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The Impact of a Recession on Startups and Small Business

November 24, 2020   Daniel KatzPhilip Evangelou

A recession is a period of downturn and decline in a country’s economic activity. There is no golden rule as to how long a recession lasts. However, the effects of past recessions are still felt by businesses all over the world to this day.

This article will discuss the nature of recessions, and how the recession impacts Australian startups and small businesses.

What is a Recession and How do They Occur?

A ‘business cycle’ reflects the peaks and troughs in economic output and activity. When in a trough for a prolonged period of time, this usually reflects a period of economic decline.

Here are some of the main, historical catalysts of past recessions:

  • A Sudden economic shocks is an unexpected issues that cause strenuous financial struggle. These occur without warning, like the COVID-19 pandemic.
  • The interrelationship between inflation, deflation and interest rates can also increase the chances of a recession. Firstly, inflation and deflation reflect the rise and fall of prices relating to goods and services over time. To control this, central banks either raise, or lower, their interest rates to regulate the demand of goods by consumers, and the supply of money in the market. Where this is problematic is when there are instances of excessive inflation, or excessive deflation. Here, history dictates that the response of rapidly increasing and decreasing interest rates has resulted in recessions.
  • Excessive risk-taking, borrowing by banks and investors, and regulatory/policy issues are all key factors that led to GFC.
  • Lastly, technological advancements can lead to a recession. Here, advancements in labour-saving technology has been seen to eliminate entire job sectors.

How will this Impact Small Businesses?

Unfortunately, small businesses normally suffer substantially during recessions. While large businesses and corporations may have large capital assets and cash reserves tied up in overseas ventures, it is unlikely that small businesses will be able to afford such luxuries. Thus, small businesses are normally hit harder by recessions. This is because recessions lowers their chances of accessing external sources of capital.

An example of this difficulty would be attracting investors. Here, a prudent investor, who would also be experiencing the effects of the recession, would stray away from investing in a small, struggling business who cannot ensure a return.

How will this Impact the Startup Industry?

Though it may seem that small businesses and startups are in the same boat, there are many who support the inference that economic downturns are the best time to get into the startup industry. Here are some reasons why it may be wise to get into the industry:

  • If you are able to self-fund your startup and get it off the ground, it may attract investors during a recession. This is because you will not be deeply indebted. This may also be beneficial after the recession, as investors will invest in startups who were able to manage on self-funding during the recession, and not accepting outside capital.
  • Less of a need to hire employees, as a startup only needs a small team.
  • Though there is less of a need to hire employees, recessions increase the number of talented workers who are seeking new opportunities and experiences.

Although the above points can prove to be extremely beneficial, these advantages are dependent on the severity of the recession, and the specialty of the startup. In many cases, startups may experience the same hardships as small businesses.

How can you Protect Yourself?

In a recession, all businesses – startups to corporations – are affected to some degree. Here are some ways to mitigate the effects:

  • Staying informed, not just with regards to Australian economics and politics, but on a global level as well. 
  • Do not take on excessive amounts of debt and risk.
  • Prepare and utilise budgets to ensure you are not overspending.
  • Diversify your investments.
  • Prepare and establish multiple streams of income.

To Sum Up

Recessions can detrimentally affect small businesses and startups. COVID-19 has substantially impacted over half of Australian businesses. However, as this article explains, starting a business during these times is not a ludicrous idea.

If you need any assistance in legal matters caused by the recession, our commercial lawyers are here to help! Just call us at 1300 337 997.

About Daniel Katz

Daniel KatzDaniel is a legal intern at OpenLegal, placed in our legal content team. He is currently studying a Bachelor of Laws at the University of Technology Sydney. Daniel's interest lies in economics and media/startup law.

About Philip Evangelou

phillipPhil is a director at OpenLegal. He has over 16 years experience working in private practice and in-house counsel in Sydney and London, giving him expertise in employment law, IP, finance, leases, dispute resolution, insurance and contracts.