10 Reasons To Start A Company In An Economic Downturn

Article first published as 10 Reasons To Start A Company In An Economic Downturn on Technorati.

2008 Recession SignThere has recently been a common theme among the entrepreneurs I have interviewed and the conferences I have attended: despite the relatively weak state of the world economy, now is a great time to create a high-tech startup.

As Guy Kawasaki pointed out in our recent conversation, “…it is cheaper than ever to start a company. People are free or cheap because of the recession. Marketing is free or cheap because of social media. You don’t really buy servers anymore…the tools are all open source. Basically, everything is free. If there was ever a time to start a company, this is it.”

Marten Mickos, Founder of MySQL and current CEO of Eucalyptus Systems echoed Guy’s sentiment in this interview by saying, “We who are entrepreneurs say, ‘This is the best time ever to start a company.’ We always say it and I believe it.”

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Save Your Timing For Comedy

Determining the perfect moment to enter the startup market, whether by creating a company or joining an ongoing venture, is akin to timing the financial markets. According to financial columnist Daniel Solin, “One large study looked at more than 15,000 predictions by 237 market timing newsletters over a 12-year period. At the end of the period studied, 94.5% of the newsletters went bust.”

As noted in Now Is Never Too Early, successful entrepreneurs are not inclined to wait. Economic conditions periodically create headwinds and tailwinds, but it is impossible to accurately time such exogenous factors.

Ten Reasons To Startup In A Downturn

Clearly, an economic downturn is not a blessing to be cherished. However, negative macro-economic trends are not a valid excuse to delay starting your entrepreneurial career, because even in a recessionary economy, there are advantageous reasons to begin a startup in a downturn.

1. Increased Probability of Success

It may sound counterintuitive, but the greater constraint investors place on their financial resources during a downturn, the better your chances of success, given (of course) that your adVenture is able to either secure funding or generate adequate revenue from customers, as described below in reason #7 - Customer Dollars Taste Great.

Marginal ventures that might be funded in a vigorous economic environment will not attract sophisticated investors’ time, attention or money in a downturn. Fortunately, this reality results in valuable resources being applied to a fewer number of viable opportunities. If your adVenture does not receive funding and you are unable to operate on customer revenue, then the Darwinian world of business (as described in Competing From The Fringe) is trying very hard to tell you something – be sure to listen.

2. Hard Knocks U

“You can learn very little from victory. You can learn everything from defeat.”
Christy Mathewson, US baseball player [Tweet this quote]

Christy was correct. Victory usually satisfies, but it seldom educates. Successful entrepreneurs learn far more from setbacks than they do from effortless successes. Thus, the more creative and wily you are forced to become, the larger your problem-solving toolkit will expand.

Elbert Hubbard, a 20th-century writer and artist, once said, “A failure is a man who has blundered but is not capable of cashing in on the experience.” Blunder away, but be sure to learn from each experience so that when you graduate from Hard Knocks University, you will have a masters degree in Down-Market Survival Tactics. Rising with the tide requires less effort, but it seldom positions you well for the market’s inevitable vagaries.

3. Great Campfire Stories

“The only thing that overcomes hard luck is hard work.”
Harry Golden, US newspaper publisher [Tweet this quote]

As noted in the Dirty Team Building, adversity can bring your team closer together. A company that perseveres in a challenging market will have a much greater probability of success, once the market becomes more robust.

Behavioral scientists have proven that the more arduous your collective journey, the stronger your Core Team’s cohesion. For instance, Elliot Aronson and Judson Mills’ 1959 study confirmed that the more adversity a person endures, the greater value they associate with the experience and the higher their degree of loyalty to the team with whom they shared the challenges. In this study, the subjects were required to suffer extreme embarrassment, before they were allowed to join a discussion group that, by design, offered little value to its members.

The embarrassed subjects consistently rated the discussion group highly. In contrast, control subjects who joined the group without completing embarrassing tasks consistently rated the very same discussion group as “worthless.” Aronson and Judson concluded that, “…persons who go through a great deal of trouble or pain to attain something tend to value it more highly than persons who attain the same thing with a minimal effort.”

