10 reasons why we should help start-ups during the coronacrisis

16 April 2020
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Bron: InnovationQuarter

The real source of economic growth and prosperity is technical innovation, says Austrian economist Joseph Schumpeter. Schumpeter is considered to be the founder of scientific thinking on innovation and entrepreneurship. He also coined the term ‘creative destruction’, which Schumpeter understands to be the process of continuous innovation, in which successful applications of new techniques destroy the old ones. Is it wise to help start-ups, scale-ups and other innovative companies now from the perspective of creative destruction? InnovationQuarter director Rinke Zonneveld and Maurice van Tilburg, director capital at TechLeap, answer this question jointly.

The skyline of Rotterdam
Photo: Danny Cornelissen

Does an accelerated process of creative destruction actually exist in the current corona crisis? Or, as someone wrote: ‘This forest fire will soon create a lot of space for new plants.’ Last week, the government announced that it would provide at least €100 million in bridging loans to start-ups and scale-ups. According to Zonneveld and Van Tilburg, now is the time to help start-ups, scale-ups and other innovative companies. Below are 10 reasons they jointly formulated.

Does an accelerated process of creative destruction actually exist in the current corona crisis? Or, as someone wrote: ‘This forest fire will soon create a lot of space for new plants.’ Last week, the government announced that it would provide at least €100 million in bridging loans to start-ups and scale-ups. According to Zonneveld and Van Tilburg, now is the time to help start-ups, scale-ups and other innovative companies. Below are 10 reasons they jointly formulated.

1. An exceptional economic situation exists.

Many start-ups and other companies are confronted overnight with an acute loss of demand or stagnation of their supply. This is not a market correction, as was the case, for example, when the dot-com bubble burst in 2000. The economy has come to a standstill due to international lockdown measures to protect our public health. There is therefore no creative destruction whatsoever, with new better technologies driving outdated companies from the market.

2. Start-ups and scale-ups are of great importance for the economy, for our innovative strength and future earning capacity.

Start-ups and scale-ups invest disproportionately in R&D, develop key technologies, such as artificial intelligence, biotechnology and photonics, and rapidly translate these into innovative services and products. Their products and services often also contribute to solving social challenges, for example in the areas of health and care, energy transition and sustainability, agriculture, water and food and safety. Start-ups and scale-ups are the necessary driving force behind this technological revolution. In addition, these start-ups and scale-ups ensure the retention and attraction of talent and expertise that is important for our competitive position in the future. Fast-growing companies of this type created around 220,000 jobs during the period 2015-2018. This makes them the fastest-growing job engine in the Netherlands.

3. Start-ups and scale-ups are in fact hit equally hard by this corona crisis.

As a rule, start-ups have little or no financial back-up. They invest all of their money in their growth and therefore often make no net gains. They live from one round of investment to the next. This also means that under normal economic conditions a large percentage of start-ups will not make it. You could see this as a form of creative destruction. Government support should not disrupt this Darwinian process. However, a TechLeap survey of more than 400 start-ups shows that 80% of the start-ups and scale-ups will be in acute financial difficulty in the coming months, mainly due to a drop in demand and the inability to acquire new clients. 67% need bridging finance and 27% were in a new round of investment that has now largely come to a standstill.

4. To a significant extent, start-ups and scale-ups do not fall within the scope of other crisis measures.

On 13 March, the government took a firm first package of economic crisis measures. The aim of these measures is to support entrepreneurs and companies, from self-employed persons to large companies, in the best possible way in these exceptional economic circumstances. However, due to the nature and characteristics of start-ups and scale-ups, they are not eligible for many of these measures. Banks will no longer suddenly extend loans with extended bank guarantee schemes to start-ups. And many start-ups and scale-ups will not be eligible for NOW, the Temporary Emergency Bridging Measure for Sustained Employment scheme (Tijdelijke Noodmaatregel Overbrugging voor Werkbehoud, NOW). Many of the tax measures also have only very limited impact for young innovative and fast-growing companies.

