What Exactly Is a Startup Company? It’s Not What You Think
The word ‘startup’ is often misused to mean ‘new business.’
- January 22, 2020
- Starting Your Business
- 6 min read
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You might have the impression that if you start a small business, then your business is a startup because you’ve literally just started a new business. However, contrary to popular belief, this is not the defining characteristic of a startup. Different factors actually determine if a business is a startup versus a small business or something else. Read on to find out what qualifies as a startup company.
At its core, a startup is a business venture that is launched by its founders based on an idea or problem with a potential for significant business opportunity, growth and impact. This typically involves searching for an idea or a problem worth solving, as well as building a dedicated founding team in line with a shared vision of how to make your solution a reality.
In more objective terms, a startup is markedly different than other classes of business. Here are some of the defining characteristics of a startup versus other businesses:
- Startup: High growth ambition and very scalable business model plus an unvalidated business model
- Scaleup: High growth ambition and very scalable business model but with a market validated business model
- Small Business: Low growth ambition and/or low-to-non scalable business model
The lack of a validated business model is what’s key in defining a startup versus a scaleup or small business. This is why the founders of a startup must craft a committed team from the get-go because you need a team with the determination to prove your unvalidated business model. Armed with a dedicated workforce, a startup is able to validate if its proposed solution fits the problem and if its product fits the market. If these validations check out, then you can shift to scaling your company and establishing a self-sustained business.
One key feature of startups is that they are aimed at reaching a very large market. A small business, such as a restaurant or nail salon, by nature, have limited markets. The aim of reaching a large market is part of the reason so many startup companies are tech companies. Digital and online businesses can far more easily reach a vast market because they are not limited by time and space.
Another defining characteristic of a startup company is the need for an exit strategy. In this context, the exit strategy is not for the startup founders or business owners to get out of the company. The exit strategy is in regard to the company’s finances because eventually a startup will bring in money and angel investors or venture capital firms will get their money out. With a traditional small or medium-sized business, you likely wouldn’t need an exit strategy until you felt finished or fulfilled with your company and its development, which usually takes many years. With a startup company, an exit strategy for investors’ money is an essential feature of the business.
Since startups are so unique, namely in their lack of a validated business model, they face unique challenges or typical ones but with greater difficulty. Here are some of the principal challenges many startups grapple with.
Probably the biggest challenges startups face is getting funding. Banks and other lenders are not usually willing to loan funds to businesses that don’t generate revenue, let alone don’t even have a proven business model. Hence the reason why venture capital and angel investors are so frequently associated with startups in the media and popular understanding.
Limited time in business is an inherent challenge for startups or any new business since you’ve only just started or recently started your company. Limited time in business is a key factor that makes acquiring startup funding difficult for companies. Most lenders have stipulations about how long your business has been in existence before they can lend to you, not to mention how much revenue your company is generating. Limited time in business can also make investors tricky to lock down unless, of course, they are venture capitalists who specifically target startups to invest in.
Developing a sustainable business model is not only a common challenge for startups: It is an essential challenge. One of the most critical phases in running a startup company is transitioning from the validation stage to the sustainable business model stage, in which your company can self-sustain and scale up. Figuring out this transition and actually making it is the fundamental dividing line between a startup company and no longer being a startup.
Unrealistic expectations are a common problem for startups due in part to their nature of going after very large markets. Unrealistic expectations can get really bad when a startup company starts showing signs of real success. The inflation of expectations can come from multiple directions too, such as from the startup founders themselves or the angel investors who might push for expansion before your company is ready. Setting high yet controlled expectations, especially ones that are measurable, is a good strategy to rein in unrealistic expectations.
Creating a committed founding team is a difficult task that nearly every startup company deals with. Since a startup company by its nature is based on an unvalidated business model, hiring a team that wants to work in such risky circumstances is challenging. You need to find people willing to work in an unproven environment. Plus, these people should have the kind of skills your startup needs to transition from an unvalidated to a validated business model.
Funding is usually the most immediate difficulty that a startup company faces. As mentioned, traditional lenders tend to have criteria that make it extremely difficult for a startup to get capital, such as time in business and revenue generation. However, this does not mean securing funding for a startup company is impossible. One of the biggest benefits of recent technological development, namely the internet, is the growth in alternative sources of lending.
Here are some of the most common ways to get startup funding:
- Business or Personal Credit Cards: Using personal or business credit cards to fund a startup is convenient in that you don’t necessarily need time in business or revenue generation to qualify for them. Plus, if you use your business or personal credit card wisely, with timely payments in full, then your startup can improve its business credit profile and help it qualify for more sources of funding.
- Friends and Family: Tons of entrepreneurs have funded their startups through this timeless form of funding. The main benefits here are flexibility and speed of funding. But there are risks involved with borrowing from friends and family so think twice.
- Angel Investors or Venture Capital: This is probably the most well-known source of funding for startups, thanks to the tech boom in Silicon Valley and the growth of so many tech-oriented venture capital firms. The primary benefit with this source of capital is the range of funding, which can be very little or a significant injection of investor money.
- Crowdfunding: This funding method has become very popular over the last several years. Crowdfunding sites, such as Kickstarter or GoFundMe, connect your startup to investors and contributors willing to put money into your company, spread among investors on a massive scale made up of typically small-to-medium amounts. Successful crowdfunding requires a large network and/or good marketing skills, so you’ll have to be willing to put in the work.
- 401k Rollover: A rollover for business startups (ROBS) lets you take retirement funds from a 401k or individual retirement account (IRA) and invest it into your business without paying early withdrawal penalties or taxes. The good thing is that ROBS isn’t a business loan or a 401k loan, and thus there’s no debt to repay or interest payments to make. The major con, however, is draining your nest egg.
There are many key points to take away, but one of the simplest ones is that a startup is not defined by age. This is a misnomer. Just because your company is a few months old does not make it a startup. What defines a startup is the concept of targeting a very large market, with an ambitious aim for growth, based on an unvalidated business model that must be proven out. When your unvalidated business model is validated by establishing a sustainable business model, your company is no longer a startup and has advanced into a true self-sustaining enterprise.
More From Seek
- 5 Creative Ways to Fund Your Startup Without Investors
- The Questions You Should Ask Yourself Before Starting a Business
- Why Traditional Funding Might Not Be Right for Your Startup
- 15 Free Resources for Small Businesses
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