This phenomenon is seen in the numerous initiation ceremonies of primitive tribes, as well as hazing associated with fraternity pledge programs. If something is hard to obtain, we assign greater value to it. As such, a startup team that faces a variety of rigors before it succeeds is likely to have a high group affinity and a resulting low turnover rate.

4. Take A Dip In The Brimming Talent Pool

“If you think hiring professionals is expensive, try hiring amateurs”
Author unknown [Tweet this quote]

One upside of an elevated unemployment rate is an increase in the overall size and quality of potential employees, coupled with downward pressure on recruiting costs. New hires in a depressed economy also tend to be more willing to accept below-market salaries in exchange for equity-based compensation.

Market uncertainty also tends to reduce the number of Wantrepreneurs, as they are generally more reticent to join a startup when their personal path to riches is less certain. However, a recessionary market also generates a number of Big Dumb Company (BDC) refugees. Such individuals are often desperate and willing to talk themselves into nearly any position that will pay their bills. Although you might get lucky and identify an entrepreneurial star, be wary.

5. Above The Crowd

“Why march to the beat of your own drummer when you can skip?”
Dave May, blogger [Tweet this quote]

Every entrepreneur who has competed in a vibrant market knows that one of the biggest challenges is getting noticed. As the overall industry noise mounts, it becomes increasingly difficult to attract the attention of Messengers, Donors, investors, potential customers and would-be partners.

In contrast, success stories are novel in a down market, which generally results in meaningful exposure for those startups which succeed. In 2001, at Expertcity (creator of GoToMyPC and GoToMeeting, acquired by Citrix), we received tremendous media coverage as a contrarian success story during the depths of the dotbomb crash. Although it can be more difficult to extract money from customers’ wallets in an economic downturn, the overall decrease in market activity makes it easier for emerging companies to cut through the clutter and tell their story, as described more fully in PR Passion

6. Match Value Prop With Market Realities

“A bend in the road is not the end of the road... unless you fail to make the turn.”
Author unknown [Tweet this quote]

Some startups are well-matched to succeed in economically challenging markets. However, even if your adVenture is not ideally suited to a market slowdown, you may be able to modify your company’s value proposition to conform to the realities of the market. For instance, a product that enhances productivity can be sold as a revenue generator in an “up” market and as a cost saver in a “down” market.

Selling a cost-saving solution is more difficult in a robust market, as greater value is placed on making money when times are good, as opposed to saving money. However, when survival becomes an immediate goal, products that help companies weather near-term economic storms become especially attractive. Tips regarding structuring effective revenue sharing and cost savings deals are discussed in Sharing Means Caring.  

During the recession of 2001 - 2003 we also sold a substantial number of licenses of GoToAssist, our enterprise-based customer support solution, by demonstrating to our customers a clear return on their investment. GoToAssist reduced the average duration of customer support calls, while enhancing each Support Agent’s overall effectiveness. Our positioning of GoToAssist as a cost-saving solution resonated with hundreds of enterprise companies that had otherwise “frozen” their technology infrastructure budgets.

7. Customer Dollars Taste Great

“Money is plentiful for those who understand the simple laws which govern its acquisition.”
George Clason, financial author and publisher [Tweet this quote]

In flush times, many startups raise too much money. An excess of capital is often driven by venture capitalists (VCs) who tend to stuff as much money as possible into deals they like. Sophisticated entrepreneurs understand that the ideal source of capital is from customers’ wallets, not VCs’ bank accounts. Not only does such revenue validate the startup’s value proposition, it results in zero dilution. The sooner you generate customer revenue and internalize customer feedback, the shorter your path to self-sustainability.

When companies have excess capital, they often dither as they attempt to craft an ideal solution. However, when faced with a precarious bank account, successful ventures quickly develop and release a Minimally Viable Product, thereby avoiding an over-engineered solution.

