So, you want to start a technology business in a recession.
…
Probably the “tl;dr” version of this view would just be the word “don’t”, but in the next 15 minutes or so I’m going to take you through what you have to do strategically and tactically to startup or scaleup a technology business in a recession.
* Introduction
The problem with trying to start or scale a business in a recession is that money starts behaving strangely – specifically we see aberrant behaviour about how customers buy, and how investors invest.
In any business, cash is king, so any change to the way that money flows within an economy is likely to affect our business.
We’re going to look at both these demand side (i.e. how customers change how they buy) and supply side (i.e. how investors change how they invest) as we go through this video.
In short though, it comes down to the fact that there is less money about – that is what a recession is in terms of how business owners feel it, it is a reduction in the amount of cash being available to your business, either through sales or through investments. As you as a business owner exist primarily to maximise and grow profits, any reduction in the amount of cash that is available to flow into your business represents an existential threat, which is why it’s important to modify the strategy and tactics that we’re using to grow the business.
In a recession, there are broadly two ways that people have. If you are a very secure person, and very sophisticated, recessions are a great opportunity to make serious money. If you are able to invest whilst there is “blood on the streets”, your chance of finding a bargain goes up significantly because people are desperate.
However, most founders in early-stage business are not very secure, even if they are very sophisticated. If you were very secure, you would not be “early-stage”. In this situation, when there’s blood on the streets, usually the best course of action is to practice restraint. I would actually suggest the best course of action would be to take the year off and wait for the recession to pass.
Anyway in this video, we’re just going to split the discussion into three parts – 1. The Numbers, 2. Demand, and 3. Supply.
* Numbers
My professional career has seen two recessions in the UK, although I technically started my career during a recession I was in my early 20s and knew nothing about nothing, so I’m not counting the early 90s. In particular, during the 2008-2009 financial crash I had a software company and the things I’m seeing at the time of recording this video at the end of summer 2023 mirror closely what I saw back then in 2008-2009.
Also, not being an economist, I have that sort of layperson’s understanding of how recessions work just by virtual of having lived through them, but I did find some things when researching this video that surprised me, and maybe they will surprise you too.
The UK is not, in summer 2023, in a recession. If you’re asking me for a personal opinion, I would say that we are in a functional recession. I use the term “functional recession”, because although we haven’t reached that technical definition of two consecutive quarters of negative growth, the behaviours that I am seeing out there closely mirror what I saw as a business owner back, in 2008-2009.
In the ten years pre-covid, in the UK the tended was to see quarter-on-quarter growth of around 0.5% per quarter. (* add B-roll from ONS chart https://www.ons.gov.uk/economy/grossdomesticproductgdp/timeseries/ihyq/pn2)
Over the past five quarters, or 15 months, growth in the UK has been pretty sketchy, running at about 0.1%.
https://www.bbc.co.uk/news/live/business-66469579
Given the typical age of a UK viewer of my videos, I want to frame this by looking at recessions in 1980, 1990, and 2008-2009. (And I’m going to ignore Covid because what happened with the economy then was just weird.)
Those three recessions each lasted 5 quarters, or 15 months, and saw considerable contractions over the period. Here’s the 1980-81 recession that starts of quite sharp and tapers off, the 1990-91 recession is pretty chill in comparison, and now the 2008-2009 recession which really starts to bite after we see Lehman Brothers go under.
The reason why I’m going though this is that although we can’t predict recessions, an planning for a recession to last 15 months seems about right given those last three. You could argue that given the low growth in the UK for the last 15 months maybe that “functional recession” was out recession, but given the mood out there, I doubt it!
* Demand Problems
As mentioned in the introduction, the biggest problem you have as a founder during a recession is that customers change how they buy, or to be more specific, customers become allergic to spending money.
I’m going to go through two examples, which are both very much informed by my experience at scaling up a technology business during the 2008-2009 recession.
Let’s imagine you have a product – doesn’t really matter what it is – but let’s say you find a potential customer. They say to you that they spend £10k a month operating a certain part of their business, but you have a piece of software that costs £1k a month, but when implemented it reduces their £10k cost a month to £7k a month.
