Startups typically have a tougher time raising money during recessions. But that’s not the only reason they struggle during downturns, according to new research — they also have a tougher time hiring. That’s because job seekers prefer safer options and so are more likely to apply for jobs at incumbent firms. This, alongside the difficulty fundraising, makes growth even tougher for startups during recessions.
Startups are an important catalyst for innovation and economic growth. Yet these important firms are also more sensitive to economic fluctuations than their more established counterparts. While the vulnerability of startups to economic downturns has been well documented, the reason for this vulnerability is not entirely understood.
Conventional wisdom suggests that startups are vulnerable to recessions because they struggle to secure financing during such times. However, the Covid-19 downturn upended this narrative. Venture capital funding surged in 2020 and 2021, contrary to expectations. That raises the possibility that funding isn’t the only factor that makes recessions so hard for startups.
We sought to shed new light on how employees choose between startups and established firms, which are increasingly competing for the same talent. Understanding employee preferences and how they change with economic conditions is critical to understanding incumbent-vs.-new-entrant dynamics. Our research offers an alternative hypothesis rooted in the labor market: Startups find it challenging to attract talent during downturns due to job seekers’ inclination toward larger, more established firms.
Testing this hypothesis is tricky. If startups hire less during a downturn, is that because workers are reluctant to join them, or because startups are reluctant to add workers to their payrolls?
To specifically detect changes in workers’ interest in startups, we partnered with AngelList Talent, the leading job-recruitment platform for entrepreneurial firms. Through this partnership, we were able to look at changes in job search and application behaviors during the most recent recession: the Covid downturn. Our findings reveal a “flight to safety” among job seekers. During the downturn, they increasingly directed their searches and applications to larger, more established organizations. Notably, higher-quality candidates, measured by experience or education, were particularly inclined to shift away from startups.
This shift had a tangible impact on firms. Less-established startups received fewer job applications, particularly from high-quality candidates, leading to a decline in the talent pool available to them. This decline happened even within the same job vacancy over time. That means it’s not just that startups demand less labor during recessions — even for existing job postings, hiring got harder. While startups faced challenges in filling their job vacancies, more established firms benefited from this shift in job seeker interest, experiencing greater success in attracting talent.
What drives the flight to safety by workers? There are two possible explanations. First, workers may become more risk-averse across the board during recessions, amplifying their desire for job security. Second, workers could change their view of how risky different employers are. Our findings point more toward the former, because both growing, successful startups and less-successful ones saw a decline in applicants. That’s more consistent with an across-the-board decline in risk tolerance, rather than a reassessment of how risky specific employers are. (Because if that were the case, the struggling startups would presumably take a bigger hit than the more successful ones.) Thus, our results are more consistent with the idea that increased risk-aversion drives job seekers away from all startups — regardless of their quality.
One might question whether these findings are applicable beyond the unique circumstances of the Covid downturn, which may have been more extreme than other downturns. However, we show that the magnitude of the decline in economic expectations during that time period aligns closely with declines observed in past recessions. Moreover, we conducted rigorous tests to rule out Covid-specific factors that might explain our results, such as a shift in job-seeker preferences toward employers who could offer remote work or strict health protocols.
It has long been recognized that startups grapple with financial constraints during periods of economic turbulence. The Covid recession was unusual in that most recessions lead to less venture capital funding, not more. Our research adds a new dimension to this understanding by highlighting that human capital — another vital resource for startups — also comes under significant strain during downturns, leading to a “double whammy.”
Historically, policy interventions have been primarily geared toward alleviating financial pressures on startups but have ignored the talent crunch they face. This talent crunch poses a considerable risk, potentially undermining a startup’s ability to survive and compete against larger, established firms. As we navigate through economic uncertainties, a more nuanced understanding of these forces is essential for both policymakers and entrepreneurs.