Key Differences Between a Small Business and a StartupDec 21, 2022
You’ve got an idea, you’ve got a plan, you’ve got the motivation. What you may or may not have is the money to make it happen. You have decisions to make, and one of the biggest decisions will be how and where to raise your initial capital. Do you invest money into your business yourself? Do you go out and get a loan? Do you make “capital rounds” and try to gain investors? A bit of all three?
The first question you should really be asking is what type of business am I? From there, you can decide whether or not seeking angel investment and/or small-scale venture capital investment is a right fit for your venture. Here are 5 major differences between a traditional small business and a startup that will help you figure this out:
The first major difference between small business and startups is the potential and pathway to growth.
A traditional small business has a business model that is largely linear; the business will grow and expand at a steady, natural pace. Think of a hair salon. There are only so many heads of hair you can cut at a time. In order for the business to grow, you need to bring on more hair stylists and more clients per stylist. Eventually, if/when you run out of new clients, you will more than likely expand into another area, opening a second location.
A startup’s growth is the complete opposite. Successful startups have exponential and scalable growth woven into the very fabric of their business model. Startups exist to shake things up in an existing market, or to create a new market all on their own; unlike small businesses they do not try to “find a spot” in an existing market. As such, they must factor in the need to adapt rapidly to changing market climates and plan to grow quickly and with efficiency. Angel investors typically expect a 3-5x return on their investment over 3-5 years and venture capitalists (the usual next state of capital rounds) will expect anywhere from 7-10 times over a total or 10 years, on average. For you this means that a successful venture would be modelled to double in size every year to two years. Depending on how much equity you plan to retain in your startup, your takeaway will be different. For example, if your company is valued at $100 million, and you retain 30% equity in the company at the time of sale/exit, your stake is worth $30 million.
2: END GOALS
A small business, like most companies, deal in something called a going concern; the assumption that the business will continue to operate in the foreseeable future. They intend to maintain profitability in the long run. This requires gradual scaling of operations, manageable growth that does not overwhelm their employees and owners, and stability. Typically small business owners intend to run their business for many years and eventually pass ownership to family when they retire, or sell the business to an interested party. The end goal for most small businesses is the business itself.
A startup, by its very nature, is temporary. They exist for scalable growth with a defined exit strategy. Exit strategies can vary, but the most common two are selling and independence. Many startups run with the intent of causing market disruption to gain the attention of larger, more established businesses. Offers for purchase from larger corporations eventually come in, and when a startup is sold to an existing company, they have successfully exited. Typically these larger corporations are the big fish in the industry, and from their perspective it is advantageous to acquire viable startups to expand their product/service offering, limiting competition, and acquiring high quality talent. Other startups do seek to incorporate (or remain private) as their end goal. When a company is stable enough to stand on its own through its current and projected profit streams, it is considered a business and no longer a startup. Typically this will result in the startup going public via IPO (initial public offering), RTO (reverse takeover) whereby shares of the company are now available to the general public.
Small businesses tend to rely on debt financing. You’ve heard the terms before: loans, line of credit, asset-assured finance, personal investment, and more. Since small businesses are more linear in scope, they are more enticing to traditional lenders like banks and creditors, as they are more stable and more likely to pay off a debt. Small business owners tend to keep full ownership in their business, but they do not gain mentorship, industry insight, and are not looking for rapid growth.
Startups rely mainly on capital rounds in which they seek investment from private investors, angel investors, or venture capitalists and in return surrender equity in the company to said investors. As a startup gains more capital from successful capital rounds, it might lose its independence as stakes in ownership are dispersed. Through angel investing most startups gain larger amounts of capital, as well as mentorship via the investors themselves. Remember that the point of most startups is to create something innovative and new and then sell for a large RoI.
4: INITIAL EARNINGS AND EARNINGS OVERALL
A small business can take months or years to be profitable, but the goal of most is to break even within the first year. Small businesses are focused on steady, linear growth of profits, scope, and scale, and are more concerned with gaining some profit now, as opposed to having an exit strategy. However small businesses are not attractive investment opportunities for angel investors, VCs, and other private equity groups. They look to invest in startups.
