In the midst of the last global recession in 2008, two entrepreneurs struggling to pay for their apartment had an idea to rent air mattresses on their floor. Over the next 14 years, Airbnb founders Brian Chesky and Joe Gebbia, with Nathan Pletcharczyk joining later, expanded their business to become one of the largest in the United States, with a market capitalization of more than $70 billion.
Fast forward to today, and countries around the world are facing the possibility of another recession. And just as with Cesky, Plicharczyk, and Gebbia in 2008, it could be another potential entrepreneur messing around in the workspace with their next great idea.
However, with soaring inflation and interest rates, lower consumer spending and layoffs at some of the largest venture capital-backed companies around the world, now does not seem like the time to take the ideas and money to take the storm.
How, then, to explain why so many investors swear that “better” companies arise in recessions—a phrase that, in personal experience, has been repeated so often lately that it sounds like a new mantra for venture capital.
Venture’s famous optimism means taking statements like this with a pinch of salt, even if these optimists have plenty of examples to back up the sentiment. After all, tech giants including Slack and Square were launched during the 2008 financial crisis, and looking beyond that, household names including Microsoft and eBay were founded in times when the global economy was faltering.
However, given how strongly venture capitalists have stuck to this idea, I’d say it needs testing. But first, let’s see why it can be true that startups launched in a period of economic weakness may be more durable than those created in a boom period.
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For now, as recession fears sweep the economy, most investors are urging portfolio companies to hold onto cash to expand their runways. Startups created in the current environment, given the belt-tightening that is happening around them, are likely to be built with a more cash-conservative mindset, which gives them a natural edge. Additionally, as a new business, they will need fewer resources to grow compared to larger players who now have to scale back to keep costs down.
This is the opposite of what we’ve seen in the past few years. Once pushed to prioritize growth at any cost, startups launched in boom times now face severe valuation cuts at times as the market shifts to prioritizing profitability (think Klarna or Gorillas).
Even layoffs can be an advantage these days. Big tech companies like Robinhood and Coinbase have laid off employees, with Crunchbase data estimating that the US tech sector alone saw more than 34,000 people lose their jobs in 2022.
With an abundance of highly skilled people looking for their next venture, new startups have the opportunity to hire experienced workers with less competition than the big competitors. Many of these former technical employees had comfortable, well-paying jobs during the good times. Not anymore. They now find themselves unemployed, and perhaps have an incentive to venture with their own ideas for a new venture.
And if a startup can not only survive the recession, but also demonstrate growth and resilience during this downturn, it can make a compelling case for investors when funding activity picks up that it is among the “best.”
While the idea that the best start-ups are born during a recession makes sense — and there are companies with track records to prove it — I’m still not convinced. First of all, even judging what “best” means is a difficult task.
One investor described the best startups as those that have an enduring product that can change the way people live, work, or behave. This may be a workable definition, but it’s hard to keep track of in a spreadsheet.
If we take revenue as a basis instead, using the Fortune 500 list could be an indicator of whether companies founded in the recession have a greater chance of becoming leaders in their own industries. A study conducted by Touchdown Ventures in 2020 found that only 24% of companies on the 2019 Fortune 500 list were founded at a time when the US economy contracted, indicating that companies launched in a recession do not necessarily have a better chance of becoming a mainstay of the company. .
The theory seems shaky at this point, but the Fortune 500 list may not be an entirely appropriate metric, as it includes many companies that have never received venture capital funding.
If we take the “most valuable” as the best, look no further than the unicorns. According to PitchBook data from 2001 onwards, 95 US-based companies valued at more than $1 billion were founded in the recession versus 757 companies that were not. Once again, these numbers cast doubt on the idea that companies founded in a downturn are more likely to succeed.
These two data points in no way provide conclusive tests, but they do suggest that the statement is more likely to be wishful thinking than fact.
Even if that’s not true, the fact remains that startups can be established and even thrive during a recession, becoming global household names. So for those investors and entrepreneurs who are anxious and worried about the future, take heart and don’t bother with the accounts.
Featured image by Joey Shaffer/PitchBook News