As the dust settles on the U.S. presidential election, the start-up community’s initial angst over Donald Trump’s victory is beginning to dissipate. Trump’s campaign promises, and the relatively few policies thus far adopted, have been a mixed bag for American start-ups—but perhaps not as devastating as most industry insiders at first feared.
“I’ve been waiting to see, like many, what will happen, trying to read the tea leaves,” says Marcelo Ballvé, research director at New York-based CB Insights, a provider of market data on start-ups and the angel and venture capital investors that fund them.
“What everyone felt in the venture ecosystem about the results of the election was a little trepidation around what direction policy would take under President Trump. That uncertainty has not dissipated. There’s a lot of smoke, but not a lot of clarity yet on regulation, tax policy and more specific policy questions,” says Ballvé.
Nevertheless, Ballvé hasn’t seen much of an impact on start-up investing since the election. “It has been sort of business as usual,” he says.
Macroeconomic conditions, the ability to raise capital and access to talent are among the biggest challenges facing start-ups. But policies and regulations issued by new administrations can also make or break innovative businesses.
“Certain aspects of his presidency should help the economy, especially sectors that expect to have their regulations reduced,” says Robert Fenwick-Smith, managing director of Boulder, Colo.-based Aravaipa Ventures, an early-stage cleantech fund. “For the cleantech sector, it’s more negative. His general disregard and dissing of science doesn’t help any industry that builds its growth on scientific innovation.”
Other new businesses will likely continue to attract capital regardless of who occupies the White House, says Kyle Stanford, an analyst with Seattle-based PitchBook Data, which provides market intelligence on venture capital, private equity and M&A activity.
“Software is still going to be the top dog,” says Stanford. “We’re such a connected society now. Developing an app can reach a lot of people very quickly. No matter what regulations come out, that won’t change.”
Indeed, Silicon Valley Bank sees a “long-term positive outlook for the innovation economy,” although some start-ups “will face challenges,” says the bank’s report, “U.S. Startup Outlook 2017.” The bank says there’s “more potential now for innovation to thrive than in the last 25 years.”
Jobs And Innovation
While some in the start-up community expressed apprehension over Trump’s election, others boldly moved forward. The CEO of Tokyo-based SoftBank pledged in December to invest $50 billion in start-ups that are supposed to create 50,000 new jobs in the U.S. The funds will come from SoftBank’s $100 billion technology fund, which includes a $45 billion commitment from the government of Saudi Arabia, according to Bloomberg News.
By sector, venture capitalists funneled $11.7 billion to life sciences (defined as pharmaceuticals, biotechnology and health-care devices and supplies), $4.6 billion to fintech and $2.6 billion to cybersecurity start-ups in 2016—just a few of the top areas for investment—according to data compiled by PitchBook for the National Venture Capital Association’s 2017 Yearbook.
Software companies received the largest share of venture investment last year, with $33 billion directed to 3,100 investments, representing 48% of the total amount invested, according to the report. Within the sector, social platform software companies received most of the capital, including those with apps that enable ride sharing, short-term rental property booking, photo messaging and cloud-based business management.
By stage, later VC investors accounted for over $38 billion of U.S. start-up investments in 2016. Early VC investors provided more than $24 billion of the funding, with angel/seed-stage deals accounting for almost $7 billion of the total capital raised, the report says.
Start-up investing is essentially a winner-take-all game. Successful angel and early-stage VC investors earn an average 2.5-fold return on their capital, according to a 2016 study funded by the Ewing Marion Kauffman Foundation and the NASDAQ OMX Educational Foundation. The savviest (or perhaps the luckiest) investors can realize a 10-fold or more gain. But the odds of striking out are high. Seventy percent of investments fail to return capital, let alone earn a profit.
Patience is also required for these typically illiquid investments. The average holding period is 4.5 years, and the largest wins take up to 10 years to realize.
Immigration And Trade
Overall, start-ups and their investors view President Trump’s emerging policies on immigration and trade as highly problematic. The “Buy American and Hire American” executive order, for example, which Trump signed in April, directs the government to enforce guidelines prioritizing the use of U.S. firms, labor and goods in federal projects.
The “Buy American” part of the order would curb outsourced manufacturing by favoring domestically produced goods. “People come up with great ideas they want to validate,” says Sandeep Sardana, managing director of San Mateo, Calif.-based BluePointe Ventures, a VC firm that invests in “frontier tech,” including artificial intelligence, virtual reality and augmented reality. “In China, it’s cheap enough to get a small batch of items produced at a high quality to show your customers the early product. If it catches on, bingo, you can capture a large market.”
Sardana says his investors helped to fund a company that used outsourced prototyping and production to quickly reach $150 million in sales. “The company would find it harder to do if there were tariffs on Chinese imports,” he says.
Domestic 3-D printing might compensate for some decline in offshore manufacturing, although it’s unclear whether onshore printing could meet demand. Start-ups that produce hardware may have a particularly tough time if Trump implements a threatened 20% tariff on imports, as these companies typically outsource most of their manufacturing to Asia, then import the finished goods.
The “Hire American” side of the executive order—by far more troubling to tech companies—instructs federal agencies to evaluate the various programs that allow foreign workers to enter the U.S., with particular scrutiny on the H-1B visa program, a non-immigrant visa system that lets employers temporally hire skilled foreigners for specialized jobs.