5. Our innovation ecosystem, on which significant efforts have been made over the past 15 years, is in danger of being seriously affected.

The Netherlands aims to develop our ecosystem for start-ups and scale-ups into the strongest in Europe and to achieve a top-5 position worldwide. In the 2019 rankings, the Netherlands had risen four places worldwide, from 19th to 15th place. The Netherlands ranks at 5th place in Europe. The increase is driven by the growth in the number of start-ups, growth in the number of investments in start-ups and a number of large ‘exits’. As a result of the current corona crisis, the number of start-ups is expected to fall, as well as investments in start-ups, and major exits will be postponed. This is a global trend, but nevertheless threatens to weaken the relative position of the Netherlands.

6. Our competitive position is at stake, because other countries are introducing significant support packages for their start-ups.

In recent weeks, several European countries have announced very generous support measures for their start-ups. These often consist of a combination of soft loans, co-investments and tax measures. France has announced a package with a total of €4 billion and Germany has earmarked €2 billion for specific start-up measures. Other countries such as the United Kingdom, Switzerland, Spain and Belgium have also taken extensive measures. For example, last week Flanders announced that it would provide €250 million in low-interest loans to Flemish start-ups.

7. Investment funds are also adversely affected by the current crisis.

Of course, investment funds (private and public) play a key role in helping their portfolio companies through this current economic crisis. Our contacts also show that they are prepared to do this. However, a reasonable number of funds do not have the deep pockets that are needed now. Just like in other European countries, they could do with some good public support. The returns from funds are also under severe pressure from the current economic crisis. And contrary to popular belief, returns from funds that make risky investments in young innovative and fast-growing companies are generally modest. As a direct consequence, it may become more difficult to raise financing for new funds in the near future, meaning that significantly less risk capital will also be available for start-ups and scale-ups in the medium term. And the crisis for them will last much longer than desirable.

8. The government plays an important role in stimulating innovation.

Perhaps the most important economist in the field of innovation since Schumpeter is the Italian-American Mariana Mazzucato. In her ground-breaking book ‘The Entrepreneurial State; debunking public vs. private sector myths’ (2013), she argues that the economic success of the United States is due much more to public investment in innovation and technology than to the free market doctrine with which it is often associated. Public investment is also of great importance in future breakthrough technologies, such as the energy transition, as is evident in the Netherlands with the establishment of Invest-NL. Public investment in innovation and technology also has major positive external effects.

9. The government already plays an important role in financing start-ups and scale-ups.

In the Netherlands, as in other European countries, the government is already a major (indirect) investor in young innovative companies. However, it does so in such a way that decisions about individual investments are made at least at arm's length and in a market-oriented manner. For example, the regional development companies (ROMs) are involved in approximately 50% of all venture capital deals year after year, making them by far the most active investors in the Netherlands. But many private funds also receive part of their financing from the government through, for example, the SeedCapital scheme or via the European Investment Fund (EIF). The government therefore already has a professional structure to provide funding to start-ups and scale-ups in a sound and responsible manner. That is why the government has decided to place the responsibility for providing the €100 million in bridging loans with the regional development companies. Invest-NL is also expected to play an emphatic role in the provision of larger tickets.

10. If properly designed, unnecessary uncreative destruction among start-ups can be prevented.

In recent weeks the Ministry of Economic Affairs and Climate, together with TechLeap, the combined ROMs and Invest-NL, has worked very hard on a facility for providing bridging loans to start-ups and scale-ups. A lot of input was also gathered from private investment funds and from start-ups. It is evident that the loans are an emergency instrument, which can provide a temporary bridge to break-even or a subsequent round of financing. Companies that qualify for this will of course have to be able to demonstrate that their financial need stems from the corona crisis and that they have taken all cost-reducing measures that can

reasonably be expected of them. Risk analysis will also be applied to assess whether they have a healthy and sustainable future perspective. Private co-financing will also be required for higher amounts. This way uncreative destruction is prevented, but the process of creative destruction that is so necessary for innovation is not disturbed.