Rationally, they should take this deal. If you look at just the hard, in-real-terms aspects of this, spending £12k a year to realise savings of £36k a year should be a shoo-in. The business should take this deal, once convinced that you’re a safe pair of hands and not going to set fire to the building.
Before I go on, there’s a maxim in software development written by the late Fred Brooks in the 1970s that goes, “how does a project get to be a year late?”, and the answer is: “one week at a time”. Hold that thought.
You customer contact is the operations director, and to get this deal signed off, it needs board approval. Imagine it’s July, and your operations director goes to the board meeting but it happens to fall on the the day that the Bank of England announces a hike in interest rates and the CEO has a couple of buy-to-let properties that they’re currently looking to remortgage. It’s not a huge amount of money, but it’s enough to put them, unconsciously, in a mood where they’re not up for spending money. Your tame operations director goes to speak at the meeting, and the CEO says, “we’re a bit short of time today, can we bump this to next month?”
So now your tame operations director goes back to you and says, very sorry, it’ll be August. And August comes and you hear nothing, and a few days later chase him to which he says, “very sorry, I had Covid and I had the week off, missed the meeting, and so we bumped it to September”.
Although that first presentation should have been July, you actually did the initial outreach back in April. So there’s now a five month gap between April and September where nothing has moved.
In the September board meeting, your operations director goes to present and the CEO says, “you know what, I’m just not happy with the state of the economy, I think we’re heading into recession, so I don’t want to talk about new spending plans until the New Year”.
At this point in the cycle, you’re dealing with September, starting in April, and now know there will no movement until January, probably February. That’s almost a year. This. Happens. All. The. Time. In fairness, it happens even in a booming economy. The pieces that you have on the board will always move more slowly than you want – you feel like you’re playing chess on a normal board, but in reality the board is at the bottom of a fish tank filled with treacle. When the economy is bad, it’s like that fish tank is not only filled with treacle, its also frozen solid.
(And there is no way I’ll find B-roll for that. It will be interesting to find what I did find.)
In my experience, the smaller the business is, the less good they are at strategy, and being less good at strategy tends to make the business’ decision makers more jumpy and emotional in how they’re making their decisions. Although this sort of “it’s safer to think about this tomorrow” behaviour exists in businesses of all sizes, it gets more pronounced in smaller businesses because their looser grip on strategy makes them more prone to be blown off course.
Even though your offer is rational and defensible, it requires an adherence to strategy with reduced emotionality. Recessions make business owners twitchy because the supply of money is constrained. This keys into the standard human behaviour that “losses loom larger than gains”, i.e. people will work harder to avoid loss than to achieve a gain, even if it’s not rational to do so. Another sales psychology thing comes into play here in that when faced with heightened emotions, people will tend to do nothing rather than do something.
For a CEO who is not necessarily that interested in what you are trying to sell, it is no skin off of their nose to bump any decision to the following month. This is one of the most significant challenges in selling B2B in any case, but in a recession the problem is even worse – especially because one option is for the business to simply bring the hammer down and put a moratorium on any spending for a season, e.g. “let’s pick this up in the spring”.
In this particular situation, there is a chance that the operations director can go and have a quiet word with the CEO and sketch out the rationality of the spend, and perhaps you can eek in an implementation whilst all the other projects the business is doing have been suspended. To do this, you require a relationship with the customer contact that’s so close they are effectively your employee.
And you can only do that if your project is small in real-terms, unlike what happened to me in the 2008-2009 financial crisis.
Back in 2008-2009 when I was running my bespoke software company, our average order value at the time was about £60k-70k. We had been having a rough year from the start of 2008, which now that I looked at the GDP figures for this video I realise there was a recession going on, but when Lehman Brothers went under everything stopped. Every project we had in the pipeline evaporated over the next fortnight, which every single customer saying, “they’ll come back and look again after Christmas”.
The problem with very large spends during a recession is that cash in the bank is safe, and giving it to you is less safe. In a recessionary environment, you will find extremely high resistance to spends on big-ticket projects.
You can sell big-ticket projects, but the value has to be ultra-compelling. You will not sell “nice to have” big-ticket projects in a recessionary environment. You can only sell things that either are or are very close to an existential problem for the client.
