What are entrepreneurial ecosystems and why do they matter in a crisis?
Entrepreneurial ecosystems are the types of people, organisations, networks, and outlooks of a place like a city or region that support high-growth entrepreneurship. While a great entrepreneur can come from anywhere , great entrepreneurship tends to be easier in particular places. These are normally cities with dynamic economies, lots of smart people, maybe a research university or two, along with lots of other successful entrepreneurs who can help, investors with money and insight into growth, and strong social networks that connect them all. Plentiful, cheep office space and lots of bandwidth help too. All these actors and factors combine to create, attract, and circulate the resources that entrepreneurs need to transform good ideas into high-growth scale-up firms.
This is important because it’s these scale-up firms that are responsible for the bulk of new job creation in most developed economies. By innovating new products and identifying new opportunities, these companies (which constitute about 2 - 6% of new firms founded in a given year ) attract new investment and revenues, creating jobs and building the local tax base.
It’s this support for highly innovative, fast-growing scale-up firms that make entrepreneurial ecosystems important for local economic development efforts. Entrepreneurship isn’t the only tool to create wealth and jobs, but it’s a powerful tool that allows a place to create its own economic destiny rather than depending on branch plants or remote offices. The archetype of an ecosystem is a place like Silicon Valley, but we can look at other places like Boulder, Colorado, Waterloo, Ontario, or Edinburgh, Scotland as places that have built strong economies around supporting digital and other types of entrepreneurs.
Ecosystems matter in a crisis because they’re a tool for recovery and resiliency. No matter how strong an ecosystem is, it can’t totally isolate entrepreneurs from an unprecedented health and economic crisis. Scale-up firms are by definition national and global in their outlook and will be hurt by the loss of national and global markets. But entrepreneurial ecosystems will play a critical role in how cities recover from this crisis as they try to replace jobs and tax revenues that were lost and orient themselves towards new futures.
Entreprenerus and Crisis
In order to think about what ecosystems will look like in a Post-Covid world, we need to think about the immediate effects of the Covid Crisis of entrepreneurial firms and their ecosystems. Though this crisis is playing out in real time, we can already see some impacts:
A swift collapse of many growing firms due to cash flow collapse
Some crises have a long lead up and give plenty of warning before they hit (at least in retrospect). By any standard, the current Covid crisis came to fruition shockingly quick. A little more than 5 months from its first emergence in China to the essential locking down of most of Europe and North America. Almost every company besides Zoom, Netflix and seed distributors are in a cash flow free-fall as customers can’t reach them or are cutting down their spending. This is as true for B2C companies as it is for B2B ones. But as these revenues dry up, their expenses don’t go down as fast. Even with layoffs, government support, and other benefits we will see many firms collapse due to the loss of cash flow. This not only adds to the unemployment, it leads to loss of IP and investments which will have knock-on effects for years to come.
Uncertainty makes it difficult for entrepreneurial firms to pivot and find new opportunities
In normal times, many entrepreneurs use lean strategies where they are constantly testing new business model and product ideas to find new customers and markets. This means that if there is a problem in one market — say a decline in demand for customised investment advice — they can pivot to new markets that take advantage of their underlying skills and resources. This doesn’t mean that all firms (or even most) can survive the loss of a major market, but at least there’s somewhere else to turn. This won’t be the case in the current crisis: pivoting can’t help you where there are few places to pivot too. This will make it harder to even well-run and well-organized firms to make it through the coming months
Loss of investment capital and loss of investors
Still lots of deal flow in Europe, but I’m sure that’s collapsed by now
Groups like Startup Genome have already started documenting the pull-out of investment in the past few months. Since the start of the year, for example, VC deals in China are down almost 60%. This only makes sense: it’s impossible to be able to value a company and predict its chances of success in such uncertainty. This will only continue over the next few months. In addition, we will see a rapid decline in angel investment. Angels are high net-worth individuals who invest in young firms as both a portfolio strategy but also as almost a social function in order to help their local business community. Given the rapid decline in equities and the chaos facing real estate, it’s hard to imagine there will be many HNW people willing to take a flier on a new company. This capital is important for helping innovative ventures rapidly scale, which in turn creates new jobs and (hopefully) new wealth.
High rates of necessity entrepreneurship
Entrepreneurship and unemployment are closely linked (from Farlie 2013)
We normally think of entrepreneurship as a good thing — mom, apple pie, and all of that. But this isn’t always a case. As mentioned above, only a very small minority of new ventures have any growth prospects. The vast majority are small lifestyle firms that will not grow much beyond the founder. And that’s totally fine!
However, in recessions we see an increase in entrepreneurship. There is a very strong correlation between unemployment and entrepreneurship. This is necessity entrepreneurship; the entrepreneur is only doing it because they can’t find a job. These are often low-quality firms with little growth prospects. Entrepreneurs who own these firms typically make less than they would in traditional employment, they take on more risk, and they are more likely to be anxious and depressed than those with regular jobs. We’d expect to see a lot more of these types of firms in the next few years, which acts as a drain on the economy.
How ecosystems can help
Ecosystems aren’t a panacea. No matter how strong an ecosystem is it can’t make up for a global collapse in demand and the evaporation of investment capital. But there are a number of ecosystems that will help entrepreneurs in the midst of this crisis.
