You can walk into a co-working space today and see freelance graphic designers, agency owners and technology founders using the same word “startup” to describe their respective business organisations.
This change in meaning has created a massive disconnect between what a startup actually is and how it operates on a daily basis, leading to great ambiguity as to how to think of a start-up.
Startups do not have to be characterised by the decoration of space (ping-pong tables, open brick walls, etc.) or the way in which people work (the present use of jeans, T-shirts and shorts as business attire).
Startups are type of business organisation which, from inception, are established for one purpose only: to achieve short-term exponential growth dramatically faster than traditional small businesses.
If you want to understand how startups operate, you can not simply look at media stories about overnight billionaires becoming “successful” within a very short time span.
Instead, you must understand how a startup achieves this by being based on a fundamentally different business model, operating on an extremely high-risk business model, and following a very different lifecycle than a standard small business.
What defines a startup
Startups have several core elements which must be in place at the same time to achieve their intended purpose, the most obvious of which are high scalability, extreme uncertainty and expectations for rapid growth.
High scalability
Startups typically have business models that allow revenues to increase exponentially while expenses grow only incrementally.
High degree of uncertainty
Start-ups are created without pre-existing blueprints.
The founders start with zero business operating experience and are actively looking for a repeatable business model.
They are not executing an already-established business model.
Expectation of rapidly growing
Startups are built to quickly capture significant market share, which often accelerates the focus on expansion at the expense of short-term profit maximization.
The majority of new businesses burn through their working capital in order to grow at an accelerated pace before they can generate enough revenue to sustain their business.
The only way for these businesses to continue to operate through their early years is to have access to external investment funds from either angel investors or venture capital.
What is a startup?
To define a startup, it is imperative to deconstruct the notion of a startup and remove the many clichés that surround this concept.
The term "innovative young company" is far too vague and can easily apply to most types of new businesses.
A temporary organization
When considering how to define a startup, a currently accepted operational definition is that a startup is a temporary organization created to develop a scalable and repeatable business model.
Understanding the uniqueness of this framing is important.
A traditional business (e.g., A local accountant or a small regional transportation company) has a proven business model and the founders are aware of their customers, the products or services they are able to sell and the pricing.
Founders of a startup do not start with this knowledge.
They have a hypothesis.
And the first few weeks and months of the creation of their startup is spent trying to validate whether or not their product will satisfy a significant enough pain point for a broad enough market that potential customers are willing to pay for their solution.
When a repeatable model is ultimately reached, the company will transition from being referred to as a startup to a "scale-up" to eventually becoming a large corporation.
Ambiguity of age and size
There is currently no concrete revenue or employment threshold that defines when a company will or will not lose its "startup" title.
Some analysts have claimed that it is at the time a company generates between $50 million and $100 million in revenue or employs over 100 people or at a valuation of a number of billions of dollars that it is no longer referred to as a startup; however, reliance solely on financial and employment metrics to classify a company is not sufficient.
A company will stop being perceived as a startup once it can stop searching for its principal growth lever by concentrating simply on optimising its already-built machine.
The critical difference between small business and startup
The single largest content gap present in our ecosystem today comes from a lack of distinction between a startup and small business.
A new bakery and a new artificial intelligence platform are both considered to be pre-existing businesses. However, only one is classified as a startup.
The difference between startup and small business lies in operational boundaries, not in a vague idea of success.
Exponential headcount & revenue growth
Small businesses generally scale in a linear format.
If a consulting firm were to double its revenue, they would typically have to increase their billable hours by doing so, thereby increasing the number of consultants employed on their projects. Thus, costs increase as income increases.
Startups tend to scale in an exponential format.
A B2B Software-as-a-Service (SaaS) company could spend hundreds of thousands of dollars developing a codebase; however, once the code is created, marginal cost associated with an additional customer is effectively zero.
The SaaS solution supports ten users, as well as ten thousand users, using essentially the same solution.
Therefore, revenue and headcount are separate.
