Startups and Emerging Technology Companies Falling Through the Cracks

While the front lines of the COVID-19 pandemic are in healthcare, and the initial economic fallout is most acutely felt in hospitality, and retail, these unprecedented events represent a fundamental shift in how we do business and an existential threat to all businesses that don’t adapt.

At The Idea Village, we work with emerging technology-focused startups in an aspiring market.  We believe these companies represent our future and are a down payment on long term economic vitality and a critical pathway to wealth creation for our community.  As an organization, we have spent the last 20 years working to catalyze a movement and champion innovation in New Orleans, an unlikely place for such activity by most standards, and can tell you from this experience, sustaining a robust pipeline of startups is a fragile endeavor, on a good day.  It is also something that is driven by momentum and density, and once lost is very difficult to rebuild.

We also know from the experiences in China and elsewhere that broadly speaking “tech” is a leading indicator of recovery which is going to be critical in the coming economic “restart.”  Tech companies can bounce back quickly, are digitally native, provide high-impact jobs with strong economic multipliers, and are generally run by people accustomed to navigating to where the puck is going in a changing environment.  China is literally seeing tech companies pulling the rest of the economy out of the ditch.

The following graph shows the performance pre and post COVID-19 of High Performing Industries (Software) vs the rest of the economy:

COVID-19 has also taught us that economic diversification is more important now than ever.  In a city, whose economy has historically been driven by oil and tourism, two supposedly highly uncorrelated industries, that certain external threats can undermine our pre-existing assumptions.  What do we want New Orleans to look like in an era of $30 per barrel oil and the possibility of an extended moratorium on travel?  This moment in time underscores the importance of the bets we have placed to put some other irons in the fire in fostering industry leading companies, not indexed to our core, and to invest in net new industry clusters that once looked like a crazy idea.  This could now become a saving grace.

This is why it gives me grave concern that certain types of startups and emerging technology companies seem to be at risk of falling through the cracks of the CARES Act legislation designed to help support businesses in this time of unprecedented uncertainty.  Building a team is one of the most important activities that an emerging company, particularly one in growth mode undertakes.  It also means technology companies are most extended in payroll and don’t have much else to cut when confronted with survival decisions.  The unwinding of this brain trust through layoffs hurts the team and the business’ momentum.  It also can have a devastating impact on families and communities as individuals are left hanging financially, and high impact jobs with pathways to upward mobility may be slow to come back.  Additionally, on a community level, we run a substantial risk of not retaining this talent.

Early stage businesses are also especially vulnerable as they may have started to build teams despite tenuous revenue and a limited operating runway.  Now customer’s attention is elsewhere, non-essential spending has been curtailed and investment capital, these businesses’ usual lifeblood, is nowhere to be found.

The entrepreneurs running these businesses need the full set of tools available to all business owners in this time of crisis.  Unfortunately, the CARES Act and specifically the Payroll Protection Program (PPP) leaves out startups and emerging technology companies in a number of important ways:

  1. Affiliation Rules – This is the big one.  Because of legacy regulation in the SBA 7(a) program on which the PPP is built, most startups with venture or angel funding are at risk of being deemed not eligible for PPP funding because their investors are considered a “controlling interest.”  Therefore, only the controlling parent company is eligible if it is also deemed to be a small business.  In the startup world, most investors make lots of investments and most startups have lots of investors.  This network effect creates a lot of confusion that slows banks down and ultimately penalizes companies with larger blue chip investors, which are also the ones that create the most jobs. 
  2. Max Loan Amount Formula – By using the prior year average as the means of calculating the maximum amount that can be borrowed and thus ultimately forgiven if used on payroll, the program discounts companies that have hired rapidly or recently.  If a business is hiring 50-100 people per year, the businesses average payroll over the prior 12 months is dramatically different than its actual payroll need today or projected need 3 months from now.  This is handicapping companies that might be able to hire today to take up some of the slack in the employment market.  Similarly, if a company has just turned the corner from a handful of people to bringing on a full team, they are similarly stuck.
  3. Focus on Debt –  Most startup and emerging technology companies are funded through the sale of equity not debt.  Debt can be dangerous when you don’t know where your revenue is coming from.   The PPP and the adjacent EIDL program, designed to catch the overflow not covered by PPP are both exclusively debt based.  This leaves out a whole generation of pre-revenue companies that could be our next industry leaders.
  4. Too Big to Qualify; Not Too Big to Fail – Successful emerging companies, which are the cornerstones of many aspiring innovation clusters are stuck in the middle of a “Donut Hole” in the CARES Act’s support structures.  They don’t qualify as small businesses, often prematurely due to the affiliation rule issues discussed, but they are not the Fortune 1000 protected under the too big to fail provisions of the legislation.  This is a dangerous place to be and risks putting some of our biggest job creators on the chopping block of this crisis.

These issues urgently need to be worked through, and the overall PPP needs to be sufficiently funded such that money remains available by the time they are resolved.  The opposite would represent an unimaginable setback to a critical sector of the economy and vanguard of the future.

Like all our business owners, we need to buy our most successful and innovative entrepreneurs time to adapt.  We also need to focus on protecting early-stage companies that represent our pipeline of innovation over the long term.  Short sightedness, now, and a poor understanding of the specific needs of startup and emerging technology companies and how they are different from other businesses, risks killing the very horse most well positioned to help pull us out of the ditch.

About the Author:  Jon Atkinson is the CEO The Idea Village, a non-profit organization created to identify support and retain entrepreneurial talent in New Orleans and the surrounding region. The organization runs two startup accelerator programs, VILLAGEx for high-growth technology companies and ENERGYx powered by Shell Gamechanger, a collaboration with Shell to spur innovation in the energy, industrial and offshore industries. The Idea Village also co-produces the annual New Orleans Entrepreneur Week (NOEW) presented by J.P. Morgan Chase along with the A. B. Freeman School of Business at Tulane University. He also runs a local early-stage investment group called Lagniappe Angels and is an active startup investor.