Zombie Startups: Coronavirus didn’t make you vulnerable, it just exposed your vulnerabilities

Towards the end of last week a VC from a fund that’s invested in a similar company to mine, reached out and asked for a quick call “to trade notes”, curious and presuming he would be just fishing for intel, I agreed to have a call and during the call to the contrary he was very transparent about the precarious situation the company is in, I won’t go into exact details but basically, the portfolio company is up the creek without a paddle and were blaming the COVID19 crisis for their current woes.

Just to be crystal clear, I take no pleasure in seeing people distressed, even competitors. However, companies with weak fundamentals, no real moat, IP, distribution or defensibility, which essentially are just well funded PPC machines, shouldn’t only blame the current crisis.

Coronavirus didn’t make them vulnerable, it just exposed their vulnerabilities.

I see founders like these raising big tickets, getting TechCrunch coverage, then acting like they’re already at the finish line, running around like they’re Elon Musk or Jeff Bezos.
The thing is, raising money is like a baker buying eggs, you still have to bake the cake. Things can change dramatically and more obvious than ever, Startups are always a race against time.
So founders and leadership times shouldn’t get drunk on their own Kool-aid in peacetime, because like we are seeing now, things can change and quickly during wartime.

If you look back at S curves, where there has been a downturn & resulting slowdown in venture capital, the companies which have successfully navigated crisis, have significantly over-performed.

These companies won’t be PPC machines…

They will be special (often unsexy) companies with real substance, strong fundamentals which are lean & navigate the challenges the crisis presents quickly, decisively and do whatever it takes to not only survive the crisis but position themselves to win when the recovery starts.

There is much debate in pretty much all European ecosystems of what is the best way that their governments should help startups extend their runway to survive what at the very least seems to be a few more months of zero revenues and potentially could extend to the remainder of 2020 and into Q1 2021.

In Germany, as I reported last week (which you can read here), the German government is launching an emergency 2 Billion EURO fund for startups, which will act as a co-investment fund, in which they will match any investment that private investors make to support their portfolio companies navigate the crisis. I like this as it in many ways polices the distribution of the money and avoids zombie startups receiving money if their investors don’t believe in them enough to also participate.

In the UK, there has been much debate about what would be the best way to use or not use taxpayer money to bail out startups. Some areas of the ecosystem consisting mainly of veteran entrepreneurs, think tanks and quangos (of which lastminute.com founder Brent Hoberman has been the spokesman) have called for the UK government to launch a £330m runway fund which would invest in 1000 startups. This has been met with much debate across other areas and stakeholders in the UK ecosystem. I’m told by several UK based VC funds they have declined to support this as the initial approach meant that there would be fees and carry. Meaning that those running it would be set to gain around £33m in management fees and also would get 10% carry (share of profits) so essentially would profit from a crisis, using taxpayers money.

I was told personally by Brent Hoberman that they have since iterated on their plan and it would be not for profit, although some funds have said publicly they are yet to see any information that states it is not for profit or who would make investment decisions, such as Seedcamp’s co-founder and Managing Partner Reshma Sohoni.

Beyond this Robin Klein Partner at VC funds LocalGlobe and Latitude praised the UK governments already generous initiatives such as EIS, BBB, InnovateUK, R&D tax credits and he feels that as 8 out of 10 startups fail before Series A the UK government should be very careful using taxpayers money to delay the inevitable for most.

Finally, in Ireland, independent non-profit Scale Ireland who provides a unified voice for innovation-driven enterprise across Ireland have not just come to their own conclusion about what should be done, but have instead asked startups to complete a survey click here to see so they can truly understand the challenges which have been presented by the current crisis.

A friend of mine put’s it best “The government should NOT have a special bailout package for startups”.

There should be a comprehensive package for SMEs, including startups, with a particular focus for those with the most number of employees and revenue prior to the crisis, the package as is happening in many places be about partial, but not full subsidies of wages for affected workers.

Startups are risky for a reason. Venture capital is risky for a reason. Otherwise, we send good money chasing after the poor due to moral hazard. One cannot expect preferential treatment for aggressiveness in expansion compared to other business.

Having a startup specific package will cause even more issues due tp misallocation of resources away from more pressing needs, Artificial delineation and classification of companies based on an arbitrary judgment.

A government’s role is not to bail out risky investments nor risky business models which were not stable even in the best of times.

The government’s role is to first and foremost protect employment for the masses, and ensure there is upskilling during times of low employment.

Helping startups is NOT wrong, but I strongly disagree that there should be a special financial package for tech startups specifically. It should be for ALL SMEs based on merit. We need to focus on the highest multiplier effect for every single dollar spent now, not simply protect private investors positions under the guise of a clever, PR friendly “SOS” slogan of “saving our startups”.

I’m comfortable with a co-investment fund but beyond that, we have to let nature take its course.

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