Targeted addressable market sizes
Small businesses will typically look at local markets or extremely limited regional markets, and they will develop a profitable, repeatable, and sustainable business within those existing markets.
Startups will typically look at large, frequently global, total addressable market sizes (TAM).
They are not looking for a share of a pie; they are seeking to dominate the market or create an entirely new market sector.
Fundraising mechanisms and risk matrix
When looking to finance a new business, many small business owners will either seek bank financing (like a loan) or small business grant funding.
A bank typically requires that the owner provide the institution with collateral (such as property or equipment), consistent cash flow (so the bank can see that the business will have enough income to repay the loan), and prior documentation of an owner's ability to repay his debt.
Most start-up businesses do not qualify for traditional bank financing because they often do not have any assets to offer as collateral, and they may have very little to no sales revenue in the early stages of operation.
They will usually rely on equity investment from venture capital or angel investors, who understand that a high percentage of start-ups fail.
These investors usually take a minority share of the company, with the hope that at least one out of ten total investments will potentially produce a return on investment of one hundred times or greater.
The true definition of a start-up
If a business is creating a truly unique product and operating as a start-up, the company will exhibit certain operating characteristics that affect the entire operation of the company, including hiring, product development, sales, and marketing activities.
The focus on high growth
The company’s focus will be on rapid growth or “disproportionate growth.”
All key decisions made by the management of a start-up company will focus on accelerating either the acquisition of customers or the use of the product.
This focus on growth usually requires a start-up's operating plan to be based upon a rapid growth strategy (to build a large customer base quickly), and this is often at the expense of short-term profits (running at a loss).
Making decisions based on unknowns
As indicated in the previous section, start-ups make their decisions with incomplete, or “inadequate,” information.
Will customers accept this new product or service?
Will enterprise customers trust this new start-up's ability to handle their confidential data?
It is critical for start-ups to create a culture that supports rapid experimentation and innovation to find the best answers to these key questions.
Start-ups will develop their MVP (Minimum Viable Product) – in essence, the bare-bones version of the new product/service, release it into the market, and gather user feedback, adjust as needed, and improve the product/service offering to suit the needs of the target customers better.
Start-ups recognize that creating a “perfect” product is not possible, and working to improve a product with a standard “good enough” approach is more productive in the long run.
The difficult truths about start-up models and return on investment
While start-ups create products that have the potential to generate tremendous sales, the operating model of a start-up is primarily a math problem based on limited time availability.
As time passes, the start-up's operating costs will increase, and the founders will experience “burn rate” and “runway.”
Corporate “burn rate” conveys the cash depletion amount a corporation incurs in a month. Meanwhile, a corporate “runway” indicates how many months a corporation can operate before running out of cash.
For example, a startup has a total of $1 million and has a burn rate of $100,000 per month.
Once burned $1 million, after ten months, the company has a ten-month runway.
Therefore, the company has ten months in which to complete its next major milestone, prove its business model, or obtain its next funding round.
If the company does not reach one of its objectives within ten months, the company will fail.
Thus, the ticking clock creates extreme operational stress.
Product-market fit (The holy grail)
A startup cannot focus on aggressive sales until it obtains product-market fit (PMF).
PMF occurs when there is sufficient demand for a product to saturate an entire market.
If a company has successfully obtained PMF, then the following are indicators of PMF: The company is experiencing organic growth; retention rates are extremely high; and the company is having difficulty meeting consumer demand.
The leading cause of startup failure is attempting to scale its operations before achieving PMF.
Startup growth stages
Most startup growth stage guides use funding rounds as growth stages; however, funding is simply fuel.
The growth stages of a startup are determined by operational maturity and the risk to which the startup is exposed.
The following provides insight about how a startup grows from a mere concept to a mature organization.
Pre-seed stage: Ideation and validation
This phase describes a startup that is essentially nonexistent.
This phase typically consists only of the founders, a pitch deck, and a business hypothesis as the primary objectives at this stage of business growth.
