Starting a business during a recession: Businesses to avoid

Starting a small business is always a risky proposition. And during a recession, the risk is even greater.

But certain businesses are more recession-proof than others. Five businesses to avoid starting during a recession include luxury retail, hospitality, manufacturing, construction, and home services.

We'll explain why and go into some of the advantages and disadvantages of opening a business during a downturn.

Defining recession

A recession is defined as continued weakened economic growth for two successive quarters. Signs of a recession can include adverse economic reports, but the biggest shift is in consumer spending priorities.

Other indicators include lower economic activity, increased shopping at discount stores and postponing auto repairs.

The length of a recession can vary from a few months to a few years, but the tough times and effects of an economic slump can last longer for some.

"A lot of people don’t know what a recession looks like," Bryan Clayton, the founder of GreenPal, an online marketplace for lawn care, says. During the economic crisis, "I saw people with multigenerational wealth almost lose everything."

Recession impact on small business

Economic downturns tend to hurt startups more than bigger companies that have the capital and other financial cushions to weather a recession. "Rising interest rates and inflation do affect small businesses," says John Fleming, a mid-Atlantic regional administrator for the U.S. Small Business Administration.

Investors tend to be more cautious with their money during economic declines, and funding a risky startup off the ground can be difficult.

"Securing funding is a crucial part of successfully running a new business," Anna Stella, the CEO of the global marketing outsourcing agency BBSA, says. "However, money lenders are often cautious about lending money to new businesses during a recession. As economic growth stagnates, both consumers and competitors are careful about spending. A new company in such times may experience challenges in growing profit and therefore paying back debts."

But not all businesses are doomed in an economic decline. Founders fund other businesses because investors and lenders consider them high-risk, even in an economic climate of boom times.

5 types of businesses to avoid opening during a recession

While there are advantages and disadvantages to starting a business in a recession, luxury retail, hospitality, manufacturing, construction, and home services are known to be hit hard during tough economic times. People tend to first cut costs in such services as shopping, eating out, traveling, buying new houses, or other real estate transactions.

Why it's especially tough for most businesses in these areas

Luxury retail

During a recession, most people are less likely to splurge on designer clothing, accessories, and jewelry and are more likely to seek cheaper alternatives. Most retailers rely on discretionary spending, Fleming says. 

"A business marketing to entry-level luxury watches will likely feel the recession. However, products aimed at upper luxury markets will have a financial cushion. It’s important to really understand who your customer is and what substitutions they might make," says Matt Brewster, the VP of capital at Hello Alice, a free online platform for advice, networking, and funding for small business owners.

Hospitality

Often consumers cut back on things under the umbrella of hospitality—such as travel, tourism, hotels, and restaurants during a recession. Startup businesses that offer fine dining are something to avoid during a recession, except for luxury dining that attracts the uber-wealthy who won’t be feeling financial constraints, according to Brewster. The restaurant business is historically a challenging one. The National Restaurant Association estimates a 20% success rate for all restaurants. About 60% of restaurants fail in their first year of operation, and 80% fail within 5 years of opening, according to the association's statistics. Budget-conscious consumers tend to save money for groceries, cook at home, or stick with low-cost grocery stores and fast food.

Manufacturing

Unlike some other startups, manufacturing businesses require large amounts of capital. Manufacturers invest in raw materials, machinery, employees, plants, and factories. Higher production costs, shortages in parts, labor, and transport affect manufacturing companies during economic downturns. Hard-hit manufacturers are forced to close plants.

 It’s harder for manufacturers to start or expand their businesses during a recession when banks are less willing to lend money, explains Rhonda Dibachi, the CEO of HeyScottie, an AI-enabled manufacturing services marketplace.

This translates into higher fixed costs such as rent, insurance, and equipment depreciation, which is a big part of a manufacturer’s cost structure. During a recession, when demand decreases, manufacturers face operational challenges covering fixed costs, so the increased capital requirements are a challenge operationally as well, according to Dibachi.

However, the biggest challenge manufacturers face is extending credit to their customers—allowing their customers to pay for their products after they have been delivered. The whole U.S. manufacturing sector runs on "Net 30," allowing customers to pay 30 days after the product is shipped, she explains.

"Everyone knows that if you don’t offer credit, you don’t get the customer," Dibachi says. "If there’s less demand, the manufacturer will be running on lower margins and will have less money in the bank, which will allow for fewer credit lines being offered, which will reduce the demand."

Construction

Like with manufacturing, the construction industry is often hit hard during a recession. During the Great Recession, for example, companies had to manage tight profit margins, layoffs, supply chain disruptions, and inflation. There are fewer home buyers and renters for new developments. Avoid startups with anything related to new homeownership, Brewster advises. "You have to understand the cycles of the [construction] industry," he says.

