From past economic crises like the Great Depression and the Asian Financial Crisis to the most recent caused by the COVID-19 pandemic, downturns have always brought about uncertainties. Despite disruptions to funding outlooks and startup ecosystems, economic slowdowns do offer compelling opportunities for early-stage investors. Seasoned investors seize this chance by adapting and taking calculated risks to capitalise on market opportunities.
Prof Wong Poh Kam, Emeritus Professor at the NUS School of Business and Director for NUS Entrepreneurship Centre, was the keynote speaker at one of our previous AngelCentral Deep Dive workshops, here are his reasons why now is the right time to invest in startups:
- Positive Self-Selection: Economic slowdowns act as a filter, separating the resilient and innovative entrepreneurs from the rest. As weaker contenders are deterred from starting their own ventures, the surviving pool of startups should display potential for growth and sustainability.
- Lower Valuation Expectations by Startups: Market prospects may not be as good during downturns, leading founders to recalibrate their valuation expectations. This benefits early-stage investors as they would then be able to acquire equity at more favourable terms.
- Improved Economics of Execution: During downturns, startups benefit from a conducive environment for execution. Factors such as easier access to tech talent (less competition for talent) and reduced operational costs contribute to streamlined operations. Equipping them with better ability to execute and thus enhancing the prospects for success, particularly in the pre-revenue phase.
- Reduced Competition: Fewer would-be competitors enter the market during an economic slowdown, reducing competition for startups operating in the same space. This can enhance the chances of success for startups, as they face less competition within their industry or niche.
- Emerging Market Opportunities: Downturns often exacerbate existing challenges or create new problems within industries, thereby paving the way for innovative solutions. Startups agile enough to address these evolving needs to capitalise on the shifting market dynamics. Presenting investors with new marketspaces to invest in. For instance, the COVID-19 pandemic prompted many businesses to become more cost-conscious and prioritise cost-efficiency. Thus, creating new areas for startups to develop innovative solutions to solve these problems, enabling companies to streamline their expenses.
- Generating new sources of entrepreneurial talent: Corporate cutbacks and retrenchments during a bad economy can serve as catalysts for entrepreneurship. Displaced professionals often transition into entrepreneurship, bringing with them valuable industry experience and novel ideas.
- Favourable Market Dynamics: Economic downturns tend to favour investments in marketspaces requiring longer pre-revenue product development phases. Investors willing to endure longer gestation periods stand to benefit from a diversified portfolio that consists of ventures with substantial growth potential.
In addition to nurturing new ventures, Prof Wong also makes a case for investing in existing startups during an economic slowdown. Here are some of his reasons why:
- Market Selection: Downturns serve as a litmus test for startup resilience. By enduring the challenges posed by downturns, it is a signal that these existing startups are more resourceful, demonstrating greater resilience and adaptability – eg. They are nimble and thus able to find a new business model to pivot to, allowing them to survive as they adapt to the changing economic situation. Which positions them as attractive investment prospects. This means that investors are more likely to find higher quality deals in the market. Furthermore, this economic environment imposes greater cost discipline on startups’ operations. Which also means that this economic state favours those business models that prioritise revenue instead of growth.
- Deterrence of New Competitors: Bad economic times often act as a deterrent for potential competitors, reducing the influx of new entrants into the market. This diminished competition fortifies the market position of existing startups, enhancing their long-term viability and attractiveness to investors.
- Lower Valuation Expectations: Existing startups may also recalibrate their valuation expectations in response to downturns, presenting investors with opportunities to acquire equity at favourable terms. This may manifest in bridge rounds with terms aligned with earlier investors. Or even down rounds, enabling investors to secure equity stakes at reduced valuations.
By capitalising on the resilience and adaptability demonstrated by both new and existing startups during an economic downturn, investors can strategically diversify their portfolios and exploit the opportunities presented by these conditions. In order to position themselves for long-term growth in their investments.
Enjoyed this article? Read more of our other articles here. This content is part of our AngelCentral Deep Dive Series – we run these workshops every quarter so do follow us on our LinkedIn and Facebook pages to stay updated on our latest events!
