Recession impact on startups
Will the recession hit global economy in the following 12–24 months?
The Moody’s chart from Exhibit 1 shows the growing trend of US corporate debt as % of GDP, slowly reaching 46%.
Exhibit 1: US corporate debt as a percentage of GDP
Dec 2018 FED rate hike to 2.25–2.5% makes the credit more expensive and the re-financing of the corporate debt even more problematic taking into account almost 50% of the US corporate debt is at the limit of investment grading (BBB-).
FED planed two more hikes in 2019, despite the announced ’’ patience and flexibility’’ of FED’s Chairman Jerome Powel, will make debt re-financing in 2019 even more problematic.
Exhibit 2: Ten years -3 months term spread & NBER dated recessions.
Exhibit 2 visualise the ten-year minus three-month term spread evolution in the last 45 years, in correlation with the National Bureau of Economic Research (NBER) recession data, which is narrowing to 0 before a new recession cycle.
Therefore, this evolution of the yield curve signals the probability of a near term recession.
Debt re-financing at a growing interest rate will lead to the bankruptcy of many corporations with low or junk investment grading. This will have a direct impact on GDP growth as they will generate less outcome. Additionally, they will generate unemployment which will affect further the private and governmental consumption and further hit the GDP decline.
Exhibit 3: 2019 Global growth projections.
Slowing down of Chinese and US economies (see Exhibit 3) in 2019 with a combined 60 bp and the unsolved trade disputes will contribute to the slow down of the global growth.
Which will be the impact in funding for startups?
Despite and excellent 2018 in VC funding, which according to Q4 2018 Venture Monitor by PitchBook reached 130 billion USD in US (Exhibit 4), during recession, the fund availability will become scarce.
Exhibit 4: Capital investment by US VC.
Human behaviour in such circumstances is more prudence. This will impact no of deals, deal size and overall funds invested (see Exhibit 5).
Exhibit 5: US VC investments Q1 2006-Q1 2009.
Tech companies, during down turn market conditions, have more volatile valuations due to higher Beta (in the case of public companies).
This will have an impact on both valuations and exits, where there are buy outs, IPOs or acquisitions.
How startups should plan and execute in recession times?
Firstly they should look more carefully in the unit economics of their venture and try to become more effective and efficient in customer acquisition and retention costs. One of the main priorities should be on selecting the acquisition channels which are giving the best outcome in specific metrics such as customer acquisition cost, customer retention cost, marginal cost of acquisition, cost per lead, cost per conversion, etc).
Prolonging the customer life time will generate additional revenues for startups without an additional cost of acquisition, which usually is higher than customer retention cost. Customer engagement pays an important role in this.
Shortening sales cycles through better sales funnel management and shortening customer (consumer) decision journeys, understanding specific barriers in each stage and activating the right drivers will have a positive effect on revenue streams.
Hiring should focus on growth and value creation, monitoring specific KPIs such us incremental revenue per new customer, incremental life time, incremental life value, marginal cost of acquisition, return on new product development costs, etc.
Funding covering longer periods of time will reduce the stress of fund rising during economic down turns when money will be less available or more expensive.