Economic uncertainty often hits young companies with a double whammy: Investor money dries up and customers rein in spending. But it turns out that economic downturns are good times to start businesses. First, the filter on ideas is much finer, so if you get going, it probably means that it is a really good opportunity. Second, the company will have a laser focus on building real ROI value. Third, while other young companies that came before may be experiencing declining markets, your company is in the development stage. Fourth, it is a great time to hire great talent since there are fewer good jobs. And finally, there are fewer cars on the road and the commute is better!
History is strewn with examples of now-famous companies, tech and otherwise, that began or flourished during recessions and bear markets, from Microsoft to FedEx to CNN. A few lesser-known but powerful examples:
- In 2000, before the dot.com bubble burst, Veritas Software was a $1.2 billion-a-year-company. At the end of 2001, Veritas (later acquired by Symantec) had boosted annual revenue by $300 million and gained market share. Conversely, Siebel Systems dropped from $2 billion-a-year-revenue to $800 million. Veritas was running storage management in the data center, which was mission critical. Siebel was adding a new application that was “postponable.”
- In March 2001, the depths of the dot-com crash, VMWare released ESX. IT departments were focusing on projects that improved the bottom line, and ESX provided an easy-to-quantify proposition – server consolidation. “Install inexpensive VMware, buy fewer expensive servers, and use less power and space and management overhead.
- Amid the tech slide that accompanied the Great Recession in 2010, storage management company Isilon Systems had four straight quarters of profitability before being acquired by EMC for $2.25 billion. Why was Isilon able to grow during this awful time? It was an ROI darling with its scale-out architecture that let companies intelligently grow storage while eliminating costly over-provisioning.
Starting or growing a business during a downturn can be challenging. Fewer companies go public, those that already have gone public often find their stock punished, and VC funding and valuations take a hit. Giving customers what they need becomes irreplaceable when times get tough. Those that achieve this objective will find a way to thrive while others fall by the wayside.
For example, companies in the software-defined storage and networking spaces will probably do well as the economy comes under pressure. They save money by enabling customers to maximize the performance of high-end systems using cost-effective commodity hardware. I’ve invested in companies like PernixData and Zerto because I think they’re the latest examples of companies with strong ROI stories, much in the same way VMware built a strong business virtualizing servers in the 2000s.
Similarly, companies that transition traditional infrastructure into cloud-based services have a distinct advantage in a downturn, as they increase flexibility while reducing costs substantially through innovative provisioning and pricing models. This is what attracted me to a company like SugarCRM.
Who will lose? Any spend seen as non-essential will be questioned. The old guard companies like IBM and Oracle have an even tougher row to hoe as customers comb through their enterprises hunting for opportunities to replace expensive, specialized solutions with lower-cost open-source and commodity-hardware-based ones that provide equal performance.
These dynamics should ring familiar from previous tech sector tumbles. Remember Sequoia Capital’s “Doomsday” presentation in 2008? It warned startups to manage spending and growth assumptions, realize that IT spending is being heavily scrutinized, and establish a clear revenue model.
How quickly we forget. Valuations have returned to new and unsustainable levels in the last few years. I frequently advise younger entrepreneurs in Silicon Valley that the joyride inevitably will end and to prepare their companies for the headwinds, but sadly they never believe me. Good times are all they have known.
The number of tech IPOs plunged to a six-year low in 2015 – just 23 companies raised a total of $4.2 billion in 2015, down from 55 and $32.3 billion a year earlier, according to Renaissance Capital – and now we’re off to the worst start of a year for tech stocks since the Great Recession. Even profitable companies like LinkedIn have seen their stocks collapse.
It is important to note that IPO access and their valuations are not isolated phenomena. Capital markets are laddered, and what happens in one part has a direct and immediate effect on those above and below.
How bad will things get? I think not as bad as 2001 or 2008. And this downturn will likely be buffered by the fact there’s still a lot of money sitting on the sidelines in VCs and there are still decent amounts of cash on the balance sheets of many young startups.
But it’s only a matter of time before we see some young firms fail because of lack of capital. It happens every time the bubble bursts, and this time will be no different.
But many companies will survive and prosper. The ones that solve real customer problems today and can easily quantify a return on investment for tomorrow will survive, and they’ll be the stronger for it.
Mark Leslie is managing partner of Leslie Ventures, a private investment company.