How a potential recession will impact venture capitalism

Many experts in the United States and beyond have long been predicting an economic downturn or even a full-blown recession. The effects of a number of factors including COVID, the war in Ukraine and many more in between, have set the stage for a period of uncertainty.

Abundant funding for scale-up businesses is a good sign of economic certainty. With the forecast for the near future looking more turbulent, we may be seeing such businesses facing an even greater challenge to get off the ground.

At chiefmachers, we are proud to work with scale-up businesses that are seeking to make a positive impact on the future of people and the planet. How, though, would a potential recession affect startup businesses and venture capitalism as a whole?

Recent years have seen huge amounts of activity in the industry, leading to a buoyant landscape. With the aforementioned projections, however, this could be under threat.

Naturally, it is expected that investors will likely be more cautious in their approach. A look at the impacts of previous recessions adds weight to this theory with figures showing a drop in the number of venture capital funds after both the Dot-Com bubble and the 2008 recession.

As we know, recession tend to cause a period of instability. Values can fluctuate wildly. Investors react much quicker to news, signaling the fragility of their overall confidence.

If trends from previous incidents are to be followed, we can see a likely impact on public valuations and subsequent mergers and acquisitions.

Startups and scale-ups are not publicly traded of course. This provides some protection from the threat of some investor activities often seen during a recession. Short-selling, for example, can be catastrophic for public companies at times like these.

A similar picture emerges when we take a look at the number of IPOs following periods of recession. Data points to low peaks in both 2000 and 2008.

With all of the above taken into consideration, what does this mean for the short and medium-term future?

With a recession, we see interest rates go up. With the possible exception of the financial sector, these higher rates will often have a negative impact on earnings and stock prices. It is therefore predicted that venture capitalists will start to tighten their investment criteria. They will act with more caution, and the expectations of startups will be higher.

For startups, this is of course a challenge. However, it shouldn’t dampen spirits. The key is how to respond to the challenge.

Economists predict that startups will have to respond to the circumstances with more in-depth pitches, considered contingency plans and, perhaps, a shorter route to profitability.

In addition to this, it is expected that venture capitalists have allocated enough money to continue investing for a number of years to come. This gives reasons for confidence in the industry. It also means that those startups who receive investment can be considered an even smarter choice than normal, thanks to the heightened threshold for VCs.

Longer term impact investors with a ‘bigger picture’ approach may well see this as merely a blip. This will certainly be the case should the recession be short lived.

The same is true for Private Equity funds, which are likely to be more resilient during a recession thanks to active ownership and a long-term outlook. These funds could potentially offer additional routes for fledging businesses.

Smart investors often see downturns with as much (if not more) opportunity as a threat. In short, there are reasons to be cheerful for both investors and startups alike. Those who succeed might well be looking at very bright futures.

We are a group of executive search experts, driven to support progressive startups. We enable growth and development by connecting businesses with high-level, experienced talent. If you think we can help you or your business with the next crucial move, please get in touch today.