You want to get into business and you have a stonker of an idea, but what’s the difference between a startup and a traditional business? Well, not all new businesses are startups and the difference has nothing to do with technology, founders, late nights or instant noodles! So how is a startup different from a ‘traditional’ business, and how does it work?
What is a startup?
A startup is a business, organisation or project that operates under extreme uncertainty where the founders do not know if their product or service will succeed. Startups are usually designed around a single project or solution for a problem they have identified as having a high demand with expectations of fast growth. Paul Graham of Y-Combinator puts it like this…
“A barbershop isn’t designed to grow fast. Whereas a search engine, for example, is.”
Paul Graham
Startups are built to scale
According to the Federation of Small Businesses, over 100,000 businesses are launched each year in the UK alone. But only a small percentage of these are classed as startups. Most are service businesses — barbers, coffee shops, auto mechanics, plumbers. These are not startups, because they are not designed to grow fast. If we continue with the barber shop model, although there is high demand for their services (I know I could do with a trim), there is no practical way to serve more than the fixed number of customers in their local area. For startups, the product needs to be something that can be sold into a bigger market so they can become a scalable business.
Where do startup ideas come from?
So as an entrepreneur, it may seem that it’s always better to become a startup – if you’re going to start a business you may as well go with the one that has the highest potential for growth, right?
Well, hold that thought. The world of the startup is very competitive.
Say you wanted to build compliance software for European construction companies (of which there are 3.2 million), then you would face strong competition because the potential prize is so big.
But, if you made compliance software for small European banks (of which there are less than 2,500) then there wouldn’t be as much competition. As Paul Graham states…
“The constraints that limit ordinary companies also protect them. That’s the tradeoff. If you start a barbershop, you only have to compete with other local barbers. If you start a search engine you have to compete with the whole world.”
Paul Graham
So, if you want to be a startup, you need to find an idea that can be delivered to a potentially large market. But aren’t all the obvious ones already taken?
Let’s look at a couple of examples of businesses that began life as startups – they may surprise you.
Apple – ‘Not everyone has the skills to build a computer themselves’
In the 1970s Steve Wozniak wanted to own his own computer, but back then you actually had to design and solder the electronics yourself. Luckily, Wozniak was a talented engineer, and had the technical skills he needed. He realised computers were actually pretty awesome and many people who wanted them didn’t have the tech skills they needed to make one. So he and his friend, Steve Jobs, started building them for other people. The company startup they founded grew into the trillion-dollar company it is today.
SpaceX – ‘Space travel is too expensive’
Elon Musk’s dream for humanity of being able to travel to other planets, started when he looked at the existing space programs and wondered how little had changed since man first walked on the moon in the 1960s. He studied the problem and realised something critical. Space travel was too expensive.
Space travel was so incredibly expensive for two reasons: (1) the parts needed came from hundreds of different companies which all needed to make a profit; and (2) the rockets were thrown away after they were used.
Musk is a trained physicist, not a rocket scientist, so he studied hard until he had enough knowledge to ask the right questions and hire people who were experts in their field. Space travel is extremely risky even for a startup and Musk gambled his entire personal fortune on his dream (and almost lost it all). Today Space X is leading the field in commercial space flight and is running shuttle missions from the US to the International Space Station for NASA.
What do they have in common?
We can see from these examples, that a successful startup has:
- an idea that is a solution to a problem,
- often this problem has been overlooked by everyone else,
- the founders have expertise in the area, or know where to find it,
- successful businesses stay focused on the core problem.
How are startups funded compared to traditional businesses?
Once you have your idea, you need some money. We regularly see headlines along the lines of ‘X Startup Raises 1 Billion in Series B Funding’ – which usually brings up questions like, ‘how many zeros are in a billion?[1]’
A traditional business founder would probably write a business plan and go to their bank for a loan. The initial capital they need is often secured against the founders’ property and at a high repayment rate. Bank loans are rarely an option for startups because they are so risky. The second option, which has become popular among many startups, would be to bootstrap – where the founders use their own money to fund the business. This option is available to startup founders.
