In my last column I revealed four reasons why the economic recovery since 2008 has produced fewer startups than those in the past, and the implications of that decline on economic growth. This week I’ll explain why companies that survived since 2008 are better off than before, including how the decline in startups may have helped them.
As great as startups can be for macro-economic growth, they can also be messy for a couple of reasons.
1. The risk for startups is extreme and the total cost can be prohibitive. Founders put into their startup more time, energy, emotion and capital than they ever thought would be necessary. And since most fail, the total cost in the aggregate to launch startups that succeed is enormously underestimated.
2. Startups disrupt the price structure. While trying to get a foothold in the economy, and before they know what it takes to capitalize business growth, a classic startup practice is to enter the market with low prices. This sounds like honest competition and good for customers. But established companies do know what they must charge to sustain their business. And even after a startup runs out of capital and leaves the marketplace, damage to the price structure remains.
Small businesses that survived the 2008 financial crisis and aftermath did so by establishing exactly what it takes to run their business in the leanest and meanest terms. One of the consequences of this trial by fire is that these firms have emerged in better shape than after previous significant economic downturns. Here are six reasons:
1. Fewer startups. There has been less price structure disruption since 2008.
2. They deleveraged. Surviving small businesses paid off debt and, as a sector, refused to add new debt (NFIB Index). The banking industry has confirmed an unprecedented lack of business loan demand, which is ironic in that interest rates have never been lower.
3. Stronger balance sheets. Reduced debt, plus disciplined merchandising, inventory and supply chain practices that prevent inventory creep, all improve important financial ratios.
4. More gross profit. Rigorous expense control relieves pressure on gross profit from flat sales and pricing pressure.
5. Improved capital and cash. All of the above practices contribute to profitability, which in the current environment is more likely to be retained. Retained earnings push capital and cash in the direction of sustained operations and long-term success.
6. More creditworthy. Firms that grow beyond organic funding will be more worthy of credit and preferred terms and rates.
When the next expansion does happen, surviving firms will be poised to more profitably take advantage than ever before.
Write this on a rock …The economy needs startups, but existing businesses, not so much.