The terms “startup” and “small business” are sometimes used interchangeably to describe a new company. But these business types are fundamentally distinct, in terms of strategy and objective.
If you’re thinking of launching a venture, it’s important to know the difference between a startup and a small business and which one you’re trying to build.
Startup vs. small business
Famed startup incubator Y Combinator defines a startup as “a company that is built to grow fast.” Think Airbnb in 2009 after landing $600k in seed funding or Uber in 2010 after raising $1.25m. Both companies had novel ideas, the ability to quickly capture a big market, and the potential to disrupt an industry.
Industry disruption tends to be a goal for startups — for example, Slack’s ambition to revolutionize workplace communications or Grubhub’s aim to make ordering food easier.
Startups usually stem from tech because tech products can reach many users and scale quickly.
A small business doesn’t need to grow fast or disrupt its sector. What it aims is to find a market, reach that market effectively, and earn revenue.
The US Small Business Administration (SBA) defines a small business as a for-profit, independently owned and operated business that does not have national (or international) reach. A local bookshop, a pet store, and a boutique interior design firm are examples of small businesses.
A business needs to fall within certain size standards — in terms of revenue and number of employees — to be classified as a small business. These size standards vary from industry to industry, but 89% of small businesses in the US employ fewer than 20 people.
Being a small-business owner in the US comes with benefits, like being able to deduct business expenses and apply for SBA grants.
What is considered a startup?
A startup is a company that is searching for a scalable business model and is built to grow rapidly.
The point at which a startup transitions to a fully-fledged company is unclear, but Alex Wilhelm of TechCrunch came up with a helpful and often cited definition — the “50, 100, 500 Rule.” According to Wilhelm, a venture is no longer a startup if it exceeds these thresholds:
- $50m+ in revenue
- 100+ employees
- $500m+ in valuation
Startup vs. SME
A SME is a small to medium-sized enterprise. SMEs are independent businesses that employ no more than a certain number of people. In the US, that number is typically under 500 people. In the UK, it’s usually fewer than 250 people.
There’s some overlap between SMEs and small businesses. But “SME” is a more globally recognized term than “small business,” and SMEs account for +95% of firms and 60%-70% of employment worldwide.
Similar to small businesses, the goal of an SME is to reach a market effectively and earn revenue, whereas a startup aims to disrupt an industry and grow quickly.
Difference between startup and small business
There are many key differences between startups and small businesses. A few of these differences center around:
Having the intention to grow — and to do so rapidly — is what characterizes a startup.
In his essay “Startup = Growth,” investor and Y Combinator co-founder Paul Graham writes that the only essential characteristic of a startup is growth and that “you can use growth like a compass to make almost every decision you face.”
A startup needs to scale, which requires it to make a product or service that can reach and be used by many people. In order to sustain their desired growth rate, startups often need to burn capital (i.e., spend investor money) before turning a profit.
The success of a small business, on the other hand, isn’t as attached to growth. A small business needs to consistently turn a profit from early on to be successful — and to last.
Success for a neighborhood surf shop, for example, might mean an 8% profit margin. Success for a new social video app, in contrast, might mean gaining 8% more users every month, even if the company is running a loss financially.
Startups and small businesses both tend to be self-funded by the owners initially.But because growth is a startup’s raison d'être, they tend to have a better shot at capturing equity financing — as investing in a startup that’s expanding aggressively comes with a big potential upside for investors.
For example, if a venture capital firm gives a startup $1m in exchange for 15% in equity, and the company later gets acquired for $30m, the VC will get back $4.5m, or a 4.5x return.
Investors offer capital to startup founders in “rounds.” First, there’s the seed round. Some startups raise enough capital with seed funding to reach profitability, but many startups seek additional funding in Series A, Series B, and Series C (etc.) rounds. Founders typically give up more and more equity with each series of funding they accept.
Since the endgame for many startups is to get acquired, or to go public, investors can expect a payout in future if the startup is successful.
Small businesses usually don’t have a market that allows them to scale aggressively, making them less attractive to VCs and other investors.
Instead, small businesses often gain access to capital through loans — as well as through credit- and asset-based financing.
Startups are temporary organizations in search of a scalable and profitable business model. A startup may go through several tries before finding the winning model.
Once a startup shifts toward executing on the winning model, it becomes a company rather than a startup. The end goal for a startup (or a former startup-turned-company) is often an IPO or an acquisition.
Small-business owners often aim to create a stable, long-lasting company. The goal of a small business is usually to stay alive and turn a profit, and it’s unlikely to garner the appeal or size required to go public.
Startup vs. small business pros and cons
Considering whether to launch a startup or a small business? Think through these factors:
Pro: If you want a shot at influencing an industry and making a lot of money — and if you’re interested in tech — you may want to try your hand at a startup
Con: Startups are risky! Founders spend lots of time and money testing out ideas that may or may not meet a market need
Pro: Small businesses tend to use tested business models, which makes for a less risky venture
Con: There isn’t as much financial upside to owning a small business as there is to owning a successful startup
Overall, startups test novel, scalable ideas and prioritize growth. Small businesses favor profitability, sustainability, and steady growth.
Your business idea, along with your risk tolerance, will dictate whether startup or small business is the right model for you.