For startups, other funding options available include angel investors, venture capital and startup incubators. These take a percentage of equity stake in the startup, so early investors are taking a higher risk, and so will usually take a higher percentage. (Founders should be cautious of rogue investors and bad deals. I personally knew a founder who received an offer for the money he was asking for, but only in exchange for 75% of the business. The founder politely said, ‘no thank you.’)
Crowdfunding (or Crowd Investing) has become an increasingly popular option for startups in recent years. This is where a group of investors (possibly a great many of them) pool together to take a percentage of equity in the startup. The advantage here for the startup, is that the investors don’t have a say in how the startup is run. But to be eligible for these crowdfunding platforms, investors usually want everything to be up and running, with customers and already generating revenue. One of the most popular crowd investing platforms is CrowdCube, who have already funded over 1,000 businesses since 2011.
For tech-focused startups, there is another option available. These are digital product agencies that can help clients to build their products in return for an equity stake. At Full Revolution we provide this service for some startups.
Once your business is making money, you’ll want to continue growing. One of the barriers to taking your business to the next level is having enough cash to invest in scaling up operations fast enough to meet customer demand. This is where funding comes in once again. The good news is it’s easier to raise money from banks once you’re generating revenue. And this process is made even easier thanks to Open Banking. Don’t worry if this is the first time you’ve heard of Open Banking, what it does is allow apps approved by the FCA to share the necessary bits of information with each other to make it easier for you to access services like loans. Of course, sharing information is only done with your permission, and if you change your mind, you can put a stop to it at any time.
Another alternative funding option available to business owners who are generating cashflow is a revenue based loan. This type of loan provides a flexible financing option where you can borrow up to 200% of your monthly revenue, based on your sales and card takings. It could provide the capital you need to drive business growth and achieve your goals.
What makes a startup different?
So once you have some finance, you need to get your business up and running. As startups operate under extreme uncertainty, you often don’t know if the product or service created to solve the chosen problem will work. You need to figure out your minimum viable product, who your customers are, and what your business model is before you run out of money.
Eric Ries’s book, ‘The Lean Startup’ details the importance of testing, creating prototypes and getting feedback from your customer base as quickly as possible, so you can make improvements to your product in real time.
The following, famous example, shows up the differences between startup and traditional businesses nicely.
Benz vs Ford
The Startup
In 1885 inventor Carl Friedrich Benz completed work on a passion project of creating a ‘horseless carriage.’ It was a project he had toiled away on for several years, using spare parts from his bicycle repair business. Benz had invented the first automobile to be driven by its own power. The great grandparent of the vehicles we drive today.
Actually, it wasn’t Carl who saw the value in his invention, but his wife Bertha, who is credited with taking the first long distance automobile journey, and also inventing brake pads. A journey of 66 miles might not sound that impressive, but it was at a time when there were no roads suitable for cars, and Bertha had to follow wagon tracks and old roman roads, stopping every few miles at a chemist for ethanol to refuel the tank. The journey took over 12 hours to complete. Townspeople along the way were either scared or inspired, by the sight of the motorcar and by morning everyone was talking about it. After the journey, Bertha returned with many suggestions for improvements for the vehicle, including adding another gear for going up hills.
The Benz Motorwagen went on sale in 1888. Without Carl Benz the automotive industry would not be what it is today.
The traditional business
It was 17 years after Benz’s invention, in 1903, that Henry Ford launched The Ford Motor Company, and debuted the Model T in 1908 – the first affordable automobile – which went on to sell 15 million units. This does not mean that Ford didn’t innovate. They were the first company to use the concept of the production line, and the first to implement the five day, working week. But they were not taking great risks. Demand for automobiles had already been established, and despite their innovations, they never strayed from the existing business model.
The Difference
Carl Benz founded a startup that turned out to have massive growth potential by testing unproven ideas and breaking new ground. Whereas Henry Ford started a traditional manufacturing business, where the automobile was already proven and becoming increasingly popular.
Is your business a startup or traditional?
As we’ve now seen, startups innovate from a position of uncertainty as they try to solve problems and become profitable before they run out of cash. Whereas traditional businesses follow the well-worn beaten path, usually copying existing business models, products and services as offered by their competitors.
So, is your brilliant business idea a startup or traditional?
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Notes:
- Until 1974 in the UK a billion used to be 12 (a million, million), but we all use the US version now, a thousand, million)