You may think that starting a new business is a “start-up.” Or you may think that forming a new business entity means you have a “start-up.” You may think the focus is on the timing or early stage of the business. None of these factors really captures the import of what the term “start-up” really means. This begs the question, what is a “start-up” exactly?
Start-ups Involve Uncertainty
A “start-up” involves uncertainty. It is a business activity to deliver a new product or service that is uncertain. The focus is on the “uncertainty.” Businesses with known problems and solutions to problems are not true start-ups.
Take a law firm, for example. A law firm may have just started operations and be a new business, but it probably would not be a start-up. The uncertainties for a new law firm relate to how it can compete with existing law firms. The new law firm just has to find new ways to provide better or cheaper legal services. The customer problem and solution are not uncertain.
This new-business vs. start-up distinction can help the start-up identify its target customer. This, in turn, can help the start-up figure out how to solve the problem and profit from it. This highlights the essential feature of a start-up. The start-up breaks new ground.
This is known as finding the product-market fit. This product-market fit can take some time to discover, which is why start-ups may exist and have a long period of being unprofitable as they find their product-market fit.
The product-market fit is uncertainty that reveals itself over time. Few entrepreneurs get it right from the start. It often takes action to observe results. The initial business models are often wrong in fundamental ways. Even the intended target customers may be wrong. The journey and learning process is where success is found. The costs incurred along the way are the education that, with persistence and luck, leads to success.
Repeatable and Scalable Business Models
This brings us to the second aspect of start-ups. Start-ups find ways to build repeatable and scalable business models.
The idea is that the business identifies a problem, preferably a big problem, and proposes a solution for the problem. This allows one to envision the end goal and work back to the present time to estimate the future revenue and budget for the expenditures needed to get there.
The repeatable and scalable business model allows for financing other than loans. Venture financing supplies the funds needed to cover the expenses in exchange for a chance at the expected revenue. Venture financing will not work if the business model is not repeatable and scalable.
The goal for start-ups is to quickly find the most efficient route to solve the customer problem. This is intended to produce the revenues that the start-up founders and financers are looking for.
Scaling a business is different from growing a business. The new law firm example described above helps explain this concept. The new law firm may develop a repeatable business model (and likely is just following a business model from a different law firm that the founder worked for), but the model is usually not scalable. The reason why it cannot scale is it is dependent on human hours worked. Adding one more client requires one more attorney, paralegal, etc., and the wages paid to these workers. Increases in profit come with added expenses. A law firm probably cannot add a hundred new clients without adding additional expenses. The law firm can grow by increasing its headcount, but it cannot scale.
Is Your Business a Start-up?
Not every business has to be a start-up. A new business, like a law firm or other service business, can be a great way to earn a living, build a business that can be sold for a profit, etc. These new businesses differ from start-ups. This is a critical distinction that drives how the business operates and how scarce resources are deployed and results are measured. Knowing the difference between a new business and a start-up, which type of business do you have?