How start-ups can combat the Covid-19 investment crisis

In a perfect world this would be a time of celebration for the Irish tech sector. With a number of high-profile deals for indigenous companies since the start of the year, the sector has had plenty to cheer. But as with every other industry, the Covid-19 crisis has changed everything.

The question now is just how many companies can weather the storm and come out strong enough to make the most of any new opportunities.

Even in an industry that tends to be full of optimists, many wonder just how devastating the coronavirus crisis will be to their business plans.

The omens certainly aren’t good. According to Startup Genome, up to $84 billion (€76.9 billion) in global venture capital investments for start-ups could be at risk if the Covid-19 crisis continues throughout 2020. If this plays out, it will lead to a lot of promising start-ups going to the wall.

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However, while funding for tech companies in the Republic has slowed down since the onset of the crisis, it hasn't dried up completely, according to Sarah-Jane Larkin, director general at the Irish Venture Capital Association.

She says venture capital firms are helping to alleviate liquidity issues for portfolio companies and are continuing to make new investments, albeit at a slower pace. The need to help keep portfolio companies afloat, however, will not come without a knock-on effect elsewhere.

“Funds are anticipating that portfolio company development plans will likely be delayed and that companies may need a bridge round, which will use up reserves. This will impact on valuations and may result in a very destructive time for funds and the industry. There is a concern that likely valuation hits may wipe out a firm’s track record, making it difficult to raise future finance,” says Larkin.

She anticipates that investment activity will continue to slow over the year with funds unlikely to deploy anywhere near the level of capital they had previously targeted. Estimates on the likely reduction of investment range from a 20 per cent decline to 50 per cent depending on how long restrictions stay in place with Larkin anticipating that some investors will likely disappear, at least for a short while.

The outlook for early-stage companies is particularly worrying, given that many of them are pre-revenue and trying to retain highly-skilled employees. Even those that are making money don’t have a whole lot of resources to fall back on. A recent survey from lobby group Scale Ireland shows that Irish start-ups have an average cashflow runway of between three and six months.

The Halo Angel Business Network (Hban), a joint initiative of Enterprise Ireland and InterTrade Ireland that serves as a go-between to bring start-ups and investors together, predicts a decline in the number of deals it expects to close in 2020.

Angel investors put a combined €16.8 million into 66 Irish start-ups last year via the network with CroiValve, AventaMed, Bluedrop Medical, Buymie, Hexafly and Deciphex among the beneficiaries. But early indications are that some deals will not be finalised this year.

"Most of the fundraising deals that were due to close in the first quarter did although a few fell away. That most of them completed was due to the fact that the Covid-19 crisis didn't really hit us properly until mid-March so many of them were in the final stages," says Hban national director John Phelan.

“In our pipeline, about 20 per cent of deals have closed out and another 30 per cent of companies have either pushed out funding ’till a later date or are taking a reduced amount for now. The other 50 per cent of deals haven’t fallen apart yet but I’d say many won’t close as planned,” he adds.

The State has been quick to announce supports for Irish businesses. In addition to early measures such as the wage subsidy scheme, it recently revealed additional supports totalling €1 billion, many of which are targeted at smaller businesses.

Jenny Melia, manager of the High Potential Start Up (HPSU) team at Enterprise Ireland, the State agency which is administering many of the new supports, says its key role is to help companies navigate the difficulties as best as they can and then position them for growth when things return to something like normality.

“What we’re doing right now is very much about helping companies to stabilise and get through the next three months and to put a reworked business plan in place because as we saw with the last recession, there will be opportunities,” she says.

Melia says that while Brexit planning was not without its difficulties it has at the least made companies of all sizes more adaptive in their thinking, as it has agencies like Enterprise Ireland.

“We are flexible and prepared to take more risk with our fast-growing company portfolio,” she says.

Phelan believes such flexibility is critical in the current environment.

