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Startups in a Downturn

By SPENCER E. ANTE, BUSINESSWEEK.COM
Posted: 2009-03-05 15:30:10
Filed Under: Small Business, Business Ideas, Small Business Funding, Starting a Business
BusinessWeek.com

Entrepreneurs who helped build their startups into tech stalwarts -- companies like Cisco, Oracle, and Google -- share lessons on how to thrive during tough times.

Stock charts

December 1987 was no time to be raising money for a startup. Computer engineer Len Bosack was trying to attract funding for a young enterprise called Cisco Systems. But the stock market had just crashed and the Dow Jones industrial average had plummeted 40% since October. Gun-shy venture capitalists either didn't get the newfangled technology or deemed it too risky.

Making matters worse, Bosack was running low on the savings he had used to bootstrap the business, and competition was gaining steam. It wasn't until this 75th meeting that he found a receptive audience. The willing financier was Donald Valentine of Sequoia Capital, a venture capital firm in Silicon Valley. On Dec. 14, two months after Black Monday, Sequoia invested $2.5 million in Cisco. "Valentine's reasoning was pretty simple," recalls Bosack, now CEO of telecom gear-maker XKL. "It doesn't matter what they are. They are selling stuff in a bad market. With a little bit of capital and more experienced help they should be able to do better."

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    Better is just what Cisco did. By the time of its initial share sale three years later, in February 1990 -- during a recession -- the maker of telecom networking equipment was worth $224 million. Within a decade, Cisco Systems had become one of the world's most valuable companies.

    Greatness Can Emerge from a Slump
    Today, some of America's sharpest financiers and entrepreneurs say Cisco's story holds a profound lesson easily forgotten amid financial turmoil: Great companies can be built during tough times. "For us, Cisco is always the company we think of when we think about bad times," says Michael Moritz, a general partner with Sequoia Capital who was a young associate when the firm made its investment.

    Cisco is just one example. In the history of technology, many other great companies either were founded during downturns or forged business models during bad times. In 1939, at the tail end of the Great Depression, two engineers started Hewlett-Packard in a garage in northern California. During the recession of 1957, Digital Equipment, the first computer company to challenge IBM, set up shop in a Civil War-era wool mill, sparking a high-tech boom in Massachusetts. "It makes sense to do research and development counter-cyclically," says Tom Nicholas, associate professor in the Entrepreneurial Management Group of Harvard Business School. "Recessions can be really useful strategic opportunities."

    Entrepreneurs, financiers, and historians point to several reasons for this phenomenon. For starters, everything is cheaper during a downturn, including the cost of labor, materials, and office space. There's less competition, both from incumbents that are trying to put out their own fires and from startups that find it harder to raise money. And the tough times force entrepreneurs to work on their business models earlier, so they end up reaching profitability more quickly than when money comes cheap. "The companies are tougher because they were tested during a tougher time," says Carl Schramm, president of the Kauffman Foundation, an organization that promotes entrepreneurship.

    In fact, Silicon Valley itself was largely created during the nasty recession of the mid-1970s. During that decade, entrepreneurs and financiers built companies that pioneered three entirely new industries: video games through Atari, personal computers with Apple, and biotechnology thanks to Genentech.

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