“If immigration suffers, there could be downward pressure on venture investing. That’s been the No. 1 topic everyone’s discussing,” says Sardana.
Current laws and regulations are already encouraging some American start-ups to locate facilities or hire personnel for non-sales operational roles outside the country, according to the “U.S. Startup Outlook 2017” survey. Twenty-six percent of responding companies said they’d hired or moved operations overseas. Of those, 38% cited immigration policy, 32% mentioned tax policy and 30% said the regulatory environment drove their decision-making.
Further restrictions on immigration could have a profoundly negative effect on the ability of start-ups to recruit talent. Limits on hiring highly skilled workers from abroad could drive up wages for those already in the U.S., making it more expensive for companies to hire employees and potentially driving down profits.
And those newly arrived immigrants often start businesses, leading to further economic expansion. The U.S. had 87 start-ups valued at $1 billion or more as of March 2016, according to a study on entrepreneurship by the National Foundation for American Policy. Over half of these had at least one immigrant founder.
Taxes, Deregulation And Infrastructure
Despite the uncertainty surrounding many of Trump’s policies, it’s not surprising that investors are sanguine about the future of U.S. start-ups. America is still a global leader in innovation. A combination of more favorable tax treatment for corporate profits, a less burdensome regulatory environment and an uptick in infrastructure spending could encourage even more start-up investing.
In late April, the White House outlined a plan that would lower the nominal corporate tax rate to 15% from the current 35%. President Trump has proposed cutting taxes in part so that transnational corporations can bring capital held offshore back to the U.S.
If companies repatriate cash, that could spur corporate venture capital investing and fuel M&A activity. “Companies like Apple, Google, IBM, GE and Microsoft, because of the tax holiday, would bring back dollars. They could go on a buying spree,” says Sardana.
Large companies are likely to reinvest excess cash into new ventures because start-ups have in essence become outsourced R&D firms. Big companies are spending less on research these days, preferring to acquire cutting-edge technologies from smaller firms that assume the risks of developing and commercializing the research. “Repatriation of corporate cash could have a beneficial effect on the venture ecosystem. It could increase M&A activity at higher valuations,” says Ballvé.
Start-up investors generally rely on M&A activity, and less frequently on IPOs, to produce liquidity and exits. Mergers and acquisitions accounted for over 80% of exits in 2016, according to PitchBook.
In addition to tax cuts, angel and VC investors generally view deregulation as positive for early-stage companies. If the Trump administration pushes deregulation, that could allow new companies to more easily raise capital and bring products to market.
Sardana, whose fund has an investment in a company that produces software to control drones, wants to see rules eased in this area. “If that happens—fantastic. Drones and self-driving vehicles will get a nice shot in the arm.”
Another wild card is the potential rollback of the government’s rules on “net neutrality,” the concept that internet service providers should treat all data the same and not charge more for access to certain types of content, such as high-data-consuming video. “Every time there’s a change, it provides opportunity for companies that weren’t there before. Any gap that opens is immediately filled by a start-up trying to exploit the change,” says Stanford.
Yet for every start-up buoyed by regulatory change, another may sink. “I’m an investor in a company that benefits from net neutrality,” says Sardana. His fund is backing Tubi TV, a service that allows users to view free television shows and movies over the internet. “If net neutrality goes away, it will impact companies that are trying to innovate in the TV market,” he says.
Regulatory reform could benefit start-ups in many sectors, but there’s always the danger that failure to regulate could create chaos. “If you have a dysfunctional government that can’t pass any new regulations, it will cause damage to advanced technologies because they won’t have the regulatory environment to be deployed in,” says Fenwick-Smith.
Autonomous vehicles, for example, could minimize the total number of casualties in an accident. But their true impact remains to be seen. “Driverless vehicles is a sector that still needs a huge amount of regulation to be viable,” says Fenwick-Smith. Given the pace of innovation, he thinks a lack of leadership from Washington could affect the sector as early as next year.
During the presidential campaign, Trump promised major new infrastructure spending. Including technology in any such spending could boost start-ups in related areas. “Because of increased attention to infrastructure, we could see more opportunities open up in the “internet of things,” Wi-Fi, smart cities, transportation and cybersecurity for sensitive infrastructure,” says Ballvé.
Winners And Losers
Ultimately, President Trump’s policies are unlikely to slow the flow of capital to potentially game-changing start-ups. VC investments in artificial intelligence, for example, were off to a strong start this year, according to the Q1 2017 MoneyTree Report from PwC and CB Insights. AI deals rose to an eight-quarter high, with quarterly funding exceeding $500 million in seven of the last eight quarters.
On the other hand, some of Trump’s policies may eventually stall the economy. Tax cuts and spending hikes, coupled with anti-immigration and protectionist trade policies, could swell the national debt and stymie growth, tipping the U.S. into a recession. Major infrastructure spending might prove inflationary in the long run.
Experienced angels and VCs know that uncertainty about a new administration’s agenda can provide opportunities to invest in emerging industries and that start-up investing is a long-horizon play. “I’m excited about the infrastructure plan. Ease on regulations is good. The tax holiday is a pro for M&A,” says Sardana.
“In the immediate term, the only concern is immigration policy. We just can’t not get our engineers. That kind of disruption can show up pretty quickly. Outside of that, the rest of the stuff will balance out. We’ll get a few things, we’ll lose a few things.”