So, how do we tie all this together.
Firstly, in terms of who you are selling to, you need to prefer businesses that are better at strategy. You can offset this “let’s just do this tomorrow” problem if you have a board that’s able to set aside emotionality, and be less “blown around” by the economic storm, and focus on strategy. One way to do this is to prefer to sell to larger businesses, as they tend to more strictly adhere to strategy and are less swayed by the “moods” of the CEO and the other decision makers.
I would avoid trying to sell into very small businesses during recessions because they get very twitchy about spending money. If you’re asking me specifics, I would not try and sell into a business that had less than 50 staff during a recession.
Secondly, the offer is key. Your offer needs to be “uncontroversial”, which means that a) the value has to be really clear and quantifiable, and b) the price of that offer has to not set anyone’s teeth on edge. A £50k up-front spend is felt differently to £2k a month for two years. People will buy no-brainer offers, even if the economy is tight.
Thirdly, as a side note, be careful with cashflow. Businesses always have the option of reducing cash outflows by just not paying suppliers. This is good hygiene anyway, but be cautious of getting overexposed to customers who owe you money.
Fourthly, if you have the option, avoid industries that struggle more in a recession. If you have an option that can be sold equally well into “healthcare” and “construction”, you might want to prefer to sell into healthcare because that industry tends to do better in recessions than construction does. Public sector customers also tend to be resistant to recessionary economics.
What we’re really trying to do is “box clever” and try and prefer activities that are less bumpy and that we can get a tighter measure of control over as the customers are feeling more flighty.
Finally, get very, very good at sales and marketing. As demand constricts, there will be a period where supply has not yet constricted and there will be oversupply of people trying to sell into a smaller number of your customers, which from your perspective will appear as there being more competition. The winner in those situations are the people who can “sell better”.
Personally, if you were asking me as a friend who wanted to startup or scaleup a business in a recession, I would actually say to you, don’t try to grow the business expressly or explicitly – instead, spend that year getting the sales and marketing operation honed, and come out stronger when GDP is back in the land of net positive growth.
* Supply Problems
The simplest way to build a business is through cashflow – i.e. all you have to do is start making enough profit so that you can plough cash back into the business to fund the commercial bits (business development and sales and marketing), and the software development / product development bits to move your story on.
For me, the most pleasing metaphor that I know of for this is “getting the flywheel up to speed”, i.e. you have to be able to fund and do enough activity to get this flywheel spinning, at which point it becomes self-sustaining and you’re off to the races.
Some businesses want to go a bit faster and don’t want to slog away getting the flywheel up-to-speed by increasing cash inflows, instead preferring to use investment as a sort of “turbo boost”. Most startup businesses – if the founder is a non-technology person, or the founding team are non-technology people – need to get some investment in order to even build the version 1 MVP (most valuable product) that they take to market, and find the initial marketing / business development activities.
However, as per the last section, the problem with recessions is that “money’s too tight to mention”, an the investment market typically dries up when the market is down.
There are, broadly, three types of investment that a business can get – and the inflow of cash I’m talking about here are ones where someone is giving you cash in exchange for equity, so I’m not talking about loans, or grants, or other oddities.
The first one is “FF and F”, and when I was growing up I was taught this meant “friends, families, and fools”, but that’s exclusionary language so I prefer to use “followers”. The idea of FF&F is that these are people who are close to you and there is a personal relationship and the strings attached to the money are more like gossamer threads of trust rather than the unbreakable carbon nanotubes one might build a space elevator with.
The second is angel investing, which is where an individual who has a bit of cash fancies putting it into your startup. And the third is institutional investment, which is what we mean when we say “venture capital”.
All three of those investors have different profiles, and they sort of linearly map to a kind of metric around confidence and trust. Your mum – a form of FF and let me assure you, she’s definitely not “a Fool” -- is predisposed to trust you, contrary to any evidence.
Angel investors are less trusting, but do arrive at the market with a relatively relaxed attitude about whether what you are doing will work. Part of that is because in the UK we have a very liberal small business investment scheme called SEIS that significantly cushions angel investors from losing money. We’re doing to dig more into angel investors in this section.
Institutional investors would sell their granny is there was a dime in it, and will not trust you at all.
