Following a 9-year uninterrupted bull run, the stock market faces a major correction caused by COVID-19 prevention measures and panic. With markets falling, is investing in startups sane?
Living and working in Hong Kong, I’ve had a front-row seat to the economic havoc COVID-19 can wreak. Canceled conferences, shuttered movie theaters, empty hotels, and restaurants closing are the new norm. I’ve seen discretionary spending in this city, like eating out, going to the movies, and vacation travel, come to a grinding halt.viagra
And that’s terrifying because discretionary spending is a huge part of GDP. In the US, it’s 6-8%.
Is it wise to invest in startups during a recession?
Yes. Early-stage tech investments can actually be a safe haven for those who have the time, money, and patience. Here’s why, from several angles:
Startups are shielded from public hysteria. Since they’re not listed on stock markets, their value doesn’t rise and fall with public sentiment. They can focus building a business without trying to meet earnings expectations. As an investor you’ll be less distracted because there’s no ticker symbol to check.
As an investor, you have some control. Most investors have zero control over the outcome of their publicly-traded stocks and bonds. But when you invest in an early-stage company, you directly impact the direction of that company by providing the resources they need to grow. With those resources comes some influence over how the company operates. You can help them by introducing vendors, talent, customers, and other investors. Meanwhile, there’s nothing you can do to influence a REIT, T-bills, or stocks.
Startups can benefit from big-company layoffs. Startups can benefit by hiring talented, experienced people laid off from big companies. Startups may have better negotiation power in compensation packages too.
Asset-light tech companies don’t have complex, delicate supply chains. Tech startups can work from home, can put all their assets on the cloud, and can get paid with only digital payments. Their services can cross borders without worry of quarantine and travel restrictions.
A recession doesn’t necessarily impact the trajectory of a startup. Early-stage startup growth follows this pattern:
- Seed round: Founders bring a product to market to see if anyone wants it.
- Angel round: Founders build a team and enhance their product to see if they can get fast traction. They figure out if they could ever become a $100 million company.
- Series A: Founders are convinced they’ve got a scalable model, grow the team more, invest in customer acquisition, and get well past $1 million in revenue.
- Series B: The model works and now the company will truly scale. This means going to new markets, building new products, and looking and acting more like a medium-sized, fast-growing company with real management, HR, and even *gulp* corporate policies.
It can take 2 – 3 years of experimentation for a startup to find its scalable business model. Companies born during a recession grow up to be much stronger for it; they provide things people need in times good and bad, and they have traction and growth just as the economy improves.
Startups can more-easily adapt to a changing environment. Large, publicly traded companies move slowly, have complicated supply chains, face regulation and above all, internal resistance to change. At big companies, there are people on payroll whose job it is to stop innovation. They’re called “compliance.” Startups have none of those things.
At least two companies in my portfolio are launching up coronavirus-adapted services – in one case to offer in-home medical care, and in another to adapt a ride-hailing service to an emergency-medical transport service. The startups’ timelines for launching new services is measured in days, not quarters. Startups that can pivot quickly are highly resilient.
Investors can see better valuations in a recession. Fundraising does get harder for startups in a recession, because so much of early-stage capital comes from people who park their money in the stock market. But those dynamics work in the investor’s favor. Investors can ask for more of the company and more rights when startups have fewer investors to choose from.
It takes an average of 8 years for startups today to see an exit. And only a tiny fraction of startups will ever see a positive exit. This mean investors need to make many investments for the portfolio to see a return, and they’ll have to wait almost a decade to see those returns. So while startup investments might be a good place to invest during a downturn, the fundamental economics of startup investing preclude most from participating.
That said, to all you accredited investors who are wondering where to park your cash now that you’ve exited the market, now is the time roll up your sleeves and dive deep into pitch decks.