May 7, 2020

Amid Vast Employee Layoffs, We Should Bail Out Tech Startups During The Coronavirus Crisis

In the United States (US), we do not have a clear definition of what constitutes a small or mid-size enterprise (SME). At MIT, Professors Aulet & Murray developed a great working definition: so that there is a distinction between an innovation driven entrepreneurial (IDE) firm and a SME enterprise.

Definitions matter, and the distinction between a SME owner and an IDE entrepreneur is very important because most small businesses do not innovate; remain small in size throughout their existence; and do not provide the desired job creation that policy makers are intending to create. 

As journalist Annie Lowery put it: “[s]cupper the image of Mark Zuckerberg handcrafting a new service to revolutionize how we socialize and adding thousands of jobs to the economy. Replace it with the image of a gas-station owner, servicing a crowded market, happy to be able to make his kid’s soccer games without a boss breathing down his neck, and more wary of innovation than eager for it.” 

So yes, definitions matter. They matter for policy design and for guidance on bailouts. 

Yesterday, it was reported that some venture capital (VC) backed startups that applied for or received Paycheck Protection Program (PPP) loans are now considering withdrawing their applications or returning the loans in full to the Small Business Administration (SBA) for fear of legal liability or reputational harm

In the last few weeks, entrepreneurs and their legal advisors have been scrambling to figure out whether they can apply for these loans because of their “affiliations” with venture capital investors. For more clarity on this “affiliation” mess and VC-backed startup eligibility, click on this link for Ed Zimmerman’s great legal analysis.

Should we care about tech?

Tech startups are IDE firms, which have an important role in contributing to job creation, to generating technological innovation and to stimulating the US economy.

The tech industry is very important to our economy because, according to the U.S. Bureau of Labor, “they produce a large share of total output, and from a workforce standpoint, they employ a large numbers of skilled workers and provide higher wages for all types of workers.” 

For those of you who want to learn more, see the following chart from U.S. Bureau of Labor Statistics

Unfortunately, vast layoffs are now part of the reality of almost every industry in the market. These layoffs affect many households around the country and the globe. 

The coronavirus layoffs did not spare the talented highly skilled highly paid tech employees. Many tech companies, from Oyo, TripActions, ZipRecruiter to now Airbnb, are laying off employees. Airbnb, for example, is laying off 1,900 Employees due to the pandemic. 

Can we bailout tech startup employees? 

Thanks to the rushed rule-making, there is plenty of disagreement and debate among entrepreneurs, investors and their legal advisors on whether tech startups should apply for the federal emergency bailout programs. There is also uncertainty about the potential legal liability if companies applied but are later deemed to be ineligible. 

Even if they are deemed eligible, there are questions about whether they should apply because of potential reputational harm. See public outcry over Shake Shack and the Los AngelesLakers.

There is no doubt that government intervention in the market, in the form of financial emergency support programs, can help prevent major layoffs in the tech industry. There is a need for clarity and specific programs designed for this industry. 

What about startups that already applied and got the loans?

Again, I mentioned some VC-backed startups are returning the loans or withdrawing their applications. There are a few reasons for these actions. Perhaps these startups are worried that they will be deemed not eligible because of their deep-pocketed investors? There are several risks, including False Cares Act prosecution, oversight and audit. Or maybe their investors are worried about the potential of extending legal liability or possible audits.

Treasury Secretary Mnuchin warned that the emergency loan programs are not designed for large companies with ability to access other sources of financing. What does that mean for tech companies that raised large amounts of capital only a few months ago from VCs, PEs or other Alternative Venture Capital investors?  

In any event, the Administration provided a safe harbor: if companies obtained the stimulus loans, they can return the loans by May 14, 2020, and thus avoid the potential penalties. 

So, what about deep-pocketed investors, venture capital firms, and private-equity firms?

If you’ve read this far, you’re probably wondering about VCs or PEs: why don’t they just bail their portfolio companies out?

The markets for allocating risk capital to tech startups are inefficient, and the financing of these firms, present countless underlying challenges to the investors and innovators.

Thanks to financing and information gaps, which describe the barriers of tech startup financings, deep-pocketed investors might need to make significant changes, not just to their business models or contracts with their portfolio startups, but also to the contracts with their own investors, in order to be able to help. 

Some think that VCs or other deep-pocketed investors are not the answer, “The cold hard truth is that VC funds aren’t social safety nets, per the legal agreements signed with their investors,” according to Dan Primack. 

Others will probably disagree

To learn more on the options to funds and their investors, have a gander at this recent post: GPs/LPs Weigh Options in Face of Liquidity Crunch

The Administration can—and should—at least mitigate some of information uncertainty about the loans ASAP. Everyone could use a little clarity and guidance on these questions. For the long run, there is a need for a new innovation policy that will take all these issues into account.  

So, theoretically, the government can intervene in the market and offer special loans to tech startups in order to help prevent mass layoffs and encourage the survival of high-growth firms, but this is a policy question, and it’s up for debate.  

The government needs to decide on which industries to prioritize and where to invest its resources for the benefit of our future generations. Once we’re on the other side of this pandemic, we don’t want to play catch-up because we’re lagging behind other countries on technology innovation.

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