What do Uber, Airbnb, GetYourGuide and Vacasa all have in common?
There were all founded during the Great Recession in the late-2000s.
The wave of travel startups that came to fruition during that time capitalized on emerging trends (such as the sharing economy and mobile devices) and attracted the bulk of funding in the years that followed.
However, raising capital during an economic downturn can be extremely difficult, with a graveyard of startups left behind.
Funding during a downturn
William Bao Bean, a general partner at SOSV and the managing director of startup accelerator Chinaaccelerator, says that venture capital investors “often have a herd mentality.”
“When things are bad, no one really does anything, and when things are hot, everybody's investing,” Bao Bean says.
“The best time to generally invest is when things are bad and the best time to exit is when things are hot.”
Although a global economic slowdown has an obvious impact on public equity investors, Bao Bean insists that earlier-stage investors are shielded due to a longer investment cycle over several years.
“The first thing that happens during any sort of a crisis or economic downturn is things just slow down measurably and significantly,” he says.
After years of growth and immense venture capital funding, China has experienced a funding slowdown - known as a “capital winter” - since late-2018.
Hundreds of Chinese tech startups were forced to shutter operations in 2019.
Bao Bean attributes this slowdown to the closures of underperforming venture capital funds and a drop in funding from the Chinese government.
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Despite a surge of global venture capital deals in 2019, Bao Bean says that funding has started to dip and attributes some of that to activity around the SoftBank Vision Fund.
“The SoftBank Vision Fund deployed a huge amount of capital very rapidly and that threw off the numbers in terms of total investment because they deployed $100 billion over a couple of years,” says Bao Bean.
“We also had some mega-rounds in 2018. That throws off the numbers.”
With the outbreak of the COVID-19 coronavirus, Bao Bean anticipates that funding will slow down significantly.
“The biggest thing to happen is the whole model of using money as a weapon and buying growth and mega-rounds and negative unit economics where you spend a dollar to make 50 cents - that is out the window.
“Now it's prove your model first, then raise money.”
Startups navigating a downturn
According to Phocuswright’s State of Travel Startups report in 2017, startup activity accelerated following the Great Recession, with more than 200 travel companies founded annually between 2011 and 2013.
Funding for travel startups skyrocketed since 2015, with investors poured billions of dollars into these new entities.
That’s great news for startups that survive the recession, but funding can be scarce before then.
Says Michael Coletta, manager of research and innovation for Phocuswright: “Times of financial crisis can cause incumbents to focus on bigger problems (survival issues) than what startups are doing.
“And meanwhile, strong startups are built since they must survive on a dry capital environment and they grow from more sound financial footing.”
Bao Bean echoes this sentiment about how some of the strongest startups are created during an economic downturn by saying that its “cockroach entrepreneurs who can survive through the tough times and come out to the other side stronger," he says.
“Basically, you get stepped on, you might lose a leg, but you get up and keep on going.
“[These] companies are hard to kill. What makes them hard to kill is that they can stay alive during tough times.”
With dried-up funding during a downturn, Bao Bean says that investors go through their portfolios to determine which startups are worth saving.
At that point, startups must make some tough decisions.
“If that means firing your entire team, that's what you do,” says Bao Bean. “The [startups] who come out the other end are the ones who act pretty quickly and not try to prolong the thing.”
Bao Bean adds: “I'm an investor in the travel industry and when people don't travel and people don't go to events, how do you survive through that?
“There's only one way - you cut your costs down to nothing.”
In the meantime, Bao Bean recommends that startups in an economic downturn go back to basics and focus on positive unit economics.
“You experiment and find something that works where you can spend a dollar and make it slightly more than a dollar, but not less than a dollar,” says Bao Bean.
“Once you have that, then you can start scaling up.”