NOISが提携しているRhapsody Venture Partners社のGPであるBernard Lupien氏より、北米スタートアップ（特にハードテック系）の現状について報告を受けました。厳しい状況ですが、今だからこそできることも多くあると感じます。
COVID-19 & Startups: An Update from the Frontline
The COVID-19 pandemic has created a stressful situation for startups in the US. Rhapsody invests and works with startups in the Hard Tech space – startups that develop products and technologies based on applied science and engineering industrial technology (not software or biotech).
The stay-at-home order in Boston is now in its sixth week. Rhapsody still interacts daily with many startups over zoom conference calls.
Here are observations on the current environment in late April 2020.
Current Challenges for Hard Tech Startups
(1) Lab / Technical Development Facilities Closed
Many startups have been unable to continue technical work on their technologies due to the mandated shut down. Greentown Labs, a local startup incubation space is closed to most startups (an exception for those that work with food technology). Employees have to stay home and though they can continue doing office type work, progress to meet technical development milestones has been halted for nearly six weeks. All hands-on engineering work has stopped.
For most startups, six weeks is likely manageable, but if the shutdown lasts for 12 weeks, it will cause severe pressure and some startups will fail as they fall behind on milestones and investor interest decreases with the lack of progress.
(2) Funding is Becoming Scarce
The Federal Government has created the Payroll Protection Program (PPP) program which pays for salaries and rent for businesses in the US for two months. This includes startups. Most of the startups Rhapsody has talked to have applied and some even have already received the funds from the government. Startups can keep the money providing they do not layoff any of their employees. In the short term, this will sustain the startups, however longer term the deteriorating and uncertain economic situation is likely to have a very negative impact on Hard Tech startups.
Startups have three options sustain their business until a sale of the company or an acquisition (exit).
The US government supports early stage startups by providing funding via competitive grants for research projects. Many of the grants are administered via the SBIR (small business innovative research) grant program. These grants are generally dispersed in two phases, with the first phase being around $100K to $200K and the second phase around $1M in size. SBIR programs last around 3 years.
These programs are administered by the Federal Government and continue to be available, though the review process is delayed by the current situation as federal agencies are operating slowly. This will put financial pressure on startups who were relying on the grants to fund payroll and rent.
Venture Capital Funding:
Funding via venture capital (VC) investment is challenging in normal economic times. Most startups in the Hard Tech space struggle to raise venture capital even in good economic periods as most venture funding is in the software and pharmaceutical / biotech space. The Hard Tech space accounts for only a few percent of the total venture industry.
In the current situation it has become extremely challenging for startups to raise VC. Many VCs are holding back from investing as they are nervous the ability of startups to survive an economic recession.
Further, even if a VC invests, VCs are worried about the ability of that startup to raise additional funding down the road. VCs invest in stages (Seed, Series A, Series B etc.). Smaller venture funds generally operate in the Seed and Series A stage. These VCs do not have the capital available to fund later rounds of investment. If they make an investment and in one or two years later other VCs are not around to make follow-on investment, the startup will fail. The availability of later stage venture investment is critical for startup survival and formation.
In this uncertainty, most VCs will wait to see what transpires in the economy leading to a dramatic drop in new funding events.
Further complicating this situation is that there will likely be fewer venture capital funds post COVID-19. VCs raise funding from Limited Partners (LPs) which generally consist of pension funds, university endowments, private investors. With some uncertainty in the stock market, these Limited Partners are holding back making commitments to new venture funds as the value of their overall portfolio becomes overly weighted on the venture class instead of in more liquid investments such as public stocks and bonds. If Limited Partners do not commit more capital to new VC funds, the fragile startup financing ecosystem will suffer. Our experience in 2009 was that many venture capital groups disappeared as Limited Partners held back in making new commitments.
Corporate Funding (JDAs etc.):
Corporate funded JDAs is a source of funding for hard tech startups however it has always been challenging to get large development contracts with private companies. Most large companies are risk averse, and don’t want to invest in speculative research but rather want products to market.
In the US, major corporations in certain energy and industrial sectors have now begun large layoffs to compensate for the drop in revenues and a possible recession. R&D for new business is vulnerable in uncertain times and is often cutback. Budgets for new business will be reduced further reducing the amount of capital available for joint developments with startups.
Startup Reality in the Covid-19 World
We anticipate that many startups will fail if the economy doesn’t open up by July. The impact of a prolonged closure will freeze up availability of investment capital. Some venture investors estimate that as many of a 1/3 of their portfolio won’t make it past the end of the calendar year under the existing economic situation. That would be tragic.
We also expect to see a decrease in new startup formation. A majority of Hard Tech startups are founded by technical graduate students leaving university research. Economic uncertainty leads to students pursing less risky paths post-graduation which means full time jobs at established companies that are perceived as “safer”. In good economic times, students feel that they can try a startup, because if there are available jobs, if they fail there is a Plan B to keep paying the rent.
The Opportunity for Corporations – Take Action!
Rhapsody is in conversation with dozens of startups. Valuations and terms for investment are becoming more reasonable (lower). Startups are more agreeable to taking offers that they would have refused in the past as they realize the severity of the economic situation. We anticipate this dynamic to continue past the COVID-19 pandemic.
This presents a fantastic opportunity for Japanese industrial companies. Where many corporations will pull back worried about risk, we believe that is precisely the time to invest with startups as better contractual terms to be had. What corporations bring – investment, knowledge and market access is more important than ever.
Even those companies that do not have a formal corporate venture capital group should consider making equity investments into strategically relevant startups. This is an opportunity to obtain favorable arrangements that were unavailable a few months ago. If there are startups, even later stage ones, that are interesting and strategically relevant, consider approaching the company to see if you can make an investment.
Furthermore, this is also a great time to push on with joint development agreements and technology development. Startups will be more receptive towards granting exclusive rights and shared IP.
Corporations benefit from this uncertain time by taking action instead of holding back. This is a fantastic opportunity to take bets with startups.