What’s this all mean for entrepreneurs?

S&P 500 Last Week

So much has already been written about the forthcoming “nuclear winter” and what the current (and future) economic conditions mean for startups and entrepreneurs. I have a slightly different view and I’d like to share it.

Certainly we have entered a severely negative economic climate. With 70% of the GDP resulting from consumer spending, and consumers spending 1.4x their actual means (i.e. a 28% decrease in consumer spending is possible if credit remains tight), future earnings of consumer-focused businesses are likely to be impacted. In addition, with 18M of the 55M US mortgages now in negtaive equity (the mortgage is appraised at a value higher than the home is actually worth), we don’t know how homeowners will react and how that will also impact spending. So, even at a P/E of 13, the S&P 500 might still come down as earnings come down.

As others like Bill Gurley have written, the investors who fund VCs are unlikely to de-fund (redeem) their comittments to VC funds. So VC’s access to capital is not likely to immediately dry up. More likey, first-time funds and funds without positive historic track records will have difficultly rasing their next fund. This means, over the next few years, we are likely to see fewer funds around to invest in startups and lots of the “outsiders” like hedge funds and strategics are also likely to devote less capital to startups.

With less capital available, a few things will happen (actually, are already happening):

• Valuations will come down, commensurate with access to less capital and the liquidity windows being closed
• Terms will become more investor-friendly, meaning lots of downside protection for the investor
• Higher-quality deals will get funded, lower-quality will not

But, with continued work-force reductions as earnings decline, hopefully we’ll see more entrepreneurs with great ideas emerge. So, startups should focus on:

• Be frugal – require less capital, hire more slowly, pick cheaper office space, make money go farther
• Demonstrate traction – show evidence of business model traction before seeking first round funding
• Iterate until your idea is great – don’t bring something sub-standard to market
• Frame your concept by how it is complimentary to a challenged economic climate (reduced capital spending for target customers, etc.)

Remember, some of the best startups have emerged during post-bubble periods. These times force only solid ideas with outstanding teams focused on long-term success to rise to the top.