One common theme dominates the media right now: a recession is coming. Although economists continue to push the date back, the fear still echoes that 2023 will be challenging for everyone. Ironically, as weird as it sounds, many within the VC world are hyped and excited. Many believe recessions are great for creating one thing: the next big startup. For years, we've said, over and over again, that the best companies are born in recessions. Still, as much as we repeat this to ourselves, we might perpetuate a myth more than the truth.
For years the startup world has had many mantras. For example, we can mention "go hard or go home" and "it's essential to know when to pivot" (which is usually earlier than later). These mantras become pillars in the lives of founders and employees alike, and we’ve grown used to working endless hours and changing ideas constantly. In the startup world, this is almost a given. The same goes for the idea that a recession will produce the next best thing. To a degree, these mantras are true, and they help to keep the startup world moving, especially if we look at the evidence.
The 2008 financial crisis was one of the worst in history. It is estimated that over 8 million people lost their jobs, and the stock market lost about $7.4 trillion. People didn't have money, employment, or hope for a solution, but the world kept turning. Collectors came looking for rent at the end of the month, and that's how one of the world's biggest companies now was born. Brian Chesky and Joe Gebbia needed to come up with the money to cover the next week's rent, so they came up with the idea of renting out an air mattress in their living room and providing a basic breakfast. (After all, they lived in one of California's most expensive cities, San Francisco.) As farfetched as the idea seems now, it worked. Someone rented out a mattress and got money for it. Thus, Airbnb was born, and by 2022, the company had reached $8.4 billion in revenue.
This isn't the only story that comes out of need and dire straits. The gig economy is a mainstay in our lives now. 30% of the US workforce relies on the gig economy for primary income or side jobs, which became essential during the pandemic. In 2020 alone, this sector contributed $1.24 trillion to the US economy, and one of its pioneers was Uber.
Uber's birth was not exactly due to dire times, as founders Garrett Camp and Travis Kalanick realized that a private driver to haul friends was too expensive. It would've been much cheaper to split the bill through an app, so they came up with Uber. The chance for drivers to get a side income came out of the trying times. Moreover, saving money on trips was all too enticing. Hence, people signed up in the hundreds of thousands; thus, the app paved the way for a transportation revolution.
The list of successful companies born out of a crisis is long. This includes WhatsApp. While it is less popular in the US, it's the communication tool of choice in many parts of the world. It was born in 2009, with the world reeling from The Great Recession, and now has two billion users. Then, there's Slack, which started out as a failed idea during the recession, making it one of the startup world’s favorite example of success. Now it's the go-to tool for business organization and communication. We use it, and we’d be lost without it.
There's no denying that a recession always creates room for opportunities. The companies I've mentioned are clear examples. A crisis calls for new solutions to old problems and new problems alike. Plus, with many looking for jobs, attracting talent is more manageable. With a good idea and a solid team, funding should come easier, but that's in theory. In real life, things sometimes don't turn out the way we want them to, and to understand why, we need to look back in time.
During WW2, the United States lost around 52,000 aircraft, and engineers needed to protect them better from attacks. So, they started analyzing all the aircraft that came back from missions. The engineers became obsessed with increasing protection in the areas riddled with holes. Still, one university professor realized this was the wrong approach. Columbia University's Abraham Wald realized it was better to reinforce the areas without bullet holes on the surviving aircraft as these were the areas where the planes that didn't return were most likley hit. This is called Survivorship Bias, and it's when we only consider those who come out of a troubling process (be it WW2 or the Great Recession) as success cases.
With only successful cases, we become overly optimistic and consider these the only examples to follow. We examined the positive aspects that we believed were the recipe for success in the companies that survived a crisis and assumed that they weren't present in those who didn't survive. So, it doesn't necessarily mean that investing in a company during a recession guarantees success if we only use examples like Airbnb, Uber, and Slack.
Even with more funding, companies had a lower survival rate during the recession. During the Great Recession, companies had an average 5-year survival rate of 48.1% in 2017, with "only" $36 billion in VC funding. Meanwhile, the survival rate in 2009 was 44.4%, with an impressive $54 billion in funding. Perhaps, those investors were too swayed by survivorship bias and believed that companies born during the recession would do great.
We can look at companies such as Google and Amazon, which managed to survive the 2001 crisis and then thrived, to confirm this mantra, but other crucial factors made them successful. These two, for example, relied on key acquisitions to grow. For this to happen, companies need money. Therefore, injecting boatloads of capital seemed like a guarantee for success, and it still does.
The problem is that only injecting money into companies because they're surviving a recession isn't the solution, though we’ve seen it happen frequently in recent times. Examples such as Klarna and Gorillas show how VCs injected millions of dollars aimed at grow, forgetting the most important thing. During challenging times, it's often better to slow down and carefully manage the various aspects of running a company. After all, and we've said it multiple times, running out of money is the one thing startups can't do, and proving you can run a company is vital.
A company that survives and thrives during a recession is an excellent example of how to do things. Still, to understand them as success cases, we must dive deep into how each company ran. There's no clear-cut process, so we can't say that any company born now (or in the coming months) will be a hit but, on the other hand, some of them will, and it's our job to find out which.
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