Since the boom of Silicon Valley tech companies, it's not uncommon for the words "startup" and "small business" to be used interchangeably, but they're not actually the same thing. When it comes to a startup vs. a small business, the major differences have to do with the overall vision. One is meant to take over the world, while the other is meant to make a steady but limited stream of income.
Funding in a Startup vs. a Small Business
The difference between a startup and a small business is largely in the funding. Though financing is a major issue for both types of businesses, the way they acquire funding is typically different. Startups generally look for large investments right off the bat from venture capitalists and angel investors. These people typically drop no less than $1 million into a company with the hopes that it will one day turn a profit.
For small businesses, landing a $1 million investment may seem completely off the table. Small business owners generally finance their operation with small business loans using either traditional bank loans or online lenders. As a result, they receive much smaller amounts of capital and accrue interest, but other people do not own equity in their company. They remain completely independent.
Basically, when you’re starting a business, you’ll probably have to pay somewhere, whether it’s in interest or in ownership. Small businesses generally take a transactional approach to funding and end up paying more in the long run in favor of complete independence, whereas startups partner with their financiers, who may ultimately influence the direction of the company.
Business Models in a Startup vs. a Small Business
Startups and small businesses have completely different business models. Yes, they all want to make money, but startups aren’t typically designed to be successful right away. In fact, startups generally test the waters in a not-so-profitable way before they manage to hit it big. This is a popular method called "the lean startup".
Lean startups generally evolve with their consumers, beta test what they have (which is also known as a minimum viable product) and then alter that product and change their business model based on consumer information. This is why startups can hit the market so quickly. We see this with the popular vacation rental company Airbnb, which started with three men renting air mattresses in their apartment. Over the course of doing business, they took customer demand and feedback into consideration and developed an app to foster private housing rentals that’s now worth an estimated $31 billion.
The business model for small businesses is a bit different. They generally have a solid business plan that outlines five to 10 years of growth potential (they need this to secure a Small Business Administration loan) and rarely deviate. They take a finished product to the market and hope that it makes money right away. On the other hand, a startup will take a minimum viable product to market, evolve it and eventually hope to make money when the idea is perfected.
The End Game
When you’re looking at a startup vs. a small business, both may have scalable business models, but the life cycle of the companies is usually completely different. Profitability is the goal, but the main end game of a small business is to stay in business. That could look like a lot of different things. For example, a Vermont-based mom and pop grocery store may want to eventually open grocery stores across New England, whereas a hair salon may just aim to have enough of a demand that it can eventually raise its pricing.
Startups aren’t generally viewed as permanent businesses. They enter the space planning to make a grand exit. They usually have one of two exit strategies. Either they evolve into a company so massively successful that they can have a stock market initial public offering or they get bought out by a larger company, and the startup founders make millions or billions.
The difference of intent is why you see so many startup founders chasing new business ideas and jumping from one company to the next, whereas small business owners generally plan to stay with their business until it fails or they retire. That’s not to say that a small business is never bought or sold — small businesses change ownership all the time — but that isn’t usually the initial intent.
Scale of a Startup vs. a Small Business
One of the key differences between a startup and a small business is the intent behind its growth. No one ever launched a startup and went through the difficult process of landing investor funding only to just comfortably stay afloat. Startups want to take over the industry and change the world, which is largely the reason it’s OK that some startups never reach profitability.
Take a look at Spotify, a tech company that’s currently a front runner in the music-streaming space. If this company was a small business, it would have failed many years ago because it failed to turn a profit for more than a decade. Instead, it revolutionized the music industry, which was desperately searching for an answer to illegal downloads. In 2019, after 13 years of business and a whopping 96 million subscribers, the company finally turned a profit.
A regular small business would be considered a colossal failure if it spent 13 years losing money. Would your local deli stay in business year after year if debt was continually increasing? Small businesses generally don’t need a giant market share to succeed; they just need to be able to efficiently reach enough of their target market to turn a sustainable profit. Startups aim to rule the entire market rather than exist within it.
Examples of a Startup vs. a Small Business
If you’re looking at the difference between a startup and a small business, you can look at the products you use every single day. Small businesses are your mom-and-pop diner, your local pub, the laundromat, mechanics, plumbers and electricians. All of these businesses have a solid local market but generally don’t aim to expand and dominate the global market. You can use the same plumber for 25 years, and it’s unlikely that anything about that service will be different (i.e., the biggest jump you can expect is a change in headquarters, not a change in the entire business structure).
Startups are very different. There’s a good chance that app you like using on your phone won’t be there in five years. There's much more risk there. Though the vast majority of startups eventually fold, successful startups almost always evolve their business to be different from the initial business model.
Examples From Silicon Valley
We see startups largely populating Silicon Valley in California. Facebook is one of the most notable and expanded from being a college-based replacement for a phone book with absolutely no way to make money to becoming a major advertiser, a news aggregator, an instant-messaging service and a content suite without even mentioning the mega apps it has acquired along the way. The Facebook that started in 2004 is absolutely nothing like the Facebook of 2020.
We also see the startup model in Uber, which eventually landed an IPO. The company started as a service that connects users with independent drivers who function like taxis. Though the drivers are the heart of the current business model, the company is evolving to hopefully include self-driving cars, essentially making drivers redundant.
- The Verge: Spotify, the Leading Music Streaming App, is Finally Profitable
- Forbes: Are You Running a Startup or Small Business? What's the Difference?
- Business Insider: How 3 Guys Turned Renting Air Mattresses in Their Apartment into a $31 Billion Company, Airbnb
- Entrepreneur: Difference Between Start-up and Business: All You Need to Know