8. Phoenix Effect

“If you want to succeed, double your failure rate.”
Thomas J. Watson, IBM Founder [Tweet this quote]

A firm that survives an economic nuclear winter is better positioned to take advantage of an economic uptick, as opposed to a startup that launches during the early stages of an economic turnaround.

This was the case with Computer Motion (NASAQ: RBOT, sold to Intuitive Surgical). We entered the medical device market during the recession of the early 1990s. The medical market was particularly challenging, as the Clinton Administration had caused a great deal of uncertainty with their proposed reforms, which resulted in most hospitals firmly closing their checkbooks.

We addressed these market realities by leasing our surgical robots, rather than following the conventional path of selling them outright. We sold the leases to a finance company, which generated a lump sum of cash from each lease, while allowing the hospitals to purchase the robots for a relatively small monthly fee.

If we had stayed on the sidelines, waiting for less market uncertainty, we would have lost the opportunity to file the landmark medical robotic patents that eventually motivated Intuitive Surgical to purchase Computer Motion for approximately $150 million.

9. Measure Thrice, Cut Once

“Failure to prepare is preparing to fail.”
John Wooden, US basketball coach [Tweet this quote]

That is correct, do not measure twice – measure thrice. A market downturn slows the velocity of everyone’s efforts. This does not give you a license to only work 10-hour days and take off both days every weekend. However, it does afford you the luxury of some deliberation, which is often more challenging to employ during periods of economic frenzy. A heightened degree of thoughtfulness will reduce costly mistakes, such as bad hires, pursuing multiple, disparate markets simultaneously, crafting one-sided partnerships to gain media exposure and making excessively expensive marketing commitments.

10. Bargains Galore

“The bargain that yields mutual satisfaction is the only one that is apt to be repeated.”
Author unknown [Tweet this quote]

Top talent is not the only resource you can economically acquire in a downturn. Nearly everything you need to fuel your business will cost you less when times are tough. As noted in Beware The Consultant, an entrepreneur’s two most valuable resources are her time and money. A down market results in a much higher propensity for companies to negotiate below their list prices and to even barter for in-kind services. Such markets allow you to creatively craft deals that reduce your costs and conserve your cash.

If your business model is predicated upon a significant marketing spend, a depressed economy can be to your benefit, as publishers are generally willing to heavily discount their perishable ad space. During the dotbomb bust, we negotiated very aggressive Cost Per Acquisition (CPA) deals with a number of major publishers, including those that publicly declared that they, “never did CPA deals.” Such agreements were a boon to GoToMyPC, as it allowed us to limit our ad spend to bounties for each new customer we acquired. As noted in Pour And Stir, we conserved our cash by investing the incremental revenue generated by each new customer into acquiring additional customers.

Pollyanna Need Not Apply

SalmonSalmon live most of their lives swimming with the current; however, once they reach reproductive maturity, they make an arduous journey upstream, often jumping up waterfalls, in order to reach the spawning grounds of their birth.

Salmon do not decide to make their epic trek based upon weather conditions, the flow rate of the streams they must traverse or even how far they happen to be from their destination. Rather, they begin their journey when their biological alarm sounds, irrespective of exogenous conditions.

This is the same mindset that would-be entrepreneurs should have when deciding the right time to jump into a startup. As described in What If?, if you wait until macroeconomic conditions are preferential, you may find that your personal situation is no longer suited to either starting or joining an adVenture.

In the startup world, there is always an upside to a downturn. Adversity translates into opportunity for those willing to swim upstream and not wait until the tide turns. Go ahead and jump in, the water feels great.

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John Greathouse is a Partner at Rincon Venture Partners, a venture capital firm investing in early stage, web-based businesses. Previously, John co-founded RevUpNet, a performance-based online marketing agency sold to Coull. During the prior twenty years, he held senior executive positions with several successful startups, spearheading transactions that generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara's Faculty where he teaches several entrepreneurial courses.

Note: All of my advice in this blog is that of a layman. I am not a lawyer and I never played one on TV. You should always assess the veracity of any third-party advice that might have far-reaching implications (be it legal, accounting, personnel, tax or otherwise) with your trusted professional of choice.

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