Some argue that an economic downturn is the ideal time to start a new business and to be sure, history evidences the fact that highly-successful companies are often born in challenging business environments.
This is little surprise. After all, they push entrepreneurs to be more innovative, resourceful and frugal than they may otherwise have been.
As they say, “necessity is the mother of all invention.”
There is no doubt in my mind that the challenges economic downturns bring also provide plenty of opportunities.
When it comes to the world of internet startups, one of the greatest advantages of starting a new business during a downturn is that the legions of fair-weather entrepreneurs who come out of the woodwork in boom times tend to disappear. And the typically tighter market for equity investment helps separate the wheat from the chaff.
But I often find that recession is romanticized to entrepreneurs, who are often told “there’s no better time than to start a business than in a recession” with little to no qualification whatsoever.
I have noticed an increasing amount of this talk and a lot of it is based on faulty notions.
For example, Melissa Chang, the operator of an internet incubator in Boston, recently wrote in The Industry Standard:
“Let’s say you have a great idea and you know that you’re going to start a company, but you’re wondering about the timing. What should you do? The answer is: Start now. This will give you a lead over the competition, and will be well worth any extra struggle.
“When the economy comes out of recession, your business will be that much further along, and that much closer to being ready to raise capital (which will once again be available, with VC firms eager to invest after sitting on their cash during the down years).”
While the idea of getting a “head start” is nice, in and of itself it’s a poor justification for starting a business in an economic downturn, because there is absolutely no guarantee that you’re actually going to be “further along” when the downturn ends.
One should not underestimate the difficulties in launching and growing a business during a downturn, and much of your effort may end up being devoted to simply staying afloat.
Given that most new businesses fail within the first several years (regardless of economic conditions), it’s worth recognizing that if your new business fails, you’re not getting a “head start” on anything.
Additionally, if one of your primary goals is to start early so that you can put yourself in a better position to raise funding when VCs return to their loose ways, you’re taking the wrong approach. Starting a business whose basic purpose is to survive the downturn so that it can be an appealing investment when the market rebounds is, for the average entrepreneur, akin to gambling.
The truth is that succeeding in an economic downturn is usually a difficult task for even established businesses and entrepreneurs, considering the launch of a new business need to make sure they have the right ingredients.
- A solid concept. If you’re going to start a business during a downturn, you should have a business concept that is well-suited for a downturn.
- The right business model. Just as you need a concept that is well-suited for a downturn, your business model also needs to be viable in the current business environment.
Resources. While I believe that equity financing is rarely a good choice for most new businesses, the difficulty in raising it during an economic downturn means that you should be confident that you personally have all the financial resources necessary to see the business through to your projected break-even and/or to brighter times.
It’s worth noting here that most entrepreneurs underestimate their capital needs even in good economic conditions.
The ability to execute. Execution plays a huge role in the success or failure of any new business.
When the economy is good, it is often possible for an entrepreneur to succeed with less-than-flawless execution. When the economy is not so good, it usually takes a highly-savvy and/or experienced operator to execute the launch of a successful new business as markets are less forgiving and mistakes far more costly.
The net effect is that your margin for error is much, much smaller.
Practically, all of these ingredients are required for a new business to thrive in an economic downturn and entrepreneurs should not be fooled into thinking otherwise.
At a very high level, I see two business categories that I think smart internet entrepreneurs should focus in on today:
Saving others money. As individuals and businesses look to cut costs, products and services that provide a clear and compelling means to reduce expenses have the potential to gain traction.
While this is probably the most viable category for entrepreneurs to find opportunity in, entrepreneurs need to be careful when evaluating the total cost savings their products and services offer.
I often see entrepreneurs who fail to consider switching costs, for instance. In a downturn, many businesses are less likely to invest in products and services that will be more cost-effective over the long term but that require additional expenditures in the near-term.
Taking advantage of markets that have been overpunished. A recession may provide an opportunity to enter out-of-favor markets that are otherwise fundamentally strong but that have fallen victim to other factors that have made them particularly vulnerable to the current downturn.
These fundamentally strong but out-of-favor markets can provide great “rebound” opportunities but entrepreneurs should note that identifying these opportunities and taking advantage of them can be tricky.
First, not all entrepreneurs are capable of distinguishing between a market that has strong underlying fundamentals and one that is generally weak.
Just as I argued that a Web 2.0 vulture fund is probably a less-than-compelling investment opportunity, I would argue that starting a Web 2.0 company in this downturn, for instance, is probably not the best business opportunity because the underlying fundamentals of the Web 2.0 market were never strong to begin with. In other words, think twice before entering a market that was not creating tangible value even when times were good.
Second, getting into a market that is simply out-of-favor and can reasonably be expected to rebound typically requires an entrepreneur to have the financial wherewithal to make it through the downturn.
For example, if an entrepreneur were to decide to start an ad-supported online content business in the current environment, I would suggest that he have enough capital to sustain the business through a prolonged downturn because all indications are that the economy is nowhere near being poised to recover as the current downturn is the result of deep systematic ills in the global financial markets.
At the end of the day, I think it’s worth considering that while economic downturns provide opportunities for clever entrepreneurs, these opportunities are not always easy to tap into and it takes a special breed of entrepreneur to succeed.
Thus, if you’re considering starting a new internet business today, you should do so because you have established that you have a bonafide opportunity – not just because somebody told you that the timing is right.