All startups are not created equally. Startups fall into two categories: venture-backed (VC funded) or boot-strapped (self-funded). These two types of startups are vastly different. In this article, I’ll explain the major differences and how they matter.
But, first, let’s distinguish a startup from a company.
Startups are NOT a company. They are legally formed entities. As such, some people just assume that startups are a company. In the United States, almost all VC-funded startups are incorporated as an S-corporation. This gives a startup the appearance of a company.
Even startups that are initially incorporated as an LLC (limited liability company) will be told to change to an S-corporation at the time of seeking outside, institutional funding.
WHAT IS A STARTUP THEN?
Startups are a formal incorporation of a project. Think of the project as the product or service to explore. The incorporation is a placeholder or shell to fill in as that exploration progresses.
The end goal of both types of startups (venture backed or boot-strapped) is to turn that project into a viable, self sustaining company. The means to reach that end goal gets off the ground differently.
The boot-strapped startup seeks to reach breakeven as quickly as possible. It is highly limited on cash flow so it must become profitable soon or face the prospects of shutting down. Consequently, boot-strapped startups tackle known problems in a highly conservative and limited way (e.g., niche needs, vertical target markets, local or regional reach, and so on).
The venture backed startup seeks to grow top-line revenues as quickly as possible - even while suffering prolonged losses. It is (theoretically) unlimited on cash since it can continue to raise more cash from outside investors. Thus, the venture backed startup will deploy large amounts of cash to grow revenues to capture market share, create a new market, or expand the market size. It will do so at global-scale and use its initial product to form a beachhead out of which it will expand.
By doing so, the venture backed startup will postpone profitability. Its goal is to deliver an outsized return on investment to its venture investors. Since a lot of cash is burned, the startup can only achieve that goal by growing revenues in an outsized manner. In turn, this can only be attained if the startup goes after an enormous potential or current market.
REALITY DISTORTION FIELD - FIVE THINGS TO GRASP
Everything that follows from this point on will be about venture backed startups. This is the type of startup I have the most experience with - and, most of my readers will find it more relevant to their own careers and ambitions than boot-strapped startup businesses.
After all, there is a ton of accurately written business literature on small businesses. However, most content about venture backed startups are a bit shallow or misleading. Nearly all of them leave out the dirty details for various reasons.
The least understood aspect of venture backed startups for both new and highly experienced people is in how operating principles can differ between a startup and an established company.
The decisions that are made at startups are not based on the same formulas as those made at established companies. Here are some key differences:
A) THE ROLE OF CASH
A startup needs to spend cash FOR growth. A company needs to invest cash TO continue growth. The minute a company cannot use cash to grow, it will either invest that cash into a new project, acquire another company (ie, buy top line growth) or distribute it to shareholders (ie, get it off its books).
B) THE PLAYBOOK
A startup is always trying to change the rules. It needs the rule changed so that it can quickly become relevant to the market and its set of relevant customers. A company spends resources to preserve the rules since rules are representative of their prior investments and key to future prosperity. This is why a startup must “overshoot” at times (voluntarily enter the “reality distortion field”) while a company must stay grounded at all times and resist the temptation to step into unfamiliar land.
C) CONSEQUENCES OF SPEED
A startup uses speed not only to gain wins but to learn from losses quickly. The death knell for startups is to lose slowly and not have the chance to course correct. A company uses speed to avoid losses as it is positioned to win by default. Ever hear the “no one gets fired for buying IBM (products)?” IBM in its glory days was a default winner so it sought to not lose.
Stretching out time - or, going slow - is the prudent strategy as it drains more resources. Large companies can outlast and beat small startups this way. The whole concept of prolonged RFPs (Request for Proposals) is an instantiation of this notion in action. Startups that get caught in RFP deals have signed their own contract for demise.
D) MAKEUP OF PEOPLE
A startup must have big game hunters - people who are not afraid to take down a lion or elephant with a little spear. A company must have cultivators (think of tillage) and farmers (think of harvesting crops). These are extremely different types of knowledge workers, managers, executives, and leaders. They are very hard to cross breed, synchronize, or tightly align toward the often singular purpose that a startup serves which is:
To disrupt, create, grow, and win significant share of an existing market by redefining the rules through breakthrough technologies.
It is worth noting that there is no such thing as a new market. All new markets are redefined existing or old markets. Startups that tend to succeed understand the distinction. Startups that tend to fail get caught up in a confusing loop because they are unable to see evolution for what it is - a chance to reignite growth. Everything new appears as a threat. Revolutions end with death. Evolutions are what disruptive technologies aim to accelerate.