Home services

Any businesses with services that consumers can tackle themselves, such as residential cleaning and maintenance, will likely face hard times during a recession. In this economic situation, homeowners are more motivated to pick up a hammer and do minor house repairs on their own rather than hiring a handyman or contractor. However, essential services, such as plumbing and electrical trades, are more likely to survive. Labor shortages, supply chain issues, and reliance on smart technology all affect the growth of the home service industry during a recession.

Recession-proof businesses

Not everyone has the choice to wait out a recession before starting a business, and while no business is totally recession-proof, there are industries known to weather difficult economic times. Health care, childcare, beauty products, the beverage and food, major house repair, and auto repair are examples of businesses that people will still rely on during a recession.

"Discount stores that sell cheap products will get a lot of customers," says Young Pham, founder of BizReport, an online guide for startup owners and entrepreneurs. "Maintenance and repair businesses also tend to thrive during this period because people are not looking to buy new and expensive items. They would rather repair what is already available and spend less."

Also, debt default tends to become quite common during a recession, Pham explains.

"You are, therefore, more likely to thrive if you work in a debt collection agency or similar entities," he says.

Some aspiring and ambitious entrepreneurs can actually capitalize on recessions and other economic disruptions, such as the COVID-19 pandemic, with the right business ideas that happen to be recession resistant. In fact, there was a record boom of $10 million in startups during the pandemic, Fleming, of the SBA, says. 

"In my experience, it’s best to stick to non-sexy businesses during a recession," Clayton says. "These are businesses that solve real problems and help people. They are also easy to start and run with low expenses and high profits."

Clayton started GreenPal in 2013.

"It’s not a sexy business, but it’s a profitable one," he says. "Lawn care is a good business during a recession. People still need to take care of their lawns even when the economy is bad. Lawn care is also a cheap and high-demand service that anyone can do with a mower and a truck."

Some people don’t have a choice when it comes to starting a business in a recession. Their only options are to start a business to support themselves, he says.

The good news is that these kinds of businesses, such as freelance writing, bookkeeping, or childcare, usually require little capital or investment.

Tip for tax season

It’s important to know that anyone who fills out a 1099 IRS tax form counts as a small business.

Every time someone requires a 1099, like for selling Avon, Fleming points out, that person is an independent contractor.

Advantages of starting a business during an economic downturn

While there's no such thing as a recession-proof business, some famous businesses have overcome the challenges of economic downturns and thrived.

About half of the Fortune 500 companies were created out of economic downturns such as a recession or depression, according to a report from investment bank Morgan Stanley.

During a serious economic recession, the costs of some resources and services tend to decrease. This sometimes translates to lower rents for commercial spaces, reduced wages, and lower prices for materials and supplies. Starting a business in such a climate allows startups to take advantage of these reduced costs, potentially saving money.

Entry-level employees may also be more affordable during a recession. "If these new-to-the-job-market workers are struggling to find a job, they might be grateful for your opportunity," says Scott Lieberman of Touchdown Money, a website for entrepreneurs. "This can be especially true if you are willing to share the rewards of your fast-growing company with them."

On the other side of the spectrum, there’s an opportunity for entrepreneurs to attract and hire highly skilled professionals who would have been out of their leagues during a boom. The recent layoffs in the tech industry, for example, provide enticing opportunities for startups to hire employees who are considered at the top of their fields.

Overall, startups may be able to attract a talented team at a more affordable salary, providing a competitive advantage when the economy eventually recovers.

Of course, many businesses struggle to survive, and some may even close their doors, in difficult economic times. This means decreased competition within certain industries or markets.

Starting a business during this time of economic uncertainty allows you to enter the market with potentially fewer competitors, giving you a better chance to establish your brand, capture market share, and build customer loyalty.

In a recession, "in B2B, customers scrutinize [their business] and ask, 'Do we need this vendor?' 'What’s more affordable?'" Brewster says. Accordingly, these businesses are more likely to be open to working with new startup vendors, he explains.

Recessions often require businesses to adapt and innovate to survive. Starting a business during economic declines can create a culture of resourcefulness and creativity.

This mindset can lead to the development of innovative products, industries, or services that meet the changing needs and preferences of existing customers and consumers.

Recessions can be challenging, but economic recovery and growth usually follow. By starting a business mid-recession, a startup has the potential to benefit from the eventual rebound and possibly even have a head start on its competitors.

As the economy improves, a business could experience rapid growth and profitability, creating a strong foundation for the long run.

Planning a startup in a recession

When planning to start a business while there's a recession happening, it’s important to understand the pros and cons. Determine whether your business idea falls into the category of traditionally recession-proof and choose how you will fund the startup.

Traditionally, there have been three choices—self-funding, attracting venture capital investors, or small-business loans. Crowdfunding is the latest twist in funding a startup and is a low-risk opportunity because business owners don’t have to repay the crowdfunding participants.

Startups that thrive during a recession tend to have a smart business plan, healthy cash flow, and a financial cushion to fall on during the ups and downs of growing a business.