After a number of new businesses, a cooling economy sets in

An unexpected result of the pandemic has been an increase in entrepreneurial activity. Since 2020, applications to start new businesses have skyrocketed, reversing a decade-long decline.

The reasons for the boom are many. Millions of people were suddenly laid off, giving them the time and desire to start new businesses. Personal savings surged, fueled in part by a frothy stock market and government stimulus payments, giving would-be entrepreneurs the means to fulfill their visions. Rock bottom interest rates made money cheap and widely available.

But the buoyant economic environment that helped foster this entrepreneurial spirit has given way to high inflation, rising interest rates and declining savings. It has allowed these fledgling businesses to navigate challenging economic cross-currents—and a possible recession—at a moment when they are at their most fragile. Even under normal circumstances, about half of new businesses fail within five years.

“Young businesses are inherently vulnerable,” said John Haltiwanger, an economist at the University of Maryland who studies entrepreneurship. “They’re likely to fail, and they’re especially likely to fail in a recession.”

In 2021, Americans filed applications to start 5.4 million new businesses, according to data from the Census Bureau. That was on top of the 4.4 million applications submitted in 2020, which had been by far the highest in the more than 15 years the government had been keeping track. (Regulations last year through November were ahead of 2020 but behind 2021; figures for December will be released this week.)

Data on actual business formation will not be available for several years, so it is not yet possible to measure the effect of the cooling economy on new ventures. Whether these new businesses succeed can have broad implications for the health and dynamism of the overall economy.

“Innovation drives productivity gains,” said John Dearie, president of the Center for American Entrepreneurship, an advocacy organization. “And innovation comes disproportionately from new businesses.”

But he warned that the Federal Reserve’s monetary policy — intended to curb the fastest price increases in decades — “increases the headwinds entrepreneurs face by crushing demand and raising the price of money.”

In interviews, founders expressed a mixture of determination and resignation about the months ahead. Some said they had learned lessons from the pandemic’s upheaval about how to weather economic hardship that they believed had secured their business models in a recession. Others were aware of a need for external funding which they feared would no longer be forthcoming.

“It’s been a bumpy ride, for sure,” said Jennifer Sutton, who is opening a juice and wellness bar in Park City, Utah, in 2021. She’s most concerned about inflation, she said, as well as the prospect of a recession that could reduce the tourism that her business depends on. She opened another location in a grocery store, partly because it required less start-up capital than opening another independent store.

In many ways, however, Sutton is lucky. She mostly funded her company, High Vibes Juicery and Wellness Bar, with her family’s savings and credit card debt.

Taylor Wallace, an entrepreneur in Florida, is in a different position.

After he was laid off from augmented-reality company Magic Leap at the start of the pandemic, he reconnected with a friend, Mike Mayleben, who wanted to start a dog daycare business. In the fall of 2020, the two began acquiring dog nurseries that were for sale and rolled them into a new business called Paws ‘n’ Rec.

The company, which offers member-based daycare, boarding and care, currently has two locations in the Tampa, Florida area, with a third under construction. But the company wants to grow by opening more locations – just as inflation pushes up construction costs and rising interest rates make the terms of loans more onerous. His borrowing costs on the company’s line of credit, which he expects to draw on soon, are based on current interest rates and have increased by more than four percentage points from a year ago.

“Debt getting more expensive is going to be hugely challenging for us and everyone,” he said. “When we started this, we were dealing with money being the cheapest it’s ever been in the United States.”

Higher interest rates and uncertainty about the economy also appeared to dry up once-fluid sources of capital, some entrepreneurs said.

When Lundon Attisha launched his first business, Bidstitch, a subscription-based online vintage clothing marketplace and news site, in the summer of 2021, he was able to quickly raise around $200,000 in venture capital and angel investment.

“I thought I was an all-star for raising capital,” said Mr. Attisha, who quit his job at a law firm within a month to start his company. “The place was kind of juicy at the time.”

But investors seemed much more reluctant to put money into early-stage companies when he went to raise money again last year, he said. “The tone in the room with investors — there was a noticeable change,” he said. He ended up selling Bidstitch in September to a portfolio company in Los Angeles.

This experience helped shape the business model for a second company he started last year, Cita Reservations, an online reservation system for tables at sought-after restaurants. Instead of relying on outside funding, the company started charging people right away, selling reservations at some restaurants for $200. To attract attention, he gives caveats to influencers on social media.

“We need to be much more mindful of where we put resources,” he said.

Census data shows that a large number of new business applications were for sole proprietorships that did not intend to hire employees. Many registrations were also for businesses in industries that had been upended by the pandemic, including retail, food services and logistics, some of which may have replaced others that closed.

But despite a slowdown that could hurt new businesses, many economists are optimistic that the rush to start businesses that began in 2020 will still lead to job growth, innovation and, ultimately, a more productive economy.

“A lot of these new businesses continue to grow and hire,” said Luke Pardue, economist at Gusto, a payroll and benefits platform for small businesses. “These new businesses are really driving employment growth right now because they continue to grow and because they are ambitious in their future roles.”

The CEO of a vacuum manufacturer in Price, Utah, that his father started in 1985, Spencer Loveless became frustrated during the first months of the pandemic that supply chain problems prevented him from getting parts from China. So he started using 3D printers that his company had on hand to make his own parts. Companies similarly stuck in the snarl of the supply chain caught wind of what he was doing and started asking him to print goods for them too.

In November 2020, he started Merit3D, a 3D printing company. The business originally had two employees, but it has been growing. Last year he had 20 workers; this year he aims to have 30 to 40.

His hiring plans don’t stop there. He wants Merit3D to eventually have 1,700 employees – who help to compensate for the loss of jobs at nearby power plants that will shut down in the coming years.

Mr. Loveless said his goal for this year was to “bring as much income to the company as possible so that it can support itself as soon as possible.” He was relatively unfazed by the prospect of an economic downturn.

“I think the recession is going to hit harder than most people think,” he said. “How we prepare for that is we become the best at what we can do.”