By: Kumaraguru Verasamy
Head of Strategic Research, Xeraya Capital
Countries the world over are bracing for a recession. While some say it’s on the way and others say it’s already here, it will impact every industry and sector, including startups that are looking to disrupt these spaces.
The 2023 Recession – How Bad Could it Be?
According to Morgan Stanley, the recession — should it come to pass — will likely be shallower and less damaging to a business’ earnings than previous ones. One of the key reasons why is that unlike the Great Financial Crisis of 2007 and 2008, excess liquidity will most likely be the catalyst behind this recession. The high levels of COVID-related fiscal and monetary stimulus that were brought into homes and investment markets are contributing to inflation and sparking speculation in financial assets.
This difference is critical for investors to be aware of, because historically, earnings are more modest during inflation-driven recessions.
The Impact of A Recession – Predictions of the IMF
According to a recent article by UN News, there are 4 issues driving us toward a recession in 2023:
1. Higher-than-expected inflation in the US, China, and the biggest European economies.
The world over, financial conditions are becoming tighter. For instance, the US, households have reduced purchasing power and there is a tighter monetary policy in place that will drive the country’s growth down to 2.3% in 2022 and 1% in 2023, according to current predictions. In China, the slowdown has been worsened due to continued outbreaks of COVID-19 and subsequent lockdowns; as with other countries, China is also still feeling the impact of the Russian invasion of Ukraine. In Europe, economic growth has been reduced to 2.6% this year and 1.2% in 2023, also due to the impact of the Russia-Ukraine conflict and a tighter monetary policy. These fluctuations in the world’s economic powerhouses has led to a contracted global output in Q2 2022.
2. Inflation on a global scale.
Rising food and energy prices are two catalysts for the world seeing increased inflation rates despite the global economic slowdown. Advanced economies should expect to see an inflation rate of 6.6% while emerging markets will see a rate of 9.5%; furthermore, this period of rising inflation is expected to remain around for longer. Another key cause of broadened inflation is the impact of cost pressures that come from disrupted supply chains and tight labour markets.
3. Geoeconomics fragmentation.
A recurring theme impacting the global economy this year has been the Russia-Ukraine conflict. If it continues, it could end European gas supply from Russia. Furthermore, the world is already grappling with rising prices, which could give way to food insecurity and social unrest. In terms of inflation, it could remain high for longer if labour markets remain tight or if inflation expectations are too optimistic and costly.
4. Risks to macroeconomic stability.
Aftershocks of the current economic situation are already being felt globally. Advanced economies are withdrawing monetary support while developing ones are raising interest rates. This synchronized monetary tightening exercise has never before been seen in history, and will cause global growth to slow next year and inflation will decelerate. As widely reported by the media, tighter monetary policies have economic costs, but the crux of the issue is that delaying it will only make it worse for everyone.
With all of these factors in play, the IMF’s recommendation for multilateral cooperation stands true: countries must band together to help each other with issues such as climate transition, pandemic preparedness, food security, and debt distress, because this is the only way the planet will be able to mitigate and improve the global economy and reduce the risk of geoeconomics fragmentation.
Startups and the Recession
All of these economic concerns will impact every industry and sector, and businesses of all shapes and sizes (including startups) will feel the impact. Key effects of a looming recession for startups could encompass the following consequences:
1. Angel and Seed Deals Still Happen, But Funding Goes Down
A common misconception is that funding for startups freezes up when a recession is in play; however, the truth is that we will likely see deals continue to happen but the amount of the funding will be reduced. This is because VCs and other investors that are in the early-stage rounds will continue to put their belief and their capital in startups because they themselves have riskier profiles, and there is a general consensus that a startups won’t necessarily shut down during a recession. However, in order to mitigate some risk, investors will likely decrease the amount they invest in a startup.
2. Limited Partners (LPs) Become Risk-Averse
The last few years, or even the previous decade, has seen some astronomical amounts of money being poured into VC funds. However, history shows that VCs will likely face a drop in capital from LPs during a recession. As such, VC will be harder to access, and a startup may have to take actions such as providing more equity during rounds, anticipating smaller rounds, and an earlier-than-anticipated demand for performance from their VCs in the form of financial and operational metrics.
3. The Rise of Default-Dead Startups
As with any small business, Series A startups or lower may suffer during a recession; due to cost-cutting and the inability to raise funds that will keep the business afloat. As a result, the drive to ensure performance of their business will become a priority, and the time period to do so will be drastically reduced in a recession scenario. Startups should therefore strive to foster leaner operations and focus on profitability in order to survive.
Conclusion: The Recession of 2023 – Not All Bad News
On a global scale, it is clear that multilateral cooperation, as well as the opening of dialogues on trade and supply between nations will be the key to mitigating the worst possible effects of this impending recession. For startups, the way ahead is to prepare for uncertain times by scaling down operations and focusing on profitability. Furthermore, just like a myriad of crisis situations, some opportunities can be found for growing companies. Later-stage and/or well-funded startups can turn their attention to buying out competitors, and for all startups, no matter what funding series they’re pursuing, there is the possibility of collaboration within the industry they’re disrupting; all it takes is a conversation with the right partner, which in turn could lead to an expansion of their business, even during a recession. Bad times allow us all to build resilience and opens doors to possibilities that we might not even consider during a period of economic stability.
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