If you could imagine what is taking place operationally at this phase, you would describe it as very chaotic.
The entire operation, from coding software to drafting product marketing materials, is handled solely by the business founders (at least at the beginning).
Typically, funding for a startup comes from personal savings of the founders, funding from their friends / family, or funds provided by specialized pre-seed accelerator programs.
The primary objective of the startup founder(s) at this stage of the company's development is to create a minimum viable product (MVP) that sufficiently demonstrates the company's core business premise.
Now that the MVP is finished and operational, the next step for the startup will be to validate whether or not people that the startup has not personally met will use their MVP and pay for it.
This validation process typically occurs through a rapid process of iterating on the company's product based on customer feedback that is collected over a relatively short timeframe, with the founders determining whether or not the company's original target market will be willing to purchase the MVP, and adjusting the company's messaging in order to reach a new target market, should it be determined that the company's original target market is not likely to purchase the MVP.
During this phase of the company's development, seed funding from angel investors or early-stage venture capitalists is used by the startup to obtain the resources necessary to validate their product/market fit.
Once a company receives Series A funding, the company has validated their product/market fit, and the focus of the company shifts from "how do we create something that will be helpful to consumers" to "how do we scale our customer acquisitions in a consistent, sustainable manner?"
During the Series A funding phase, the business organization of the startup becomes more formalized, with the founder stepping away from leading the entire organization and the startup employing skilled sales personnel, a marketing officer, and engineering specialists.
The company's focus during this phase is primarily towards increasing the number of customers acquired on a sustainable basis by lowering the cost of customer acquisition, while maximizing the lifetime value of a new customer.
The goal of the Series A funding phase is to build a reliable and scalable sales
Transitioning from a startup to a scale-up
The transition from being a startup to becoming a scale-up is characterized by the desire for substantial growth in terms of geographical reach, market share, and volume of products sold.
The company may decide to establish multiple international offices, introduce several new lines of products, and actively pursue acquisitions of smaller companies to quickly gain customers or competitive advantage.
Therefore, the number of employees at this point experiences tremendous growth, however, the company's growing number of employees means the need for more formal internal structures and politics than a startup with 300 employees could provide, and it becomes impossible for companies of 300 employees to function with the same flow and flexibility as a startup with 10 employees.
How it ends: Initial public offering or acquisition
The end of the startup is always marked by a liquidity event, or event that allows owners of startup companies access to the funds they have invested.
Venture capitalists will not keep their investment indefinitely, because they need to provide their own investors with an opportunity to make a return on their investments.
The owners of a startup will likely have 2 choices:
- The company will be acquired by a larger company that would benefit from acquiring either its technology or market share; or
- The company may go public through an Initial Public Offering (IPO). Going public gives the company an opportunity to list its shares on a public stock exchange. After going public, the company's status will be subject to strict financial and regulatory scrutiny and will experience significant quarterly pressure to perform financially.
The startups' founders' decisions
The success of a startup is rarely linear, and is instead marked by a multitude of either/or decisions that will ultimately determine whether or not the startup survives.
When to pivot
The decision to pivot, or change the strategic direction of a startup based on information and feedback received from users, is usually driven by the recognition of the necessity to do so due to the loss of ego.
The founding team must acknowledge the likelihood of making the wrong decision and concluding that the original strategic direction was incorrect before reallocating engineering resources and funds to another direction while the company still has cash to operate.
Finding a pivot point quickly is important due to the limited time frame to operate with cash before the runway is exhausted (time before contact with customers to generate revenue).
When to inject capital
The challenge for founders is determining the timing and maximum amount of funding needed to achieve the goals and objectives of the company (availability of funds to execute their plan).
Founders who bootstrap, or self-fund their business using revenue generated from sales, will have 100% control and ownership of their companies.
On the other hand, venture capitalists will allow for faster growth but at the expense of diluting the founder's ownership stake and creating an ongoing demand for high performance from the founder.
Managing the hiring rate
If a startup hires too slowly, it will become overwhelmed by work, resulting in employee burnout and missed product delivery deadlines.
