Startup general interest

The impact of recession on startups – not as much as you might think

By December 6, 2010 4 Comments

Techcrunch have a story up this morning: To date, US online holiday spending up 12% to $16.8bn, in fact revenues of ecommerce companies have grown consistently through two recessions since 1999 (source Ray Kurzweil, The Singularity is Near).  A recession is obviously never good news for anyone, but these stats are a timely reminder that if a startup has picked its market well it shouldn’t worry too much about recession.

The quintessential venture backed startup is in early at the beginning of a new market opportunity (either a genuinely new market or a re-segmentation of an existing market) and raises money to grow as fast as possible to lock down a leadership position – a process that will likely take five years or more from the date of company formation.  If they have picked their market well, during that time it will go from tiny – usually sub $10m, to substantial – usually $100m+, and sometimes way bigger than that.  In other words for the company to be successful its market will need to be growing at near exponential rates over five years or more.  If a recession hits during that period (which is pretty likely) then market growth might slow, but it should still be significant – as ecommerce companies are seeing now.

There are two reasons then why startups shouldn’t worry too much about recession – firstly their market should be buoyant enough that they can continue to grow at a good rate, and secondly it is very likely that recession will hit at some point during their formative years, so preparing rather than worrying is the sensible course of action.

The most important differences recession makes to startups are:

  • it will be harder and/or more expensive to raise capital,
  • executives at large corporations are more cautious during recessions which extends the time required to partner with them and/or sell to them, and
  • exit values and multiples will be lower

These differences are all manageable with good planning.

The current scarcity of venture capital in the European market is not a feature of the recession (although not helped by it), but rather a result of market dynamics stretching back over ten years, during which time the industry has collectively failed to make enough money to attract massive in-flows of capital.

Once again, a recession isn’t good news for anybody and it is particularly bad news for companies at the margin – i.e. the ones that would just about have made it if times were good, but my point here is that because they are targeting high growth markets startups are better placed than larger companies who are much more clearly tied to the overall economy.  There are also some positives for startups about being in recession – competition will be weaker, large (potential) competitors will likely be under-investing, staff will be cheaper to hire and easier to keep for longer, and the exit timing is likely to coincide with the recover in the overall economy when multiples will be at or near their peak.

Enhanced by Zemanta