As people get increasingly jittery about the state of the economy, with warnings of a coming recession getting louder, it’s natural for aspiring entrepreneurs to wonder, “Should I hold off on that startup?” After talking to experienced investors and entrepreneurs, it’s clear the answer is a resounding “probably not.”
“A lot of amazing companies are started during economic downturns,” said Tyler Jewell, managing director at Dell Technologies Capital. For instance, New Relic, Cloudera and Slack all started in the thick of the Great Recession.
“Right now the challenges are going to be economic and financial in nature. But even if that wasn’t, you’d have other problems; you might have hiring problems, you might have intellectual property issues, you might have market problems. There’s always going to be problems that you need to deal with.”
So what is different about starting a company during a downturn? What should entrepreneurs and prospective entrepreneurs be aware of?
Survival: It’s Job One
The most important thing for companies of all sizes, but especially startups, in an economic downturn is survival.
The harsh reality is that not all companies will survive a recession, and if your company is one of the survivors, when the economy starts heating up again you’ll be positioned to rapidly expand — because your competitors will have gone out of business or never will have been founded in the first place.
Just surviving isn’t always easy, though. “In the ’08 downturn, we made some very, very aggressive cuts in order to reduce our burn, things that were very uncomfortable,” said Peter Pezaris, senior vice president of strategy and experience at New Relic and a serial entrepreneur, about the company he was running in 2008.
As a result, his company was acquired in a nine-figure deal. Without taking those aggressive measures, Pezaris thinks the company would have been worth nothing.
Cost-cutting, of course, is often a euphemism for laying people off — and that is part of it. But in the case of Pezaris’ company, it also involved a very painful data-center migration that saved millions of dollars.
Cutting costs is particularly important if you’re not profitable yet, because in a downturn you can’t count on being able to raise money — and getting to profitability should be the company’s top priority, more so than it would be in a more growth-focused environment where venture funding is plentiful.
Exactly how you make those tough choices isn’t the same for every organization. “It’s a function of the market of the company, the stage of the company, and their total cash position,” Jewell said.
Fundraising: Don’t Depend on VCs
The biggest challenge in an economic downturn is that venture capital (VC) often dries up, at least initially. At the same time, valuations tend to come down across the board, so entrepreneurs at every stage often have trouble getting funding at favorable valuations and terms.
Exactly how this plays out hasn’t been consistent across downturns. When the dot-com bubble burst in 2001, it took years for the venture funding landscape to recover; in 2008, after the housing crash, the rebound started within months.
“I think it’ll return to more nominal levels, but nominal here being like 2015, 2016. There was a lot of VC money flowing around at that point in time,” Jewell said. The past three years, he said, have seen unusually plentiful amounts of venture funding, and he thinks a return to 2021 funding levels isn’t likely in the near future.
Aside from the obvious financial challenges this can bring, it can also lead entrepreneurs to waste a lot of time chasing venture funding that isn’t going to come through.
“One thing that tends to happen in times of economic uncertainty is that venture capitalists won’t stop taking meetings, and they won’t stop giving you feedback,” said Pezaris.
“So it’s easy to get deluded into thinking that you’re doing well, because of the positive reaction from the venture community, even though you haven’t seen the check yet.”
So what about bootstrapping? If you can, during a downturn, when VC money is hard to come by, bootstrapping can be particularly attractive. But going it alone is hard, and not just financially.
“If you bootstrap your own company, the major downside is that you’re not plugging into the system,” Pezaris said, based on his experience bootstrapping his third company. “What [VCs] do is they’ll signal to the rest of the world that you’ve gotten a stamp of approval, and depending on who that VC is, that can change your fortunes.”
On the other hand, the farther you can get as a bootstrapped company, the more favorable terms you’re likely to get if you decide to get venture funding down the road.
Mindset: No Time for Vanity Projects
“Startups are hard,” said Andrew Lau, CEO and co-founder of Jellyfish, a platform that helps align engineering teams with business goals. “I don’t just mean hours. I mean, getting it to fly is hard. Some luck, some perseverance, some innovation, some listening, there’s a mix of all these things.”
This is why he’s adamant that startup founders need to make sure their company isn’t just a vanity project. “If you’re in it for the right reasons, which is your inner desire for creation, this might actually be the perfect environment for you, the caveat that you can support yourself economically, and your family and your team,” Lau said. “It’s a tough time to be in it for vanity.”
Even in the best of times, being a startup CEO can be mentally grueling, and that is even more so during tough economic times. “The most difficult skill as a CEO is managing your own psyche,” Pezaris said. “Because when times are tough, ultimately everything’s your fault.
“It’s a tough mental challenge. So I think the number one question to ask yourself is whether you want to sign up for that, whether you’re the right type of person for that”
Silver Lining: a Stronger Value Proposition
So does this mean embarking on the startup journey now would be foolish? Absolutely not. There are advantages to starting in a downturn, and as Jewell mentioned, many very successful companies were started during economically tough times.
“Companies forged in those times actually have really strong value propositions,” Lau said. When times are tough and cash is scarce, it’s even more important to focus on products that are essential for customers, that deliver incredible value and that communicate that value effectively. Products that don’t provide massive value won’t get off the ground.
There’s another advantage of starting a company in a downturn, Lau said — you’re out of the hype cycle.
“Everyone puts their head down and works hard,” he said. “I think the outcome is often really strong products, really strong companies and really strong teams, because they’re forged in that time.”
So should you start that company? “I think that question is really independent of market cycles,” Jewell said. “If you’re a builder and you get human value and utility out of creating something from nothing, the best time to start a business is right away. It doesn’t matter what the economy is doing.”
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The New Stack is a wholly owned subsidiary of Insight Partners, an investor in the following companies mentioned in this article: Jellyfish.
New Relic is a sponsor of The New Stack.
Featured image by Michelle Maher.