AI Funding Booms, Everything Else Swoons. A Look at the State of Entrepreneurship
There's no stopping startups, but they continue to face headwinds and fundraising difficulties. And the upcoming election could throw everything into flux.
BY SARAH LYNCH, STAFF REPORTER @SARAHDLYNCH
It was the year of the A.I. boom and the IPO drought, of still-too-high inflation yet startling economic strength, of return-to-office resolutions and resentment. Entrepreneurship remains alive and well in 2023. That said, headwinds, culture conundrums, and fundraising woes continue to challenge business leaders. Not to mention, there's an election in 2024.
During the pandemic, entrepreneurship spiked--reaching a 15-year high in the summer of 2020--but business creation remained "historically elevated through mid-2023," per a paper from Ryan Decker of the Federal Reserve Board and John Haltiwanger of the University of Maryland.
Naturally, not all these startups will survive: About 20 percent fail within the first two years. And from 2019 to 2022, business closures increased notably: from a rate of 2.9 percent to 5.2 percent, according to the Global Entrepreneurship Monitor from Babson College released in August.
Indeed, smaller firms have felt the crunch these past two years, as their optimism has remained below the 50-year average for the past 22 months, according to the National Federation of Independent Business (NFIB).
Thus, despite the ever-present entrepreneurial itch, daunting challenges continue to cloud the startup ecosystem. Here's the scoreboard for the state of entrepreneurship:
The Economy
This year, two issues have topped small-business woes: inflation and labor quality, according to the NFIB. Though both issues have eased from their 2022 heights, there's more to be done before that pessimism abates in earnest, says Holly Wade, executive director of the NFIB Research Center.
Inflation hit a four-decade high in June of 2022 at 9.1 percent, and the Federal Reserve unleashed a series of interest rate hikes into 2023. This July, rates reached a 22-year high.
The Fed's rate hikes seem to have worked. Inflation has since moderated, dropping to 3.2 percent in the latest report. It's positive progress, but still above the Fed's 2 percent goal. Thus, the central bank has signaled a higher-for-longer approach, and economists don't expect to see a cut until around the middle of 2024.
"That would be consistent with past hiking cycles, where on average the first cut comes about six months after the last hike," says Brett House, professor of professional practice in economics at Columbia Business School. "But because inflation has remained a bit more persistent than we might have otherwise expected, it may take longer than that to get a cut."
This isn't good news for small-business owners and entrepreneurs, as 22 percent say inflation is their top business concern and 30 percent are still raising their average selling prices--at an inflationary level, according to the NFIB report.
Similarly, the strong labor market--while cooling from the rapid job gains and record-high quit rates of 2022--is still putting pressure on companies to compete for talent. In October, 31 percent of owners said they had few qualified applicants for their open positions. Twenty-four percent reported none, which--according to NFIB data--is historically elevated.
And yet the labor market's continued strength and inflation's gradual cooling has helped create a booster for the economy: the resilient consumer. Consumer spending drove the 4.9 percent increase in GDP in the year's third quarter, keeping recession fears at bay and a soft landing on schedule. As a result, "owners want to hire and make money now from strong consumer spending," Bill Dunkelberg, chief economist at the NFIB, said in August.
But this growth won't last, Wade warns. Household savings are declining, student loan payments have already resumed, and wage growth is easing--a good sign for inflation, but also a sign of a slowdown in consumers' ability to spend. Retail sales already declined for the first time in six months in October. Thus, owners must consider "what to anticipate when that [economic growth] shifts and how to keep going," Wade says.
Staying on top of the economy's recent ebbs and flows has been a top concern for David Jarrett, the 39-year-old co-founder and CEO of Rootstrap, a software development consultancy based in Los Angeles. Working in the tech space, Jarrett's seen the impact of interest rates and cutbacks firsthand, as tech layoffs exceeded 240,000 this year.
