Does it often seem that these two terms – startup vs. small business – are used interchangeably?
As an entrepreneur, knowing how they differ helps you decide what type of company you really want to be running.
In this article, I’ll discuss the differences between startups and small businesses in terms of growth, goals, profit motive, exit options, funding, and risk.
After all, it would be a shame to get all those business cards printed with Startup Founder only to find that you are actually a small business owner.
Are you content being the sole employee of your company?
Maybe you want to just work with a few friends or family members.
If things go well, you might even bring in a sales team, an IT person, and a few other team members.
As long as it stops there, you’re probably looking to run a small business.
But what if you want to build the next Google, Home Depot, or United Airlines?
Now we are in startup territory.
But growth just for the sake of growth is hardly useful, so let’s come at this from a different angle.
I like video games.
If I notice that people find it difficult to buy video games in my area, I might open a video game store.
This isn’t a new business model.
It’s not a novel product or service.
Everything about my idea has been done before.
Except that nobody has opened one in my neighborhood.
That might be enough to make this business viable, but it’s not enough to let me compete nationally with Gamestop and Best Buy.
There’s no reason to think this will ever grow beyond a small business.
If you wanted to build a startup, that’s probably not a great place to be.
But if you wanted to be a small business owner and you love video games as much as I do, that sounds like a pretty great option.
But what if you find that there is a wider desire for something unique to your store?
Without even trying, some business owners stumble upon a secret sauce that the big competitors are missing.
In that case, you might find that there is an opportunity for your small business to start growing, transforming it into a startup.
Shortly after I founded my first company, somebody asked me where I wanted to be in 10 years.
I had to think about that for several moments.
I felt like the answer should be something like still running this company, but with a lot more employees.
But that wasn’t what I wanted.
I gave the only answer that I felt was honest.
I told them that I saw myself right back where I was, building another company from scratch.
I’ve always been a serial entrepreneur, and I always will be.
I want to watch my babies grow to be so big that I become a horribly ill-equipped father figure.
Then I want to hand it off and go raise another one.
That’s a mindset that works much better with startups than with small businesses.
A small business can stay a small business for all of eternity.
Many small businesses are intended to be lifestyle businesses – they exist to bring their founder(s) a consistent, comfortable amount of income.
Startups aren’t made to stay in a steady state.
They grow and they grow, but there is a final step after that:
This exit takes one of two forms:
- Your startup gets acquired
- Your startup goes public (goes through an IPO)
Getting acquired is by far the more likely path for a startup.
Startups are 16 times more likely to get acquired than to go public.
Whichever path they go, startups have to start with an exit in mind.
Why do startups need to exit?
For that, we need to look into how startups and small businesses are funded.
Businesses need money to keep running, and they need lots of it if they want to grow.
This money can come from a few different sources:
- Company revenue – Reinvesting the money the company makes to fund itself
- Debt financing – Loans
- Founders’ personal finances – Previous savings or bootstrapping the company with outside work
- Equity financing – Selling partial ownership of the company (shares) to outside investors
The first two are widely used by any company.
Personal finances are common in early stages but usually disappear fairly quickly.
Nearly all high-growth startups rely on equity financing.
However, it is much more difficult for small businesses to find equity investors – and most don’t want to anyway.
Whereas debt financing usually comes from a bank or other financial institution, equity can come from a variety of sources:
- Angel investors
- Venture capital (VC) firms
- Institutional investors
- Corporate investors
All of these sources are looking for an expected return on investment (ROI) that is worth the risk.
The riskier the investment, the more investors want to get in return.
Startup equity is highly risky, so investors are looking for a huge rate of growth.
I’m not going to pay 100K for 10% of your company if it will only be worth 150K in a couple of years. I could get that rate of return from a much less risky investment.
And that’s the problem for small businesses – slow growth and high risk makes them a terrible choice for investors.
By the way, I did say that ‘nearly all’ high-growth startups use equity financing.
I believe that the exceptions – such as the amazing story of Sara Blakely and Spanx – show an exciting opportunity for founders that can manage growth without equity funding.