In terms of recessionary reactivity, FF&F are going to be less reactive, because the reason why they are giving you money is because of the personal relationship, and the economic environment is of secondary importance.
Institutional investors definitely do react to recessionary activity, and not in a good way. Remember how I said that very resourced, very sophisticated investors like recessions because you can get a decent bargain when there is blood on the streets? Any VC in a recession will assume you are desperate and you will get – to be honest I struggled to find any PG-13 analogies to use in this video -- expect to be heavily squeezed on price.
Angels investors are more interesting to viewers of my videos, and in the UK at the time of recording this, the issue with angel investment is that higher interest rates take angel investors out of the market.
Generally speaking, if you have some money and invest it in the US stock market, particularly the S&P 500 stocks, you will make 8-10% per year on average over the long term. Any investment an angel is looking to make has to do better than that, and what brings angel investors into the market is either a) the fact that they want to make more than 10% per year, and b) that they want to do something more interesting with their money by actually having a relationship a founder and helping to grow their business.
Interest rates at 0.25% created a lot of angel investors, because if you had a chunk of money sitting around, it was difficult to do anything with it that was interesting. However, in the UK in September 2023 you can get 5.0%-5.2% interest in an instant access savings accounts, and interest rates are still predicted to go up.
That takes a LOT of angel investors out of the market. You also need to factor in that a lot of angel investors are older and have one eye on retirement, and have now seen three recessions and are not up losing their nest egg before retiring.
If you’re an early-stage startup within the UK, you are likely seeking between £125k and £150k for your initial seed investment. You would normally split that roughly 50:50 with 50% software development / product development and 50% business development / sales and marketing. That’s the sort of money required to “move the needle” of a startup.
That is going to be a stretch for FF&F, even in an up market. Using anecdotal, finger-in-air data, I would imagine it’s workable enough to find £50k from your own funds and FF&F, leaving £75k-£100k from angels. It would from there be unusual to get one angel to throw in in very early stage, so you would need 2-3.
In a down market, you may have to pay your angel more (practically this means fixing a lower valuation, and proportionality they would get equity more for their money) You may also find that whereas you only needed 2 angels because both would put in £50k, you may now need three who are putting in £33k each as they spread their risk.
That adds complexity and work on your end, but it also adds time. Investment always takes masses of time longer to bring in than you’d think it would. My analogy before about the chessboard in a fish tank of syrup? Imagine that but you’re on Earth and the fish tank is on Mars and you’re using a telepresence robot arm. It will Go. As. Slow. As. Molasses, and having to work with three angels rather than two will just add to the delay.
What I would in this situation, I’m not sure if coming out of this next recession helps, i.e. on the demand side I suggested you wait it out, but on this supply side I’m not convinced there is value in waiting.
FF&F as I said is unlikely to be affected by the fact of a recession or not – they love your style and believe in you, and some of them will write cheques off the back of that.
For my audience, you’re likely too early for VC money (and are likely not taking advice on how to work with VCs from YouTube and/or random podcasts).
It’s the angels that’s the key, and it is likely permanent structural damage has been done to that market because of the interest rate rises taking so many angels out of supply. Interest rates are not going to go back to 2008-2009 levels, especially not as we still have this inflation problem. In the 15 years before the 2008-2009 financial crisis, the average interest rate was 5.5%.
Over the long term, angels have to come from somewhere, and that means that Gen X and millennials have to have enough money to become angels – and we know that there are structural, generational problems with wealth creation in those generations.
Unlike the demand-side of the problem where waiting for a recession to resolve likely sees a restoration of demand, coming out of recession likely does not see a change to the quantity or behaviour of angel investors. Covid-19 put me off the phrase “the new normal”, but I suspect that what we have now in terms of the size and behaviour of that constellation of angel investors won’t change significantly, recession or not.
Balancing those two factors together, I suspect my advice is going to be to slow down expectations of demand and focus on building skills up around “market access”, i.e. get better at marketing, get better at selling, and deal with a larger number of slower moving angels in what for them is a “buyers market”. Get those investors lined up, get some money in, and then when you start to see demand come back, you’re in a stronger position.
* Signoff