After his company's explosive growth during the pandemic, Jarrett now finds his tech clients facing declining renewal rates and lower engagement, and the resulting belt tightening is impacting his business. Thus, Jarrett's focus is now on how to become a "better company if we can't necessarily become a bigger company over the next year," he says, upskilling employees on new technologies and tools.
Meanwhile, Awestruck--a marketing agency that specializes in tourism, hospitality, and entertainment--has been racing to keep up with the sizzling services sector. As "revenge travel" and entertainment spending boomed in the pandemic's wake, Awestruck brought on new clients, expanded offerings, and increased head count, from 19 people in 2021 to 51 now. Over the past three years, Awestruck grew 11,247 percent.
Fast growth might be every company's dream, but it can be a handful to manage. For Awestruck, the operational challenges in scaling up quickly were daunting, says Ryan Sprance, co-founder and chief brand officer. "It pushed us to the brink in a lot of areas," he says.
The key is to stay on top of that growth and quickly identify needs within the organization, he says: "Look at your organization every three months, and don't become romantic in your approach."
Access to Capital
The Fed's interest rate policy has a downside, too. It can threaten an entrepreneur's access to capital--the fuel they need to keep their business moving ahead. "Today, financing is just much more expensive than it's been in the past 20 years," says Neil Bradley, executive vice president and chief policy officer at the U.S. Chamber of Commerce.
Indeed, rising interest rates led to a big run-up in the yields on medium- and longer-dated U.S Treasuries, which are directly tied to lending. "They act as the benchmark for commercial and corporate lending rates to small, medium, and larger businesses," House says.
Small businesses are striking out on getting loans from large banks as lending standards tighten, and the failures of Silicon Valley Bank and Signature Bank made funding for smaller and regional lenders more expensive, resulting in higher borrowing costs there, too, House adds.
Thus, financing remains a top concern for entrepreneurs, even months after the SVB collapse, and "sustaining a business based on borrowing will get harder in 2024," predicts Mahdi Majbouri, a professor of economics at Babson College. "Those rates will not go down for a while."
And if you thought VC funds would be any easier to come by, think again. The funding spree of 2021 is now a distant memory--funding has declined for the past five or six quarters, per Crunchbase.
Zach Olson raised a seed round this year for Treads, his Park City, Utah-based A.I.-powered mobile app and subscription that aims to simplify car management and maintenance, covering oil changes, tire repairs, and more. The 41-year-old founder and CEO knew higher interest rates would be a challenge, and they were: He spoke with about 30 funds before ultimately closing his $4.6 million seed round in August. "It was still a five-month process for us, which felt like eternity," Olson says.
Entrepreneurs looking for VC funds right now need to be extra intentional about talking to the right people to maximize their chances, he says: "Do your due diligence and your homework on who's actually writing checks and who's just taking meetings."
For entrepreneurs of diverse backgrounds, the funding slowdown is especially disconcerting: In 2022, just 1 percent and 1.5 percent of funding went to Black and Latino founders, respectively, and 1.9 percent went to women-founded teams. Now, with funding squeezed even further, diverse founders could be in even more jeopardy.
Rosena Sammi, a female founder of color, has been trying to raise $500,000 this year for her New York City-based sustainable luxury jewelry curation, the Jewelry Edit. The 49-year-old has heard VC funds say again and again that if she'd pitched them two years ago, she may have had a better chance. Sammi senses that the bar for founders like her is even higher now. "We often as women of color have to work 10 times as hard as some other folks to get our point across or to be seen or to be heard, to get that meeting or to get that second meeting," she says. As a result, Sammi has started to look toward more angel investors who can connect with the company's mission.
Similarly, Jonathan Marcoschamer, the 47-year-old CEO and co-founder of the meditation pod company OpenSeed, found VC fundraising increasingly challenging. So, within the past year, he's turned his efforts toward crowdfunding. He's already raised $50,000 without any marketing spend, and he's aiming to raise $1 million by Q1 of next year.
