay, so at least on the whole
that seems to be the case.
And then part of it really kind of,
goes to lifecycle of venture firms
where generally they get
money from limited partners
and have funds that have
a term of about 10 years.
So in fact, at least,
the technically that mode of dry powder
that they have to deploy has
not taken as much of a hit
because of COVID-19.
So that might explain kind of why
this might seem more of a
mothballing effect currently.
But at the same time,
there's also evidence of permanent loss
and particularly kind, even
in the data I highlighted
that the sharpest contraction
or pullback has been in
terms of funding startups
at the seed stage, seed stage
is kind of the first time
the startups are approaching
the institutional investors.
And I know for example startups
with maybe one or two business employees
that they absolutely needed to be paid
to keep the startup going, right.
If it's not going to happen,
even as many of these
employees who are running labs,
for instance could not go into the labs
and the startups could not afford
to pay these unproductive employees,
even if they were the
only person on their team
and they have to
basically get rid of them.
And I think there are some of those cases
also, obviously that suggests
that there have been permanent losses,
and really it's a matter of time.
I feel the longer this prolongs
and the more likely we return
to the drastic world scenario,
the more of the permanent
losses you'll see.
But right now, by and large,
it seems to be a mothballing instance.
- [Batia] And so, Manasa, maybe you
could address the question of
do we think that there
are productivity losses?
I know also part of
what Deepak referred to
as a digitalization, we certainly gone
through a digitalization
working from home, remote work.
The question is, is it
more or less productive?
Obviously a lot of businesses
can't do work from home.
CEOs are telling us that
work from home is even more,
they're having productivity
gains in work from home.
I wonder if you think that
these COVID-related disruptions
are coming from productivity changes.
- [Manasa] Yeah so I think that's a great question.
So it was something I alluded
to briefly in the talk,
which is about COVID
has differential effects
across different
industries, different firms,
based on the ability
to remote work, right?
So a lot of tech firms
able to continue working,
or actually even be more
productive working from home
while there are businesses
that just cannot do
any of their operations remotely.
And one of the reasons for
like maybe differential
targeting of these business loans
would have been helpful was if work
was continuing as normal,
if earnings and revenues
at certain businesses would
continue doing things flat,
maybe they don't need
government assistance
as much as businesses that
have lost their ability
to continue working.
Because potentially it's
useful to have airlines
and restaurants around when
we come back from the crisis,
even if they're not particularly
productive at this point,
because there's just, one, drop in demand,
and two, they're just not able to work
when everything is under lockdown.
So I think at some level
they need assistance
to survive this crisis
because at the end of it,
we want them to survive.
So yeah, I mean, potentially
people will still take flights
after yeah COVID has found the treatment.
- [Batia] So as we're getting
to the top of the hour,
one last question that I think
really interests everybody
Who's got an NYU stern connection,
which is, are there things
that can be done in New York
or in the Northeast, in our area to help,
to support small businesses
and entrepreneurial firms?
Are there things that you'd like to see
from a policy standpoint,
from a financing standpoint
or any other perspective that
would help to buffer New York?
Sort of put New York back
on the right trajectory.
- [Manasa] So I don't know if this
is New York specific,
but I think one thing that
is potentially been noticed
is even when the economy's opening up,
it's not necessarily
that smaller businesses
are back to having levels of revenue
that they had pre-crisis
because consumer demand
still needs to go up, right?
So maybe potentially one way
of helping small businesses
is to actually redirect some of the demand
towards small businesses.
And I think at least around
NYU there are a lot of them.
Yeah, so I think that's one way
to potentially improve
outcomes at smaller businesses.
- [Batia] Anything you want to add Deepak
as the head of our
Endless Frontier labs
and therefore invested in the future
of entrepreneurship in New York City?
- [Deepak] No, New York has
always been a great place
for entrepreneurial activity.
I think the big difference
between Silicon Valley
and New York is that Silicon Valley
somehow has managed to
acquire a reputation
of building startups that
seemed relatively well-shielded
from economic upturns and
downturns for better or for worse.
And the role of universities
has always been very important
because universities generate scientific
and technological innovations
that can create or improve
productivity in the long run.
So in fact, then for New York
to be very much the same up until now,
it appears much of new York's uptick
in entrepreneurial
activity has been driven
by the markets here, the
businesses rather than the push
sort of strategy but for
New York policy makers
to acknowledge and recognize
that all universities
are amazing and can equally contribute
to entrepreneurship as they have done
in Silicon Valley would be phenomenal.
It would also make us
more robust, I think,
in the longer run.
- [Batia] Thank you both so much
for such a terrific session.
It was full of insight and definitely got,
it sounds like we need
to all be doing more
to support our small businesses
and entrepreneurial firms.
Thank you very much and
we'll see everyone next week.
- [Manasa] Thank you.
- [Deepak] Thank you, Batia.
Thank you, Manasa, thank you everyone.
(bright music)