Sharing knowledge about how to survive
All entrepreneurial ventures have one goal right now: survive. They do that by reducing their cash burn rate, trying to make what ever sales they can, or applying for grants, loans, and other kinds of public support. While each individual entrepreneur needs to make really tough decisions about how to do this that are specific to their firm and context, there are only so many ways to do this. There are lots of common practices and choices that will work in a variety of firms. One of the most important aspects of ecosystems is that they allow for the quick circulation of practical know-how. While in good times this might be knowledge of investor preferences or good employees who are looking for new opportunities, now the most important knowledge is tips for managing remote workers or how to apply for new bridging loans.
Entrepreneurs sharing what they’re going through with one another, what’s worked, and what hasn’t helps everyone. This will be particularly true around government support programs, which are complex, difficult to understand, and complicated to apply for. Sharing best practices helps people avoid mistakes (say, not having the right documents when they apply for support) and they learn what works from each other.
Now, because we’re all locked-in to our homes, this knowledge sharing can be global. But the relationships and trust that have built up between entrepreneurs within ecosystems makes the knowledge sharing quicker and more effective than what we can get from just reading blogs and twitters.
Emotional support and solidarity
Business advice is one thing, but only entrepreneurs know what other entrepreneur are going through. It’s not that every entrepreneur in a city is friends with each other, but in my research I’ve seen a lot of emotional support within entrepreneurial networks. Simply knowing that others are going through the same experience as you helps make it less traumatising. We’re already seeing this solidarity in the informal chats between entrepreneurs on community message boards and Slack channels. This kind of support is as valuable as any more formal support and is only possible because of the prior relationships entrepreneurs forged before the crisis.
Bringing together key plays to create local solutions
So far I’ve been talking about informal support in the ecosystem. This is because the crisis is so fast moving and so complex that it’s hard for formal support programs or organisations to keep up, to say nothing of leading their community out of danger. But in the coming months there will be a need for localities to find local solutions and identify local resources that can help local entrepreneurs. This likely won’t involve lots of money — that’ll be scarce for the next long while. But there are other options. Some cities with major universities of anchor firms may be able to leverage their resources to help the start-up and scale-up community, maybe by bringing them into their supply chains or sharing resources. Likely, this will involve lobbying local political leaders for specific forms of support. In either case, having a pre-existing community with key leaders (successful, engaged entrepreneurs, prominent support organisations, ect) makes this much easier.
What will post-Covid ecosystems look like?
Ecosystems will have an immediate role in helping entrepreneurs make it through the crisis. But what will they look like in a year or two? When we can go outside, but where we’re in what will likely be a significant recession and in which cities themselves may be fundamentally changed.
Fewer investors, less know-how
We know that lots of really innovative firms are going to go out of business in the coming months, and the something will happen to many venture capital firms. Given the shocking drop in stocks, real estate, and other assets we can also assume that there is going to be a drop in the number of angel investors and high net worth investors. This will look like a spectacular decline because we’re in a VC-bubble to begin with.
The withdrawal of investors is more than a problem of not enough investment capital (though this will be a big problem!) Good investors bring knowledge and insight with them to the firms they invest in. They provide advice on how to handle the HR, legal, and strategic issues that come with growth.
I saw a similar phenomenon in my work on Ottawa’s entrepreneurial ecosystem. All of the city’s VC and angel investors effectively vanished after the dot.com bust. Entrepreneurs had to learn how to scale with minimal outside Investmet, driven by internal revenues and efficiencies. The success of Shopify helped build a new investment scene more than a decade later. Many other ecosystems will see a similar pullout of investment, requiring radical changes in growth strategy amongst entrepreneurs.
Less focused policy
In the past few years we’ve seen a major focus in many cities and regions to have an explicit ecosystem strategy. Some of these efforts have worked better than others, but they represent a realisation that there is a need for public support for early stage firms as well as the importance of these firms for local economic development office.
There is likely going to be a paradigm shift in economic development logic, which will hopefully lead to more resources available at all levels. However, immediate policy over the next few years is going to focus on triaging the damage and trying to get people back to work. I think this will lead to a much larger focus for most local economic development agencies. Maybe this will be led by public works, maybe by some form of universal basic income. While high-growth innovative entrepreneurship will be a part of these efforts, it’s going to be a huge effort. I can see there being a shift of focus away from supporting these types of startups for now in favour of broader self-employment strategy.
Different meet-ups
Meet-up events have always been a really important part of how ecosystems work. They provide a meeting and learning space and help introduce new entrepreneurs to already established communities. I don’t know how society is going to change after Covid — will we all become hypochondriacs who are afraid of shaking hands or will we hate to spend a night at home when we could be out with other people? Local meet-ups for entrepreneurs have moved on-line, but eventually they’ll be back in person. I can see them remaining important, but maybe with a larger, more permanent virtual component. I can also see problems emerging in the loss of major sponsors who will be looking to control their own costs.
More inclusive
Many ecosystems aren’t as inclusive as they should be: people are excluded based on age, gender, race, care responsibilities and a lot of other factors. In the past year I’ve begun to see a change in many ecosystems and leaders and organisers try to explicitly including as many people as possible rather than just hoping they show up to events made for and by white men. I hope that as people get more used to online meetings they can begin to develop new methods that make it easier to include people who can’t necessarily make an afterwork bar event.
What should ecosystem leaders be doing right now?
Stay inside. Wash your hands. Sneeze into your elbow.
The world right now is about as uncertain as it can be. It’s impossible to say what will be happening next week, to say nothing of 6 months from now. It’s simply impossible to make any good predictions about what people or organisations should be doing now to prepare for the future.
Instead, they should stay flexible and lean. See what happens and look for opportunities to help the community. React to changes as they occur using the same entrepreneurial thinking that underlies the entire idea of entrepreneurial ecosystems.