Startups: The Upside of a Downturn

My advice for tech entrepreneurs thinking of launching right now? Don't wait. A recession can be your ally in building a lean, thriving company

In early October, Sequoia Capital summoned executives at its portfolio companies for an urgent meeting to discuss survival in the economic downturn. The presentation at the meeting, titled "R.I.P: Good Times," quickly made its way onto the Internet, adding to fear in the startup community in Silicon Valley and beyond. Sequoia, after all, is one of the most respected venture capital firms in the country, an early backer of Google (GOOG) and several other huge technology successes. One takeaway from Sequoia's presentation was clear: With the economy souring, now is a bad time to launch a venture or to expand an existing business.

Or is it? The founders of Johnson & Johnson (JNJ), Caterpillar (CAT), McDonald's (MCD), and Walt Disney (DIS) might not agree. All of those companies were founded during an economic downturn. So were Adobe (ADBE), Intel (INTU), and Compaq (HP). Bill Gates didn't let a recessionary environment stop him from launching Microsoft (MSFT). Chuck Schwab founded his discount brokerage during the recession of 1974. And in 1982, U.S. unemployment was soaring to the highest levels in decades; that didn't stop Scott McNeely and Vinod Khosla from launching Sun Microsystems (JAVA). In fact, 18 of the 30 current Dow Jones industrial index companies were launched during economic downturns, according to research by Reference Capital Management, a venture capital fund based in Tigard, Ore.

I, myself, have been through the startup process twice, in both economic ups and downs. My first company, Seer Technologies, was conceived at New York investment bank Credit Suisse First Boston (CS) after the market crash of 1987. The bank soon needed to divest key technologies. Despite the gloomy economic market, by 1989 we had raised the capital needed. And with almost no competition in sight, we grew the startup to a public company with $120 million in revenue in 1995.

I started working on my second startup, Relativity Technologies, in late 1996, before the dot-com boom. We built the products, understood our markets, and recruited a solid executive team. The result? By 1998, we had venture capitalists tripping over each other to give us money, and I was able to raise about $10 million over two years to expand a successful startup.

My advice for other tech entrepreneurs thinking of launching right now? Don't wait. A recession is your ally in building a lean, thriving company. Consider the following four advantages.

Less competition. An economic downturn clears the competitive landscape for startups. Most of the "me-too" companies with inferior products and weak business models go out of business, and fewer are started. Plus, it becomes a lot easier to do licensing deals with universities and business partners—no one else is.

Lower costs. It is a buyer's market, and you can negotiate deals on real estate, equipment, and materials like never before. Salaries are lower for new hires, and there is little pressure to give big salary increases to existing staff.

Easier to recruit and keep employees. You will readily find people who have been laid off and are eager to get back to work. They will accept lower salaries in return for stock and take the risk of joining a startup. And rather than focusing on getting a job with a competitor who pays a little more money, employees are usually content to build tenure and focus on your success.

Less pressure to expand. Rather than rushing to expand your business, you have the luxury of doing it right. You can conceive of better products, test them carefully to make sure they work and meet customer needs, and experiment with different business models. Since you are not in a frantic rush to get a product out or build market share, you can do things more methodically.

True, it is harder to raise venture or angel capital in bad economic times, but such funding is not the main source of capital for most startups anyway. Research that my group at Duke University is conducting in partnership with the Kauffman Foundation shows the majority of first-time entrepreneurs fund their startups from personal savings and borrow from friends and family.

So you are going to be getting money from the same sources whether it is now or during a booming economy. The big difference is that you have a chance to build your company the right way if you start now—and you have better odds of perhaps being listed on the Dow Jones one day.

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