The challenges of accessing capital right now reflect a capital market system that "doesn't meet people where they are," argues Victor Hwang, founder and CEO of Right to Start, a nonprofit aimed at expanding entrepreneurial opportunity. "It's like going into an ice cream store with two flavors right now: venture capital or banking. And really, most businesses don't fit either."
That said, he sees more flavors becoming popular, like revenue-based investing, profit-sharing models, and crowdfunding.
Even with the capital challenges present today, Olson is optimistic for the startup community: "There's something in probably every entrepreneur's blood ... a push to work through any challenging problem, and fundraising is just a small piece of any company."
The Future of Work
In addition to fighting assorted financial obstacles, company leaders continued to navigate the new world of work this year--one irrevocably shaped by the pandemic.
Companies largely landed on a hybrid approach in 2023, as approximately a quarter of working days in the U.S. are now remote, according to the latest data from WFH Research. Office occupancy, meanwhile, rests around 50 percent, according to the security company Kastle Systems.
Thus, it seems companies have settled into a new status quo--one that's harder to break the longer it exists, says Joe Galvin, chief research officer at the executive coaching organization Vistage. But Galvin says the big question for entrepreneurs right now is: Does the status quo work? And do they need to make a shift? "Do they pull people back, and can they make that stick with a workforce that still has flexibility and opportunity to move? And will that be a driver for the business?" Galvin says. "Or do you move the other way and become even more flexible?"
It's clear that company leaders are still trying to fine-tune solutions that both suit their corporate culture and maintain productivity--and it doesn't help that the research on the productivity of remote work is mixed, as outlined in a New York Times report. But the success of a remote workplace hinges, at least in part, on a company's specific approach, Stanford economist Nick Bloom told the Times.
At Super.com, a tech company "at the intersection of fintech and commerce" based in San Francisco, co-founder and CEO Hussein Fazal has committed to a fully remote workplace--an approach taken by approximately 21.4 percent of companies.
Fazal, 42, wanted to attract the best talent, regardless of location, but knew it would take certain steps to make this model the most effective. For Fazal, that means documenting everything, establishing very clear objectives and key results, and hosting numerous offsites with different groups within the company.
In addition, the company offers twice-per-quarter "recharge days" when everyone is off--Fazal's answer to the four-day workweek, which--despite recent research espousing its benefits--he disagrees with. "When you're working with external partners, which are working a five-day workweek, that ends up slowing a lot of things down," he says.
Small Girls PR, a New York City-based communications firm, has had a hybrid schedule for two years now, with two in-office days and three work-from-anywhere days. But co-founder and CEO Mallory Blair, 35, and her team have developed some remote-friendly approaches for their workflow, such as asynchronous brainstorming templates and "Slack storm" sessions, where team members simultaneously contribute to a Slack channel brainstorm and feed off one another's ideas.
"Those are both inventions that we've had to create in response to trying to build equity and trying to make sure that every voice is heard--and is heard at the same cadence whether they're in the office or not," Blair says.
All the while, there's another force fundamentally changing how many teams are working: generative A.I. While the technology has been developing for years, ChatGPT's public release last November made the technology easily accessible, sparking a wave of A.I. exploration. Now, one in four small businesses are using A.I., according to a recent U.S. Chamber of Commerce report.
The technology's impact on the workforce is expected to be great. Earlier this year, Goldman Sachs estimated that generative A.I. could automate 300 million jobs. Not even CEOs are safe from the disruption: A survey this year found that 49 percent of CEOs believe that A.I. should automate or replace "most" or "all" of their job.
For startups, in particular, this technology could be hugely helpful, says Hatim Rahman, assistant professor of management and organizations at Northwestern University's Kellogg School of Management. For instance, it could accelerate the ideation and prototyping stages--where many entrepreneurs struggle--and later in the development, it could help founders more quickly parse customer feedback and surveys, he says.