Conversely, if a startup hires too quickly, it will experience rapid turnover and create an unhealthy company culture.
Owning a startup entails managing the shift in culture from the generalist employee that can function optimally during the initial startup phase to the specialist employee that can develop scalable, enterprise-scale systems.
The culture shift can be one of the most difficult aspects of being a founder.
Myths about startups
Many myths about startups exist in the media. These myths create misconceptions in the public eye.
The myth of overnight success
The media enjoy telling stories about startup companies that achieve billion-dollar valuations seemingly overnight.
However, the historical data on startup success shows that it typically takes seven to ten years of intense, uncertain work before a startup can reach its first major exit.
The tech fallacy
Software companies dominate the startup world due to their high profit margins and limitless growth potential. However, start-up companies can create products other than software.
There is a commonality between hardware startups, our 'biotech companies' who develop new drugs and 'space-tech' businesses;
Such a large volume requires high uncertainty, tremendous scalability and dependence on venture capital funds.
The cult of sole founders
While there is much romanticism surrounding the image of the sole founder developing code in their garage, evidence reveals that teams of 2-3 founders are far more successful than solo founders.
Founders face an overwhelming number of tasks, emotional stress, and the operational burden of starting a business.
Such a large volume requires the support of more than one person working at the same time to grow their business quickly.
Conclusion: Are you creating a startup?
If all of the 'buzzwords' associated with starting a business are removed, what you will see is a diagnostic framework.
When the objective is to serve an existing need, generate an immediate return, and build the business over a long period of time, it falls within the category of being a small business.
While being a small business is a highly respectable and economically important way to build a company, there is a specific plan of operation for small business.
If the start-up is being built from a hypothesis that has not yet been proven, if it is targeting a large addressable market while using technology to decouple revenue from employee headcount, and if the start-up is to succeed disproportionately large in revenue compared to headcount, then it is considered a startup.
Starting a startup is to experience engineered chaos.
A startup requires specific funding mechanics, a very high degree of risk tolerance, and unwavering commitment to iterative processes.
Knowing the difference between these two paths is critical to understanding how your business will develop.
The first step to creating the proper metrics, hiring the appropriate people, and managing the expectations for the upcoming difficult times is to understand what a startup is.
Frequently Asked Questions (FAQs)
How long does a company remain a startup?
There is no set time period for a company to remain a startup.
Once a company has established a reproducible way to create a product or service for consumers and has evolved into the execution phase, the company will no longer be considered a startup.
The duration of time spent in the startup phase can vary; some companies will complete the startup process within three years, while others will have a very experimental approach to their business model for over ten years after receiving investor support.
Typically, reaching $50M in recurring revenue, or executing an IPO are two common indicators of a startup's end.
Can a single person start and operate a startup?
A single individual can move through the ideation and validation phases of starting a business as a solo founder.
However, because a true startup requires rapid growth and aggressive market share capture, eventually, a solo entrepreneur will need to build a team.
A business created with the idea that it would remain one person's operation indefinitely is referred to as a lifestyle business or freelance business—not a startup.
What's the difference between a startup incubator and an accelerator?
Startup incubators and accelerators are often used interchangeably, however, they have distinct roles in the entrepreneurial ecosystem.
Startup incubators are typically for pre-seed businesses and provide resources for building and developing a business concept over a flexible timeline.
Accelerators are designed for seed-stage businesses that have a functional minimum viable product (MVP).
Often a business will receive cash and a structured timeline for establishing their model within an accelerator program (usually three months), followed by a day to present to venture capitalists, with the goal of quickly "accelerating" the growth.
How do most startups fail?
Startups' main problem is they usually do not have a product or service that addresses consumer market needs.
As a result, the company's cash runways are spent developing a product that consumers do not want or will not purchase.
Other common reasons for startup failure include: running out of cash before they can raise the next funding round, having major disputes with the founder and being outpaced by a competitor with a larger amount of funding.
