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The opinions expressed by entrepreneurial contributors are their own.
Today’s macroeconomic environment is changing dramatically, and the signs are everywhere. There is a clear economic slowdown, stock markets are falling, and recent reports of layoffs point to a looming recession, especially in the tech sector. Such an economy has its downsides, but it is also an opportunity for smart startup founders and knowledgeable investors to succeed.
The impact of venture capital
It may surprise you how much impact venture capital (VC) investments have on the global economy. Forbes reports that VC investments used to be very risky. Even if it does grow, it only accounts for 0.8% of gross domestic product in the US compared to about 5% for the private equity industry. The numbers are even lower in the UK and Europe. Nevertheless, between 1980 and 2020, about 39% of all IPOs were venture-backed. VC-based companies have also proven to grow more than twice as fast as his non-VC-backed peers in 10 years.
The data also show that VC investment drives innovation and employment. 44% of US public company R&D spending comes from VC-funded public companies. Over the decade, employment by VC-based startups increased by 475% compared to 230% in the control group.
In my experience, startups are usually initially funded by their founders and then raised with the help of family, friends, or angel investors. Beyond that, VCs often provide the additional capital needed by startups to grow their market and expand into new territories. VC firms are made up of experienced investors who provide valuable advice as well as fundraising. It helps startups avoid common mistakes, connect with corporate partners, and move their business forward.
Many of America’s most valuable companies are funded by venture capital. These include Pegasus’ investments in Airbnb, SpaceX, Stripe, DoorDash, Instacart and Robinhood.
Related: Why Some Startups Succeed (and Why Most Startups Fail)
thrive in this environment
How should investors make decisions in this environment? We recommend investing in stable, quality companies with low debt, strong balance sheets and good cash flow. . Ideal if the company is in a stable sector with growth potential. Now is not the time to make highly speculative investments, nor is it the time to bet on highly leveraged startups. A reasonable debt-to-equity ratio (comparing debt to equity) indicates that the company is not taking unnecessary risks in trying to grow.
A recession changes the game for both startups and VC firms. With funding potentially unavailable, startups need to improve their business strategy and be disciplined in spending money to make their companies more sustainable in the long run. Entrepreneurs may consider starting a business to be risky. Still, startup hiring is getting easier, given the number of tech layoffs in corporate sectors like Meta, Amazon, and Twitter in recent months.
This environment provides an opportunity for investors to fund startups at better prices than during a good economy. Deals are usually less competitive and lower valuations mean investors get more for their investments. VCs should also pay close attention to conducting due diligence to ensure that the investments they choose are worthwhile.
In my experience, from the seed round stage through subsequent rounds, I’ve seen venture investment prices drop by up to 30% during economic downturns. This confirms that a macroeconomic slowdown helps VCs win lucrative deals, and that stock prices tend to stabilize in such an environment. Investors can rest assured than otherwise.
Related: Diverse Hiring and Inclusive Leadership Key to Startup Success
Act now and reap the benefits
Despite the bad news in today’s economic environment, we encourage startups to improve their business strategies and VCs to take advantage of less competition to invest. Many successful companies were founded during a recession, so smart founders and investors can each benefit from active participation even when the risks are perceived.
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