Still, there are a number of risks that entrepreneurs need to be aware of when using the technology, Rahman adds, including copyright and plagiarism. There's also the potential for biases and hallucinations. Thus, entrepreneurs must figure out where the technology can augment operations, and where humans still need to be in control, Rahman says: "The most powerful combination is still a human-A.I. collaboration."
The next wave, he says, will be more customized A.I. for companies--but he adds that organizations will soon discover that this is an expensive and often complex process.
The team at Double, a Brooklyn-based flexible assistant service for executives, started to brainstorm and develop its own specialized A.I. in the first quarter of this year. Because of the company's small size, co-founder and CEO Alice Default didn't want to waste time developing a tool that a larger tech firm would surely generate. Instead, Default, 32, focused on: "What is the A.I. that no one else is going to be building? ... What is the thing that is going to make us different?" she says.
In September, the team launched the first version of their A.I. feature, Mingo: a delegation tool to help executives and their assistants stay in sync. Through this development process, Default says that she learned the importance of keeping up with the latest A.I. news and designated a member of her team to provide a biweekly A.I. report. "You have to stay super, super close to the tech," she says.
Policies and Politics
This emergence of A.I. technology is expected to beget new regulations--and the Biden administration already released an executive order on October 30 establishing "new standards for A.I. safety and security." But that's not the only regulation under way this year that could impact entrepreneurs and their businesses.
First, how startups hire may need to change. In New York, a salary transparency law went into effect in September requiring that employers with at least four employees disclose the salary ranges for job opportunities, and that's expected to spread, with similar laws already in effect in Colorado, California, and Washington. New York City also passed a law this year regulating the use of automated employment decision tools to hire or promote candidates.
And for companies committed to hiring diverse candidates, the Supreme Court's decision to strike down affirmative action policies at two universities has made some leaders concerned about the future of their diversity, equity, and inclusion initiatives, says Mandy Price, CEO and co-founder of Kanarys, a Dallas-based tech platform aimed at helping companies improve DEI.
But Price affirms that the laws around corporate environments haven't changed. That said, she recommends that companies consider the language they use and clearly describe the goal of their programs. Kanarys even released an assessment to help companies determine their risk of litigation in the wake of the Supreme Court's decision.
Other legislation is pending and could have significant consequences for businesses. For instance, the Federal Trade Commission has proposed a rule to restrict noncompete clauses. The Securities and Exchange Commission proposed a rule on climate-related disclosures that could require companies to report emissions data. While the SEC rule currently only applies to public companies, the California law enacted this year applies to both public and private companies that meet certain requirements--and demonstrates what could be possible if other states follow suit.
There's also the "Basel III Endgame" proposal from the Federal Reserve, which would set new and stricter standards for capital requirements, leading a group of Republican senators to argue that it would "create severe, adverse impacts on the entire U.S. economy, from everyday American consumers to the small businesses that are the backbone of our economy."
But many of these proposals and pending pieces of legislation may be up in the air, thanks to the upcoming election year, Bradley says: "The environment that we're in, where political power and the direction of policy just seems to be constantly shifting, really creates a lot of uncertainty for business in general, but particularly for startups."
Political divisiveness, in particular, can have a real impact on the entrepreneurial environment, says Kent Syler, professor of political science and public policy at Middle Tennessee State University. He points to Moody's lowering its ratings outlook on November 10 in response to the congressional chaos over the deficit and the threat of a government shutdown, which was again averted--until next year.
"When you see Congress unable to pass the budget, you see the deficits continuing to increase and the cost of capital going up ... government is not doing the basics of what they need to do, which impacts entrepreneurs and the economy," Syler says. Plus, how politics play out on the global stage--with wars in two parts of the world and an ongoing trade war with China--could impact world markets, Syler adds.
"There are headwinds--there's no question about that--and, in particular, headwinds from government," Bradley says. Yet, looking toward the next year, he's hopeful: "It's also equally true that there have never been more avenues for people who have the entrepreneurial bug."