A startup is rarely profitable from the get-go, and profits may not even be a major part of your exit-strategy. Startups can take months or years to break even, as the major intent is the creation of your product and/or service that will disrupt the market. Unlike Small businesses, startups have rapid profit growth in a relatively short amount of time. A successful startup is one whose plan includes projections of exponential growth. Angel investors want to see projections of 3-5 times their initial investment within a 5-7 year turnaround. This means that the fair evaluation of your startup should triple or quadruple in that timeframe. VCs usually want to see your startup double in value every year or two.
Angel investing and venture capitalism are not the be-all-end-all of capital rounds, however. Government grants and tax incentives are becoming increasingly available, particularly to those innovators who are focused on new, green technologies. Programs like the Strategic Innovation Fund (SIF), the Scientific Research and Experimental Development Fund (SR&ED) (a tax credit), and the SmartStart Seed Fund in Ontario are just a few grants that can be used by startups that fit certain parameters, usually with focus on new tech and innovative, eco-friendly endeavours. There are also government-backed initiatives that blend private equity and non-dilutive government grants. The Southern Ontario Fund for Investment in Innovation (SOFII) is a one-to-one matching program, whereby private equity investments are matched in the form of a non-dilutive loan. Eg. if you raise $200k amongst private equity investors, you can get a matched loan of $200k - therefore giving you $400k capacity, and only half of that is dilutive.
In addition to capital rounds and government grants, crowdfunding has exploded in popularity with those raising capital, whether for a small business or a startup. Kickstarter, Frontfundr, Fundrazr, Patreon, GoFundMe … the list grows by the day. Crowdfunding and equity crowdfunding can be an ingenious way to show investors (angel or otherwise!) that your ideas have merit and have a demand. They’re also a good way to raise some capital at the very beginning so if/when facing capital rounds with investors, founders will not feel pressure or the need to lower their personal equity expectations!
Another option for startups would be to work alongside a non-profit focused on aiding budding entrepreneurs. Futurpreneur in particular offers a full mentorship program that has helped launch 12,000 + businesses as of March 31, 2021 as well as a focus on community-driven, coaching-focused approaches meant to aid startups in the early planning stages. Entrepreneurs of ages 18-39 can use Futurpreneur’s resources to turn their ideas into business plans and themselves into founders, and Futurpreneur is just one such organization.
With so many different ways to approach funding, you may have to get creative … but creativity is why you’re looking into creating a startup or small business in the first place, right?
5: LIFECYCLE AND RISK
Finally, we come to the overall life of a startup versus the life of a small business.
Around a one-third of all small businesses shut their doors in the first 2-3 years. The life cycle of a small business is one of gradual expansion and growth that follows a predictable pattern. Small businesses run with the intent to continue running for the foreseeable future, and intend to stand on their own without much, or any, private investment.
Many startups doing their initial rounds have business models and/or plans that too focused on initial profit and not focused enough on exit strategies and exponential growth capacities. The life cycle of a startup is short by comparison. Remember that 5-7 years? While that is the average, there are startups that “exit” in a much shorter time. Startups whose growth projections are high and backed by concrete data might get scooped up by a larger business within the first few years of operation, resulting in a large ROI in a very short amount of time.
As you can see, the differences between startups and small businesses are stark, but both are dependent on innovation, growth, and knowledgeable management to succeed. It is not unheard of for a startup to transition into a small business, or vice versa, but it is helpful to know into which model your business fits. Knowing where you stand can help you retool and reimagine your plans to have a successful application to angel investors and VCs.
Both small businesses and startups have a shared commonality of having an entrepreneurial spirit. The goals of a business is driven by the motivations of yourself, the founder, the business owner. Your aspirations, how you measure success and ultimately what you want to get out of the business dictates how it's run.
We created Insights to be beneficial for both types of business models. We were constantly meeting with founders from startups looking for access to capital and our growing frustration with the lack of good advice being given to these founders was the seed planted that would grow into the Insights program. That being said, we also feel that not every business needs external capital, instead it needs a plan to profitability. Whatever business idea you're wanting to explore please don't hesitate to reach out, we are genuine in our desire to see entrepreneurs succeed while also being critical to ensure your business idea can withstand scrutiny before you waste thousands of hours and dollars.
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