Startups can often justify going years without earning a profit.
Some go all the way from founding to exit without their ledger ever going black.
Once again, this is because of equity and growth.
By growing quickly and selling off equity, you can maintain enough liquidity to survive.
It’s risky, but it’s often what your investors want you to do.
After all, they didn’t invest in you because you were profitable.
If you have to choose between profits and growth, and you often do, they will always push you to choose growth.
Without equity, you are left with 3 options to finance your business – debt, personal finances, and revenue.
Debt is great when you need quick liquidity, but it won’t sustain your business forever.
Your personal finances might work for a little while, especially if you are bootstrapping your business with a job on the side.
But that’s not where you want to be long-term.
Eventually, your small business needs to turn a profit to stay alive.
After all, even if it’s getting rich is not a good reason to start a company, every entrepreneur expects to make some money eventually.
Focusing on growth instead of profit is risky.
Giving away equity to fund that growth is also risky.
And they have a very limited lifetime in which to do it.
You shouldn’t subscribe to the go big or go home mentality if you aren’t prepared for the risk.
The risk is not just financial, either.
When you have put your everything into a business, watching it fail is miserable.
I will never forget how I felt when my first startup failed
I’m not saying that small businesses can’t fail.
In fact, 20% of small businesses fail within the first year.
Within 5 years, have of small businesses fail, and only a third survive to year 10.
The two biggest reasons for business failures are:
- lack of demand (often called product/market fit)
- Insufficient cash flow
It’s no surprise that startups suffer worse from both of these causes.
Small businesses are taking advantage of a small-scale need in an established market.
Startups, on the other hand, are introducing something that is at least partially new – and that makes it harder to gauge demand.
At first glance, cash flow would seem to be an advantage of startups because they have equity available.
But exponential growth requires an exponential increase in spending.
Startup founders are always operating on a limited runway, so cash flow is an ever-present risk.
Small businesses can escape some of that risk by becoming profitable and growing slowly.
There are other growth-related risks for startups as well, including
- Finding quality talent
- Maintaining customer relations
- Company culture / team dynamics
- Legal challenges
- Technology scaling
To end this section on a positive note, let me just say that failure is not an ending in entrepreneurship.
There is a lot you can learn from a failed business, and second-time founders have a much higher success rate.
Lots of founders want to run the next Starbucks, but the world needs family-owned coffee shops too.
Certain types of businesses almost necessitate a high-growth startup model.
The biggest example of these being technology-based solutions that rely on economies of scale, network effects, or virality as a core part of their business model.
If you aren’t sure whether your company is in that category, it’s probably not.
There is one other reason that a company might need to focus on growth:
They are operating in a very narrow window of opportunity.
Those are also not common cases, so you’ll probably be aware if you fit that mold.
If not, you likely have options.
Nearly any other business that could be a startup can also be a small company.
But is the opposite also true – can any small business go on to be a high-growth startup?
Well, that’s a more complicated question.
What’s the difference between Amazon and your favorite small e-commerce store?
It’s a mixture of motivations, risk aversion, and a whole lot of luck.
If you want to build an empire, you can go in with a do-or-die, high-growth mentality.
And do be honest about what you want – don’t start a small business if you would only be happy with a startup or vice versa.
Aside from that, maybe hold off on the decision until you see where opportunity takes you.
Most of the best companies simply started with a passionate founder that had a knack for recognizing a market need.
If in doubt, just focus on building the best product with the best customer experience.
From there, you can keep an eye on the market, and jump on any opportunities you see.
Maybe that means you’ll need to grow to seize the opportunity, but maybe it means your company will stay small and agile forever.
The distinction of startup vs. small business all comes down to one word: growth.
Once you understand that, the rest of the differences above all fall out as side effects.
Startups have to sacrifice everything for growth – and that often includes profit.
If you know you’d only be happy with one or the other, plan accordingly.
Otherwise, the best type of company – as with the best product or business model – starts with one question:
How can I best serve my customer?