Uber, Airbnb, WhatsApp all started during a crisis. Startups must be protected during Covid too

Startups are key drivers of economic growth, job creation & a catalyst for radical innovation. But Covid-19 has halted the creation of new businesses.

Representational image of an office in Silicon Valley. Photo | Bloomberg

Start-ups have emerged as key drivers of economic growth and job creation, and are often a catalyst for radical innovation. Young firms account for about 20% of employment but create almost half of new jobs on average across OECD countries (OECD 2016), and innovation by young firms contributes significantly to aggregate productivity growth, accounting for half of it in the US (Klenow and Li 2020).

During the COVID-19 crisis, start-ups have continued to play a critical role for economies. Some innovative young firms have reacted fast and flexibly to the pandemic, and have been critical in helping many countries shift towards fully digital work, education, and health services, and have provided innovations in medical goods and services.1

In a recent note for the OECD COVID-19 Hub (OECD 2020a), we analyse the challenges that start-ups are facing and the opportunities that may arise during and after the COVID-19 outbreak. The crisis is reducing the creation of start-ups, challenging their survival, and limiting their growth. A missing generation of new firms has significant implications for economic outcomes – notably employment, given start-ups’ disproportionate contribution to job creation – which can be mitigated by supporting existing start-ups and the creation of new firms. Policymakers should tackle short-term challenges, but also and importantly foster the ability of start-ups to grasp new business opportunities, reducing barriers to entrepreneurship, providing the right incentives, and boosting entrepreneurial potential.

Start-ups face significant challenges during COVID-19

Most existing start-ups face significant challenges due to the COVID-19 crisis, as they are more vulnerable than older incumbents to the shock brought by the pandemic. They tend to engage in high-risk activities compared with other small and medium-sized firms (SMEs), face constraints in accessing traditional funding, and have a formative relationship at best with suppliers and customers. They also often crucially rely on a small founding team, and this can further increase their vulnerability to labour supply shocks during the pandemics.

At a time marked by significant economic uncertainty and with their revenues affected by containment measures and significant drop in demand, start-ups become even more financially fragile and need support for their short-term liquidity needs, critical for their survival.

In many countries, policy responses aimed at shielding the economy from the crisis are already targeting firms’ financial fragilities, especially for SMEs. These include measures to sustain short-term liquidity needs, such as loan guarantees, direct lending, grants or subsidies. However, policy responses should take into account the specificities of start-ups with respect to other SMEs (OECD 2020b). Some countries have introduced measures more specifically focused on start-ups. For example, France has set up a €4 billion fund to support start-up liquidity, including bridging start-up funding rounds; Germany has announced a tailored start-up aid programme, expanding and facilitating venture capital financing; and the UK has announced a co-financing fund for innovative companies facing financial difficulties (OECD 2020a).

COVID-19 is not only a challenge for existing start-ups but also for the creation of new ones

Periods of crisis usually correspond to drops in business registrations. Analysis of the most recent data (Figure 1) confirms that firm creation dropped significantly across many countries in March and April 2020, with a decline as severe as 70% in April 2020 in Portugal compared to the same month of prior year, and 46%, 54%, and 58% in Hungary, France, and Turkey, respectively. Milder but still very strong declines are evident in Australia, the US, and Spain.

A simulation based on the OECD DynEmp3 database – a database collecting harmonised information on new firms and job creation across more than 15 countries based on confidential data – evaluates the aggregate employment effects over 3 to 14 years of a 20% decline in the number of entering firms in a year (Figure 2). The simulation uses the decomposition of the contribution of new firms to job creation proposed by Calvino et al. (2016). It decomposes the average number of jobs created by surviving entrants into four components: start-up ratio, average size at entry, survival share, and post-entry growth. This highlights four margins that determine the employment contribution of new firms, bearing similarities with the Startup Calculator presented by Sedláček and Sterk (2020).

Focusing on the first margin, our simulation suggests that a 20% decline in the number of entering firms induces a persistent employment loss of about 0.7% of aggregate employment three years after the shock, and still of 0.5% 14 years after. This confirms the large aggregate effects of a missing generation of new firms (e.g. Gourio et al. 2016, Sedláček 2019), which may be further reinforced by changes in their characteristics, their survival, and post-entry growth. The lower number of new firms may also amplify pre-existing long-term declining trends in business dynamism observed in many countries.

Although the COVID-19 outbreak is, and will continue to be, a significant challenge for the start-up ecosystem, the current crisis may also create short-run and longer-run opportunities.

There are relevant opportunities for start-ups in times of crisis

Notwithstanding the significant economic disruption caused by the COVID-19 crisis (OECD 2020e), long-term effects on employment and innovation may be mitigated by taking steps now to support existing start-ups and the creation of new firms, limiting the negative effects discussed in the previous section. Recessions are often times of heightened restructuring that may ultimately lead to a stronger and more resilient economy.