E) MAXIMIZATION VS. OPTIMIZATION
A startup aspires to maximize limited resources. A company seeks to limit aspirations and optimize near limitless (or less limited) resources. Think of what kills each of the organisms. Operating below maximization will cause a startup to go into a slow death spiral. Operating below optimization will cause a company to enter a fast degradation of the whole. To use a networking analogy, a thin pipe is valuable when it is maximized (frequently utilized) while a big pipe is made valuable when it is optimized (fully utilized).
DELAYED GRATIFICATION
This is the final area that is more often misunderstood than appreciated - the idea of delayed gratification. Since nearly all people write about a startup’s exit (M&A, IPO), it is common for us to view a startup’s lifecycle as being a lot shorter than it is in reality.
A venture capitalist (VC) measures lifecycle through the fund’s life span. This is why the general business population thinks of a startup endeavor lasting 8-10 years.
A great founder must not view lifecycle in terms of time from incorporation to a cash-out event. Startup lifecycles are determined by (a) technology lifecycles and (b) path to ultimate profitability. Doing so stretches a startup’s lifecycle into 10-25+ years. Why?
Because most technologies with staying power lasts several refresh cycles (for corporate or business buyers) and at least a generation (defined by most people as 25 years). A startup that can last a full generation becomes “established.”
Refresh cycles are extremely short for business applications or very long for infrastructure and hardware-dependent products. The former requires constant innovation a lot more than the latter. Infrastructure technologies are generational while business applications are not.
Once infrastructure products are installed they are difficult to displace since they are long-term bets and investments. Business application are easy to rip-and-replace since they are short-term bets intended to be re-evaluated as a customer grows, shrinks, or changes around its core competencies.
Great founders and their people must believe in “delayed gratification” which can only work if a startup is trying to build toward a generational outcome. Those outcomes are rarely attained in 8-10 years. It’s the same concept behind why we sacrifice 4+ years in college.
No one sacrifices for only four years. The sacrifice actually starts in middle school or high school so the real number of years is closer to a minimum of 8-10 years. And, no rational person expects that sacrifice to payoff for only 8-10 more years. We expect to benefit for life or at least most of our working years.
A big company is not run by people who think this way. Their people are already in the gratification or payoff period. They are not incentivized to sacrifice. This is not a bad thing. They have put in their time and it is beyond reasonable for them to reap the rewards for as long as possible.
A startup is not a company. It hopes to one day become a big company. Thus, it makes little sense to say that a startup is better than a big company. They are just different. The “delayed gratification” is reached by becoming a meaningful, big company.
For a few fortunate startups, they will exit sometime along the way. For the very best of that fortunate batch, they will never exit and grow into a big company. Remember that an IPO is a fundraising event - not a literal exit - as it just moves money from public investors to earlier private investors (and shareholders).
TAKE A COUPLE SHOTS
I believe everyone should try forming or working at startups at least a couple times over the course of their careers. I say try it at least twice because most people do a lot better in their second go around.
Some people find it worthwhile because of regret minimization. And, others find it worthwhile because of a “wealth creation event” - through an unexpected but great near term exit or a fulfilled long term outcome.
But, everyone finds the experience of the attempt and journey to be a valuable learning experience. It inspires a few to get the courage to go out on their own while it even makes some talented people better appreciate what a large, established company offers.
In other words, there is very little downside risk while the upside is nearly limitless.
Nearly all of today’s great leaders in the technology industry have spent some time at a company that was once a startup. Even so-called lifers who have worked at a single company for 20+ years have startup experience as most of those big companies were startup-like when they first joined as a twenty something year old.
Very few technology companies (especially outside of IT infrastructure) last two or more generations (25+ years). And, even less leaders have never left a big company to try out a startup only to return to the familiar surroundings of a big company.
If you enjoyed reading this article, please become a paid subscriber to share your support with me and the other readers just like you who value straightforward, unfiltered coverage of topics related to tech startups, business and career management, and professional leadership growth. This will incentivize me to spend more of my free time to writing even more useful articles for you.
Having said that, there is little doubt in my mind that we are heading into a prolonged recession so please do not become a paid subscriber unless you can very easily afford to do so. Now is not the time to add small expenses to your budget if those items are not contributing to your future income and well being. Small expenses add up and now is the time to actually cut those recurring items that have little to no payback.
Let’s all get through this inevitable recession by continuing to develop as informed professionals and come out of it as strong as ever to take advantage of the next period of high growth. It will be around the corner a lot sooner than we think if we are focused and keeping busy.
Those who try to wait out the recession will feel like time is crawling by like a turtle. And, they will waste the opportunity to get ahead. Some will study the course and keep driving toward their destination while others who are completely reliant on lights will slow to a crawl or seek refuge on the side of the road.
Recessions are dark but the road does not change. It must be embraced, constantly studied, and traveled in both light and dark.
Have a great weekend everyone!