By Caroline Baum, MarketWatch
It may seem counterintuitive, but downturns and bear markets present an opportunity for entrepreneurs to start a new business.
Why? Because the “uncertainty” that traditional businesses, not to mention financial markets, reputedly hate, isn’t an issue for entrepreneurs. They aren’t worried about trying to assess and meet demand for existing goods and services. They are busy inventing or creating something you never knew you wanted or needed.
The current downturn, often referred to as the Great Lockdown, is likely to produce permanent changes in how and where we do business: home versus office; electronically versus face-to- face. It will open new vistas for technologies that can facilitate contract tracing and monitoring. It will drive the development of more sophisticated data processing equipment — and maybe even a better nasal swab!
The unique nature of this recession seems to have opened a gaping hole that an enterprising entrepreneur could seek to fill.
The data support the idea that downturns may be a source of inspiration for startups. More than half of the Fortune 500 companies were started in a recession or a bear market, according to a 2009 study by Dane Stangler for the Ewing Marion Kauffman Foundation. The list of companies includes such household names as General Electric /zigman2/quotes/208495069/composite GE +0.08% , General Motors /zigman2/quotes/205226835/composite GM -1.26% , IBM /zigman2/quotes/203856914/composite IBM +0.45% , Hyatt Hotels /zigman2/quotes/207542923/composite H +0.09% , Hewlett Packard /zigman2/quotes/203461582/composite HPQ +1.44% , and Microsoft /zigman2/quotes/207732364/composite MSFT +1.23% .
Stangler, currently a fellow at the Bipartisan Policy Center, says the Fortune 500 finding is “compelling when we look at when our largest companies were started,” even though before World War II the economy spent almost as much time in recession as in expansion.
For the potential entrepreneur, an economic downturn provides a ready-made pool of labor looking to be re-deployed. Borrowing costs are low. Existing businesses are generally looking to unload unneeded equipment or office space on the cheap.
But “the principle dynamic that propels entrepreneurship during downturns is necessity,” says John Dearie, president and founder of the Center for American Entrepreneurship. “Someone may be harboring an idea for a new business and was just handed the circumstances that allow him to take the leap.”
That doesn’t mean it’s easy to start a business from scratch during a downturn.
“Economic downturns can propel entrepreneurship, but there are cross-currents that make it more difficult,” Dearie says. “Money may be cheap, but credit is still tough to get.”
What’s more, “startups are risky because they don’t have the things banks lend against, such as cash flow, revenue, customers, inventory or a track record,” he says. In other words, “of the things banks typically look to lend against, startups fail.”
Venture capital is typically not early-stage risk capital but is allocated to businesses that have already established themselves.
Only a tiny fraction of startups — anywhere from 2% to 8%, according to experts I talked with — have access to venture capital, which is raised mostly from institutional investors. An aspiring entrepreneur is apt to use his own savings, take out a home-equity loan, use a credit card or tap friends and family for savings to invest.
The other source of financing, if an entrepreneur is lucky, is angel investors: wealthy individuals willing to take a risk with their own money. Many are former entrepreneurs themselves who invest in exchange for an equity stake in the company, Dearie explains.
The checks tend to be smaller than VC, according to Dearie: $25,000 to $500,000.