“One of the things I have proposed although maybe it is too simplistic, is to look at the companies that have come through EI’s [Enterprise Ireland] HPSU programme and identify which ones have scaled to a certain size and are likely to make it. Give them each €100,000 and see if that will be enough to get them through the next few months,” he says.

“If you do that for say 120 companies employing five people each then the effect of keeping those individuals off the Live Register alone for three months will be significant and hopefully most of them will still be in business,” he adds.

While the measures introduced to date have been largely welcomed by those in the tech sector, many don’t believe that they take into consideration the specific needs of start-ups.

Larkin says many of the supports are working well, with some – such as the recent decision to frontload R&D tax credits – especially welcomed. However, they don’t go far enough for early stage companies or those that are scaling, she says.

“The very early stage companies with low employee numbers and lean outlook are significantly at risk as cashflows will quickly dry up before any recovery happens. Specific measures that relate to pre-revenue or companies with less than 10 employees should be considered. Presently, they can access several grants for small sums of upfront cash. However, unfortunately that will not likely produce enough cover over time,” says Larkin.

“There has not been enough focus on what can be done for Irish scaleups – typically these are businesses at some scale that are meaningful employers and have a strong shareholder base. Without additional support via debt or equity there is a strong chance we will see the loss of a generation of future Irish unicorns.”

Liz McCarthy, head of Scale Ireland, which is backed by many leading figures in the start-up community, also wants to see further supports introduced. The lobby group has called for several measures, including the introduction of a bridging finance scheme for start-ups, a deferment or suspension of employer-related taxes and an assurance that the wage subsidy scheme and other business supports apply to pre-revenue start-ups.

She believes angel investment will have a greater role to play for start-ups given the pressure on venture capitalists and wants to see more efforts made to incentivise this.

“We’d like to see more high net worth individuals investing in high-growth companies through tweaking the Employment and Investment Incentive Scheme. Even if that was just done for 2020 it would really accelerate private capital to augment public money going into companies and if they survive, they would be on a very different playing field post the crisis.”

McCarthy believes that France, which has set aside nearly €4 billion in liquidity supports for start-ups, shows what can and should be done to help save indigenous businesses that may offer a lifeline in a post-Covid-19 economy in which foreign direct investment (FDI) may play a lesser role.

“Innovation-driven start-ups are a different breed.They are a distinct grouping who could complement our success with FDI if we do enough to help them through the crisis and beyond it,” she says.

“It is reflective of the level of political commitment that has gone into start-ups in France that they have a minister of state for digital affairs whose role it is to make sure their part of the economy thrives. This means you see a coherent strategy at play and greater support for early-stage entrepreneurs. The current crisis gives us an opportunity to think about the role start-ups can and should play in our economy and to position them to succeed,” adds McCarthy.

The year started impressively with what is believed to have been the biggest acquisition of an Irish tech company to date as Qurvo bought chipmaker Decawave in a $400 million deal. It is just one of a number of noteworthy deals in recent months that also include Unity's purchase of Artomatix, Google's $160 million swoop for Pointy and more recently Apple's acquisition of Voysis.

Most of those companies were founded in the years following the last recession and benefited from decisions made during that period. Speaking to The Irish Times recently, John Sullivan, a general partner at Dublin-based Act Venture Capital, which has backed more than 200 companies across five funds, marvelled over the fact that even at the worst point, the then government had backed the Irish tech sector.

"Where we are now is to a large extent a result of the allocation of new money to the likes of Science Foundation Ireland and Enterprise Ireland that began in the mid-2000s for supports and which also dovetailed well with the IDA's strategy," he said.

“This is something which was severely tested during the recession when there were widespread cuts. But the then government kept the bets on and it is amazing that the State committed to doing so given the circumstances,” he added.

With pressure on the Government to be mindful about where it commits precious resources during the Covid-19 crisis, it would be easy to overlook tech start-ups at this moment. But if we want a thriving Irish tech sector from which companies can compete effectively on a global scale, then we need to ensure that bets are not only made but doubled down on.