Tech startup greed amidst a pandemic
Most startups would like you to believe that they are trying to save the world in one way or another. For some, this is true and their hearts are in it. For most they are simply trying to solve a hard problem with technology and hope to make a lot of money from it. The employees at those companies also hope to not just build careers but amass a large amount of wealth in an eventual exit (IPO or private sale). There is nothing wrong with wanting to make money but many of these founders, their employees, and their investors seem to forget that the entire startup ecosystem is designed to have way more failures than successes.
Yet, despite years of reckless “growth at all costs” without attention paid to margins or cash reserves, over $140 billion in venture investment in 2019, and several major IPOs recently, tech startups are trying to frame themselves as poor small business in need of government bailout because of the covid-19 pandemic.
In March, the U.S. Congress passed the CARES Act “to provide emergency assistance and health care response for individuals, families, and businesses affected by the 2020 coronavirus pandemic.” This bill includes fully forgivable loans to small businesses under 500 employees as part of the Paycheck Protection Program. These loans are administered by the Small Business Administration, which means they fall under their rules for disbursement. The SBA has a clause called “affiliation through majority investment,” which states:
Ownership of 50% or more of the voting stock of a business concern will result in affiliation under SBA rules and require aggregation of headcount with the majority owner and its other affiliates.
In short, no money for venture-backed startups because, even if they only have 100 employees, the total amount of employees of the venture firms that funded them will be pooled and counted for eligibility. Sounds like a pretty good rule to make sure that companies who have already received millions of dollars in funding aren’t essentially double dipping and trying to take money away from companies that need it. Tech startups seem to feel differently.
I was first alerted to this stipulation by a venture capitalist I typically respect, Fred Wilson, in his daily post on March 30th. In reference to the the PPP he complained, “this sounds great for startups, right? Well not so fast.” He then goes on to explain how startups can work with their legal teams and those of their VC firms to help figure out how to get the money. He closed by saying, “It is my hope that this ‘bug’ in the law will get fixed over the next week or so.” Sorry, Fred, this is a feature, not a bug.
Those loans are designed for actual small businesses like coffee shops, hardware stores, and restaurants that employee almost half of all Americans. Yet that didn’t stop some of the world’s most wealthy (majority) men to launch an all-out lobbying campaign to get this rule changed. On March 29th the National Venture Capital Association issued a letter to Steven Mnuchin, the Secretary of the U.S. Department of the Treasury, and Jovita Carranza, the Administrator of the Small Business Administration, on behalf of 126 “pro-startup groups” asking them to change these rules. They contend:
In addition to laying off workers, startups will have to shut down critical research and development (R&D) projects in fields like bio-research, medical technology, and artificial intelligence, setting back our country’s competitiveness and delaying the creation of new tools to combat the COVID-19 pandemic. Bottom line: not providing this critical support to startups now will cause both short-term pain and long-term consequences that linger for years.
What they’re not admitting to themselves is that most of those companies were bound to go under anyway. Recessions and depressions tend to accelerate this process and it is not the U.S. government’s job to stop or slow it. In fact, if these companies need more cash and the venture capital investors deem their business model worthy of further investment then it is their responsibility to continue to provide it.
It doesn’t stop there. On March 31st, the lobbying of the venture capital industry convinced Nancy Pelosi, Speaker of the House from San Francisco, and Ro Khanna, Member of Congress representing Silicon Valley, to also issue a letter to Secretary Mnuchin and Administrator Carranza asking to change the rules. They plead:
Many small businesses in our districts that employ fewer than 500 employees, particularly startup companies with equity investors, have expressed concerns that an overly strict application of the Small Business Administration’s (SBA) affiliation rule my exclude them from eligibility from PPP loans. For these small businesses, as for many across America, access to forgivable PPP loans will be critical to preserving jobs during the coronavirus pandemic and to securing America’s leadership in science, technology and innovation.
It’s despicable that these two Congressional representatives are trying to frame not giving free government money to venture-backed startups as some sort of national security issue whereby them going out of business will threaten the future of America. Nobody inside or outside of the industry actually thinks that is true. All of this is selfish motivation driven entirely by returns for venture funds, venture investors, startup founders, and their employees with options in the company.
What you don’t see is all of those same people worried about the non-employee staff they have cleaning their offices, serving their food, and often completing tasks that underpin their very businesses. Those are the small businesses and individuals that the loans are designed for. It could be argued that if the startups don’t exist then those people won’t have jobs either and thus startups should get the loans. But the only startups that will go under are those that cannot weather the storm. Most of those are already sitting on shaky financials, bad business models, and are overvalued. A public market reckoning had already begun months ago and now this will accelerate a private market reckoning. What will result is a much healthier startup ecosystem going forward.
Many of my friends and past colleagues at startups will not agree with my stance on this. Working for a startup is high-risk, high-reward but most people focus on the latter and forget about the former. There are plenty of other places to work if you want stability and a guaranteed return but a startup isn’t one of them. I’m disappointed in the venture capital industry for trying to take advantage of a global pandemic for their own gain.
To my knowledge, as of this writing the SBA has not changed the rules around affiliates and it is my hope that they do not. I want to see that money go to the thousands of small business and millions of employees that desperately need it right now so that they can feed their families and keep their homes. Unfortunately, this will mean that many startups will lay off staff and/or go out of business. But I believe in the system and know that the capital will eventually be reallocated and the talented people that work there will find new jobs where they continue to push American innovation forward.