The jury has historically been out.
Some economists have argued that recessions are good for startups. As larger, inefficient firms fail, they say, there’s more space for new, more agile players to enter the playing field.
Others believe that downturns hurt entrepreneurship. They point to an increase in risk aversion among investors when times are hard, a tightening in the flow of finance to new ventures that stymies growth.
Access to Talent for New Ventures
But what about talent? More than any type of business organization, startups depend on the quality of their human capital to grow. Founding teams and employees are typically small or limited, with each individual playing a strategic role in the effort to scale up. For this reason, it’s often argued that human capital, more than funding, is key to startup success.
So do downturns make it easier or harder for startups to access the talent they need?
Shedding new light on this is research by Darden Professor Ting Xu. Together with Richard R. Townsend of the University of California, San Diego, and Harvard Business School’s Shai Bernstein, he has looked at the impact of the COVID-19 recession on entrepreneurship in the U.S. through the lens of hiring. And they have identified significant shifts in job-seeker preferences and activity that suggest there could well be a problem when times are tough.
“We were interested in what the pandemic has done to new ventures in the U.S.” says Xu.
“We hypothesized that rising unemployment could make startups more attractive to job hunters; that they might be more open to smaller, riskier firms precisely because they have less to lose during a recession.”
The opposite, he says, could also be true: that skilled workers looking for opportunities are more inclined to “fly to safety” in hard or uncertain times, preferring opportunities with larger, more established organizations to mitigate personal risk.
An Exploration of the Question: The Methodology
To explore this, Xu and his co-authors pulled a large proprietary data-set from AngelList Talent, the largest online job platform that connects startups and entrepreneurial firms with potential job seekers.
They looked at job seekers’ search and application activities between February and June 2020. AngelList also provides a wealth of details about the quality of each applicant: academic and professional qualifications, skills and years of experience, hich are synthesized into a quality rating by the platform.
“We wanted to capture any changes in job seekers’ behavior to see whether they continued to search and apply for jobs with smaller, riskier companies at the start of the pandemic, or if they were looking elsewhere,” says Xu. “We were particularly interested in whether high quality candidates have shifted their search, given the importance of skilled workers to startups.”
Xu and his colleagues first analyzed 3 million searches conducted by job seekers on the platform, focusing on their search filters, including firm size (number of employees), location, salaries, types of contract, roles and sectors.
“You see a clear and drastic shift in behavior around late March. Applicants started to look for jobs with firms that are 25 percent bigger than those they were considering before.”
And that wasn’t all. When the researchers dug deeper into those search parameters, they discovered that, simultaneous to flying to larger firms, people were broadening other search criteria to include lower-paid roles, part-time jobs, and jobs in different locations and industries.
“In other words, job-seekers are willing to make compromises on other job dimensions in order to avoid working at a startup,” says Xu.
In fact, Xu and his colleagues found between mid-March and June 2020 a drop in job applications to small and early-stage startups of 14 percent, while this drop is only 4 percent for large, late-stage firms.
“These drops happened not just within a firm over time, but also within a given job posting, suggesting fewer applications is not driven by a weaker labor demand by firms”, says Xu.
Then there’s the issue of quality.
Cross-referencing applicants’ quality scores, Xu and his colleagues found that the drop in applications to young startups are mainly driven by high-quality candidates. “It’s the high-quality candidates that are abandoning young ventures, not low-quality ones”. As a result, they found that small startups experienced an 8 percent drop in applicant quality, while mature firms barely saw any applicant quality changes. “And this is worrying,” he says.
“We know that entrepreneurship is a powerful engine for innovation and job creation in the U.S. Downturns are precisely those times when economies are in greatest need of new ideas and the kind of corporate agility to pivot and adapt to change.”
“But our study shows us very clearly that in this recession, these types of companies are really struggling to recruit. And importantly, they’re struggling to hire the type of high-quality human capital that their viability and growth depend on.”
Challenges: A Double Whammy
“We’ve known for some time about the challenges founders have finding finance in depressions, but now we see the trouble they face in recruitment too. Combined, these present a ‘double whammy’ that can put founders out of business when there are dips in the economy — at precisely those times when you want to see more entrepreneurial activity.”
There are measures that founders might take to attenuate some of the difficulties in hiring, he says. One is to leverage digital flexibility that has been accelerated by COVID-19.
“Entrepreneurs might want to be flexible about the types of contract they offer. They may want to embrace things like remote working, or flexible hours or other perks.”
“Building equity into remuneration packages is another option for cash-strapped startups to look more attractive to job-seekers relative to larger firms.”
At the macro-level, there is a clear imperative for policymakers to rethink the allocation of subsidies, he says. Above all, government needs to look at entrepreneurship through the lens of labor market.
“Until now, U.S. policymakers have been focusing on finance and R&D when looking at how to support entrepreneurship. But we’ve under-appreciated the roles played by the labor market. Our recommendation would be that policymakers look for more creative ways to mitigate the labor market risk surrounding entrepreneurial failure. One approach might be to improve social security nets so that job seekers don’t view young firms as too much of a risk when times get tough.”
Ting Xu co-authored “Flights to Safety: How Economic Downturns Affect Talent Flows to Startups” with Shai Bernstein of Harvard Business School and Richard Townsend of the University of California, San Diego, Rady School of Management.