Over the last few years, damage to
world financial markets has negatively impacted the global economy. One area in
particular which has felt the greatest impact has been the labor sector.
Companies and in some cases entire industries (such as the US automotive
industry) have been hit hard leaving many without jobs and a means to support
themselves. Individual approaches to remedy the situation have varied greatly.
Some have gone back to school or switched industries and others have resorted
to defining their employment on their own terms- by starting a business.
Starting a business during an
economic downturn can be a complex affair. By definition, economic and
also consumer activity have slowed down considerably. There is less
available for consumers to spend and the little that they do have is much more
carefully guarded. With all this in mind, does it make sense to start a
business during a recession? Entrepreneurs starting out during recessions face
higher failure rates as consumers are less willing to spend overall and in
particular on new products. Additionally, there is increased financial
risk. If you sink what you have into the business, it fails and you are unable
to find employment afterwards then you’ve dug yourself into a deep hole.
For entrepreneurs targeting
specific niches however, a recession can be a perfect time to start a business.
The professional networking site Linkedin for example has achieved enormous
success during the recent recession. Social media is the new way in which
professionals network and for those looking for jobs it has proven to be an
invaluable and efficient tool. Do-it-yourself businesses catering to
entrepreneurs (for example software) have also enjoyed positive results during
the recession as businesses try to cut back on external costs.
Overall the stakes are higher, but
the rewards can also be greater- is it worth starting a business when the
economy is in bad shape?
Juliana
A Taylor
Fuqua School of Business, Duke University, 2012
Princeton University, 2010
Fuqua School of Business, Duke University, 2012
Princeton University, 2010
Juliana is highlighting a central tradeoff when creating a new business: access to resources and risk versus opportunity costs of being and entrepreneur. In a downturn, risk is higher and access to capital is more limited (and expensive), but also the opportunity cost of labor is very low – especially if people are out of a job and are not likely to land a new one in the near future. It is well documented that venture capital (VC) investment is cyclical, but there are also many evidence of great companies formed in tough recessions (Microsoft is one example). I am not aware of any systematic study that investigates the relationship between business cycles and new firm creation. But, if capital is more expensive and funding new project is subject to greater scrutiny, and the opportunity costs of being and entrepreneur are low, wouldn’t this imply that, on average, we would see higher quality companies emerging in recessions as compared to booms? Anecdotal evidence on this would be extremely interesting.
ReplyDeleteRaise money before you have an idea! Of course, having the right connections and track record helps a bit.
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Free class on tech entrepreneurship (Stanford) if anyone is interested:
ReplyDeletehttp://www.venture-class.org
It is also important to remember that usually in recessions the opportunities costs of capital in terms of returns (for a given level of risk) is low, which works in favor of the entrepreneurs. However, in the current economic environment, publicly traded firms, which are much less risky than new businesses, trade at very low valuation relative to their economic fundamentals. In my view this goes strongly against new venture creation, especially due to the current difficulty in sustaining a robust growth model by traded firms (that is, if valuations by established growth firms are low, very young VC-backed growth firms are likely to suffer even more in terms of valuations). Another related point we should think about is that when VCs invest they cannot afford investing in very low valuations, because they have to leave a significant amount of equity at the hand of the founders to create the optimal incentives structure small firms typically benefit from (VCs typically get between 10 and 25 percent of equity per investment). But if valuations are very low, it may mean that funding may not take place at all. Thus the question is not only of price, but also of actually starting up new businesses.
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