Finances and Taxes

What’s the Difference Between a Startup and a Small Business?

Kim Porter  

Brainstorming a new business idea? When you’re in the planning stages of starting a company, there’s an important piece you’ll need to consider: whether you’re launching a startup or a small business. While the terms are sometimes used interchangeably, they each have their own distinctions. Here’s what makes each type of business unique.   

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What’s a startup?

A startup is a type of young company designed to disrupt an industry and quickly gain market share—and generally, the founder seeks funding from outside investors so it can grow quickly. These companies operate like any other, with a person or a group of employees working to produce something. But their main goal is to grow into a larger, influential company and create a totally new way of offering a service or product. For instance, Uber created a new way of hiring drivers on-demand, while Airbnb changed the vacation rental market. 

But just like small businesses, startups aren’t all the same. Here are just a few different ways to classify this type of venture: 

  • Scalable startups, like Facebook, Google, and Amazon, are ultra-focused on quick growth. According to Silicon Valley entrepreneur Steve Blank, this type of startup “takes an innovative idea and searches for a scalable and repeatable business model that will turn it into a high growth, profitable company.”
  • Buyable startups are designed specifically to create a new product or service and eventually sell it to another company. Plenty of tech-focused companies and apps, such as WhatsApp, start as buyable startups.
  • Social entrepreneurship startups work toward social change and aren’t driven primarily by financial growth. Toms shoe company is one example of a social entrepreneurship startup.

What’s a small business?

A small business is a privately-owned company, whether it’s a sole proprietorship, partnership, or corporation. While small businesses can have up to 1,500 employees (depending on the industry), about 90% of these companies employ 20 or fewer workers. To be considered a small business, the venture also needs to be for-profit, independently owned and operated, and not nationally dominant in its field, according to the U.S. Small Business Administration (SBA). Small businesses also tend to sell within a local market and form personal relationships with customers. 

Differences between startups vs. small businesses

Startups and small businesses are both companies that may grow and earn a profit, but they differ in the way they go about it. Here are some of the key differences between a startup vs. a small business.

Growth plans

One of the biggest differences between a startup and a small business is the company’s plans for growth. Generally, startup founders want to scale their businesses as quickly as possible. These companies need significant capital to reach the next level, and growth is critical for attracting investor dollars. Some startups even temporarily set aside profitability in favor of growth, which allows them to capture a bigger market share. Startups can do this because their investors aren’t repaid in the same way bank loans are.

On the other hand, small businesses seek growth by creating reliable, long-term income streams. They often keep costs and expenses low because their funding is limited and loans must be repaid with capital. And in terms of employees, small business owners typically maintain a small-sized team indefinitely.

Funding

Startups and small businesses are both typically funded by the entrepreneur or partners in the beginning. The business owners might chip in money from their own savings, take out small-business bank loans, or accept financial gifts from friends and family

But successful startups eventually receive additional funding from other sources like venture capitalists and angel investors. The startup can offer investors (and employees) something the small business might not be able to: equity in the company. Typically, founders offer equity to investors in rounds (seed funding, then Series A, B, C, etc.)—each with specific goals, terms, and pricing. Each round of funding erodes the startup founder’s equity and diversifies the company’s ownership. Notably, shareholders and board members generally have voting rights.

Later on, the founder may decide to raise capital from the public via initial public offering (IPO), sell the startup, or merge it with another company to scale growth and capital. In contrast, giving up control of their business isn’t usually as palatable for small business owners. 

Business goals

Most small business owners plan to continue running their businesses for the long haul. They might pass the business on to a family member or sell the company when they’re ready to retire. Therefore, a small business’s long-term goal is often to stay in business and earn a profit. Unlike startups, IPOs are not typically one of the exit strategy options for small businesses. 

On the other hand, while startup founders may also run their companies for the long haul, they usually have a different business approach that entails market disruption, shared ownership with many investors for the purpose of fundraising, and an exit strategy that triggers a liquidity event (like an IPO) for the founder(s), employees, and investors. The startup is the earliest phase of this type of company’s growth; it’s the period in which it’s proving its business model, raising funds, and scaling rapidly. 

Risk factors

While there’s some degree of risk with any new venture, a startup generally comes with more compared to a small business. 

Startups are often formed based on a totally new concept or product that’s designed to disrupt the market. They may go through several rounds of funding and test several product iterations before finding what works—and success is never guaranteed. 

On the other hand, small businesses tend to use fairly proven business models that they can either match or improve on, they launch within established markets, and they aim for longevity. These organizations also take a longer approach to growth, if at all. So while there are risks involved with starting a small business, they’re generally more manageable than they are for startup owners.

Which type of business is right for you?

When you’re figuring out how you’ll execute your new business idea, it’s important to think about whether you’re a startup entrepreneur or a small-business owner. Why? Making the distinction early in the process will help you define the path for your future business. You’ll be able to set growth expectations, research your funding methods, create a plan for your business, and define what “success” means to you.

Kim Porter
Kim Porter Kim Porter covers personal finance topics for AARP The Magazine, Bankrate, U.S. News & World Report, Reviewed, Credit Karma, and more. When she’s not writing, you can find her training for her next race, reading, or planning her next big trip. Twitter | LinkedIn
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