Are the 'best' startups really founded in a recession?

In the midst of the last global recession in 2008, two entrepreneurs struggling to pay for their apartment had an idea to rent out air mattresses on their floor. Over the next 14 years, Airbnb co-founders Brian Chesky and Joe Gebbia, with Nathan Blecharczyk joining later on, would grow their business to one of the largest companies in the US, with a market cap of over $70 billion.

Fast forward to today, and countries around the world are facing the possibility of another recession. And, just as Chesky, Blecharczyk and Gebbia were in 2008, another would-be entrepreneur could well be tinkering away in a workspace with the next great idea.

However, with rising inflation and interest rates, decreased consumer spending and layoffs at some of the biggest VC-backed companies across the globe, now hardly seems the time to take ideas and money to brave the storm.

How, then, to explain why many investors swear the "best" companies are created in recessions—a phrase that, in personal experience, has been repeated so often recently that it seems like a new VC mantra.

Venture's renowned optimism means taking statements like this with a pinch of salt, even if those optimists have plenty of examples to back up the sentiment. After all, tech sector giants including Slack and Square were launched during the 2008 financial crisis, and looking even further back, household names including Microsoft and eBay were founded during times when the global economy was faltering.

Still, given how strongly VCs are seemingly clinging to the idea, I say it needs to be tested. But first, let's see why it could be true that startups launched in a period of economic weakness may be more durable than those created in a boom.

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Right now, as worries about a recession sweep the economy, most investors are urging portfolio companies to preserve cash to extend their runways. Startups created in the current environment, taking a cue from the belt-tightening going on around them, are likely to be built with a more cash-conservative mindset, which gives them a natural advantage. Plus, as a new business, they'll need fewer resources to grow compared with the larger players now having to scale back to cut costs.

This is the exact opposite of what we've seen in the past few years. Having been pushed to prioritize growth at all costs, startups launched in boom times are now faced with sometimes severe valuation haircuts as the market shifts to prioritizing profitability (think Klarna or Gorillas).

Even layoffs could serve as an advantage these days. Large tech companies like Robinhood and Coinbase have been shedding employees, with Crunchbase data estimating that the US tech sector alone has seen over 34,000 people lose their jobs in 2022.

With a glut of highly skilled people looking for their next project, new startups have the opportunity to recruit experienced workers with less competition from larger rivals. Many of those former tech employees had high-paid, comfortable jobs during the good times. Not anymore. They now find themselves unemployed, perhaps even having the incentive to venture forth with their own ideas for a new business.

And if a startup has managed to not only survive a recession, but also demonstrate growth and resilience throughout that downturn, it can make a compelling case to investors when funding activity picks up that it's among the "best."

While the idea that the best startups are born during a recession does make sense—and there are those companies with track records that seem to prove it—I'm still not convinced that it's true. To begin with, even judging what "best" means is a difficult task.

One investor described the best startups as those with an enduring product that can change the way people live, work or behave. That may be a viable definition, but it's tough to track in a spreadsheet.

If instead we take revenue as a basis, using the Fortune 500 list could be an indicator of whether companies founded in a recession have a greater chance of becoming leaders in their respective industries. A study conducted by Touchdown Ventures in 2020 found that only 24% of companies in the 2019 Fortune 500 list were founded at a time when the US economy contracted, indicating that businesses launched in a recession don't necessarily have a better chance of becoming a corporate mainstay.

The theory is looking shaky at this point, but the Fortune 500 list may not be an entirely suitable measure, as it includes many companies that have never received VC funding.

If we take "most valuable" to mean best, then look no further than unicorns. According to PitchBook data from 2001 onward, 95 US-based companies valued at more than $1 billion were founded in a recession as opposed to 757 that were not. These figures once again pour doubt on the idea that companies founded in a downturn are more likely to succeed.

These two data points by no means offer conclusive tests, but they do suggest the statement is more likely to be wishful thinking than fact.

Even if it isn't true, the truth remains that startups can be founded and even thrive during a recession, becoming household names globally. So for those investors and entrepreneurs who are worried and anxious about the future, take heart and pay no mind to the math.

Featured image by Joey Schaffer/PitchBook News
 

This article originally appeared on PitchBook News