In fact, even as the number of new business registrations generally drops during recessions, many successful innovative start-ups or businesses have emerged from periods of crisis. Examples include Dropbox, Uber, Airbnb, WhatsApp, Groupon, and Pinterest, which were all founded during or just after the global financial crisis, and Alibaba’s Taobao that was founded during the SARS outbreak in China in 2003.

This confirms that periods of crisis are not only a challenge, but also provide new opportunities for entrepreneurs, as start-ups can help address the constraints created by difficult health or economic conditions, and respond to changing preferences and needs. Relevant examples in the time of COVID-19 are outlined below.

First, there are opportunities for start-ups that introduce (or upscale) radical innovations that can be useful in the short run. Today, that could mean innovations in tele-medicine, remote personal care, medical equipment, home delivery, food processing, teleworking, online education, contact tracing. Support for start-ups to respond to such short-term needs has been provided through targeted policy interventions, including a call from the European Commission for start-ups with technologies related to treating, testing, monitoring or other aspects of the COVID-19 outbreak to apply fast-track funding under the EIC Accelerator programme. These, however, tend to ultimately address specific activities for which there is immediate demand or need.

Second, and importantly, the COVID-19 outbreak may induce persistent changes in societies, consumer habits or needs that could uncover valuable business opportunities for start-ups that are able to anticipate these changes. For instance, demand for remote working, e-commerce, education and health services may also change in the medium run, global value chains and cities may be transformed.

Policy makers should therefore consider interventions oriented at raising awareness of these opportunities, especially in industries that appear more resilient to COVID-19, such as digital intensive sectors, which are also generally characterised by higher post-entry employment growth (Figure 3) and contribute disproportionately to job creation.

Policy responses can help speed up the recovery

Policy interventions should aim at tackling short-term challenges, supporting short-term liquidity and availability of funding, as well as providing the right conditions and incentives for innovative start-ups and potential entrepreneurs and boost their potential and capabilities to grasp them.

In particular, policymakers may consider the following:

1. Tackle short-term challenges

Support short-term financial needs of existing start-ups (e.g. with loan guarantees, direct lending, grants or subsidies, keeping in mind start-ups’ specificities in designing these policies) with minimal bureaucracy, and help secure jobs and incomes of their workers (OECD 2020c).Raise awareness about existing measures and support initiatives that provide guidance to help start-ups adapt to the COVID crisis (e.g. through official platforms that centralise information on support programs, provide advice on cash-flow management, best practices to connect with investors remotely, etc.).Support R&D and prizes for radical innovations to help tackle the health crisis, and support start-ups adapting their products (OECD 2020d).Promote investments in skills and online training especially during the crisis, to prevent skills depreciation and encourage upskilling of start-up workers.

2. Reduce barriers to entrepreneurship and provide the right incentives

Reduce administrative burdens for start-ups by implementing simplified procedures, and accelerating transitions to e-government. Minimise regulatory uncertainty, both during the crisis (e.g. red tape) but also after (e.g. health and safety requirements in the early recovery phase), as start-ups suffer most from these uncertainties.Reduce possible barriers associated with the entrepreneur status, especially those that may be seen as particularly critical during and after the pandemics (e.g. related to access to health care and paid sick leave), making social protection more portable. In other words, link entitlements to individuals rather than jobs.Ensure that funding remains available for innovative start-ups at all stages of their development, in co-ordination with private actors. For example, provide additional public funds to public venture capital umbrella-fund-investors, which can be used in co-investment with private investors for financing rounds of start-ups; take over shares from defaulting fund investors with additional public funds; or simplify venture capital financing).

3. Boost entrepreneurial potential

Promote entrepreneurship training, also in combination with benefits for displaced workers and lifelong learning, to facilitate (un)employment-to-entrepreneurship transitions, with particular attention to disadvantaged groups.Promote university-business collaborations to facilitate industry applications of innovation and university-to-entrepreneurship transitions.Promote network developments, including those linking job seekers and start-ups and those facilitating access to international markets.Maintain investments in the start-up ecosystem, notably to ensure incubators and accelerators continue playing an important medium-term role in providing guidance, coaching, and mentoring to potential entrepreneurs and existing start-ups

Tackling short-term challenges, reducing barriers to entrepreneurship, and boosting entrepreneurial potential could help speed up the recovery and preserve aggregate employment in the long term. This may occur through different margins: i) keeping start-ups alive in the short-run; ii) limiting the detrimental effects of a missing generation of new firms; iii)boosting the growth potential of young firms.

This article was originally published in World Economic Forum.