Pros, Cons of Starting Tech Firm in Recession

Ted Sullivan last summer was kicking around the idea of starting a company that married his tech experience with his love of amateur sports.

He and partner Kiril Savino worked on creating a prototype while both held full-time jobs. Everything changed in October, when, like many, he was "downsized" because of the recession. Rather than seek another full-time position, Sullivan decided to launch Gamechanger.io, the score-keeping and stat-management application, despite the tough times.

"There is no price on the freedom of working for yourself," he explains. "I may have dialed down on anything that was frivolous. And I may be working more than I ever had. But it makes it all worthwhile, even if I'm eating one level above Ramen."

Sullivan isn't alone in launching a tech company in the recession. But before you write that first line of code and think you'll be another Cinderella story like Microsoft ( MSFT) or Hewlett-Packard ( HPQ), here are 11 tips to remember:

Go with what you know: Unless you're sitting on a winning Mega Millions lottery ticket, you can't afford to burn through your life's savings or other people's money. Start with a business idea in a space you're familiar with. You'll make fewer rookie mistakes. It'll also be easier to network for advice and to raise cash, says Richard Weede, vice president of communications for rentacarnow.com.

Partner up: They say two heads are better than one. Know what you bring to the company and find someone who makes you a more rounded team. Offering someone else equity in the company is also the cheapest way to get labor. Sullivan came up with the vision for Gamechanger.io, but Savino is building the application. "If I had brought on contractors to even get to the fundraising stage, I would have needed cash right off the bat," he says. "But by working together, we had a rough alpha product to show investors last summer."

Recession-proof the idea: Getting funding will be easier if you have a business that fits with today's tough times. An e-commerce Web site selling high-end luxury goods isn't going to win over many investors. But an idea about giving people free advice on what cars to buy got TrueCar founder Scott Painter $4 million in funding.

"You have to articulate how much money you need, what you need it for, and how long it will take to achieve," says Painter. "You still have to speak 'investor.' They still want to know they will get their return. They are looking for recession-proof ideas."

Multiple revenue streams a must: Another way to ensure survival during a downturn: be more creative with finding ways to make money. The old model of relying on ad dollars doesn't fly anymore. Midway through its launch, Geodelic, a location-based mobile application network, had to add an enterprise part to its business model, where it works with places like hotels and theme parks to help them create personalized mobile experiences using its platform.

Money games: Venture capitalists and angel investors may be harder to find but they're out there, willing to invest in the right start-up. Yet the hurdles are higher. Where once an idea was enough to open the coffers, investors now want a working prototype. Some even want paying customers.

In addition, investors will give you less money. So, unless you have a long track record of successful start-ups, expect to bootstrap for some time. Even when you do land seed money or series A funding, be as lean as you can. Andy Firoved, CEO and founder of Homeowner Toolbox, didn't pay himself for 10 months after he and a fellow founder self-financed the online loan modification service at the beginning. Even selling stock to some investors, he's still paying himself as little as possible.

Stakes are high: Starting a company is a huge risk, personally and financially. However, with tech companies, the gamble can be greater because the market changes at warp speed. PeeWee PC, which builds computers and software for children, took a risk and made products for Microsoft's Vista. "Vista was an utter failure," says founder and president Oscar Ferreira. "That was an obstacle that we had to overcome and rethink."

Meanwhile, Geodelic is betting its future on the success of the Linux-based mobile operating system, Google's ( GOOG) Android. The Los Angeles-based tech firm made the decision in December, long before it knew the system would take off.

"In the last 15 months, we've gone through a couple of cycles of technology," says CEO and founder Rahul Sonnad. "There is no other market that within a year can radically transform itself on a continuous basis. Even the mobile space is a faster curve."

But gains can be huge: One benefit of the recession is that there is likely to be less competition. Established companies are retrenching. Small start-ups can carve out a niche. And if you are good at reading trends, you can find a space that is just beginning to explode. Sonnad says he's surprised by the lack of "incumbent" players in the mobile space. "I would have guessed two years ago that there would be more. So we can be a player."

Time is money: Since investors are choosier than ever, cast as wide a net as possible for funding. When you get your foot in the door, try to push for an answer sooner rather than later. The reality is it will take time to scare up some funding. Where once it took Painter, who's raised close to $1 billion in venture capital for companies like CarsDirect.com and Pricelock, 60 days, it will now take him four months. As a result, the time between funding can also be shorter, depending on your burn rate.

Painter also recommends that you seek funding that will last at least one year. Building a tech product always takes twice as long as you think. When he talks to investors, he says he prefers to get enough cash for two years "no matter what happens."

Assembling a team: Given the high unemployment numbers, you may have your pick of talent. Even superstar engineers can be wooed, as they too feel vulnerable. Putting together that first team can be crucial to your future. Not only are they laying the foundation for the company, you'll be tapping them to make sacrifices as everyone works toward profitability. Says Homeowner Toolbox's Firoved, "If we did not have sacrifices from many of our employees and those in ownership, we would not be where we are today."

Finding the right backers is equally important. If they won't support you when you don't meet some of the agreed-upon milestones, you may not see another round.

Deals can be had: One boon to launching a start-up during the recession: not only can talent be cheaper, but so are essentials like equipment and real estate. Suppliers are just as eager to have new revenue streams as you are about finding paying customers. As a result, start-up expenses for rentacarnow.com are lower than originally budgeted for, says Weede.

Reputation matters more than ever: Since the spring launch of PeeWee PC's e-commerce site, Ferreira has been surprised by how many potential customers call to find out about the company's history. "People are looking for validation," he says. "They're asking questions about the organization and making sure it's reliable. Whereas in the past, when we were selling in the local market, they were more traditional selling questions like what's included, turnaround time, and support-related questions."

Lan Nguyen is a freelance writer based in New York City. She has written for the New York Daily News, The Wall Street Journal, Worth magazine and Star magazine.

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