What Is A Startup? Why You Need to Know the Different Types

The word “startup” has become ubiquitous in the American vocabulary. However, there is really no common understanding of the definition.

Why should we care that there are various ways the word “startup” is used? Well, since there are so many conflicting definitions, it’s difficult to keep everyone on the same page when you’re discussing such things as economic policy issues related to new businesses. Moreover, since there are two primary types of startups, entrepreneurs need to know exactly what they are signing up for.

What is a Startup?

Wikipedia defines a startup as “an entrepreneurial venture, typically describing a newly emerged, fast-growing business.” Yet, if you look further, you’ll find that different people mean radically different things when they use this term.

Some people define a startup simply as a newly registered firm with at least one employee – the founder. However, many also include the attribute of scalability in the definition. Others only consider businesses that develop software or produce hardware as startups.

I have recently noticed that the press, and even certain groups of business mentors, imply that a startup is an innovation-related business that will need to raise capital from investors at some point. These same people also use the phrase “small business” to describe service-oriented businesses such as freelancers, subcontractors, or restaurants.

The reality is that a startup is a temporary status applied to all business ventures when they’re looking for a viable business and economic model. When you are a startup, you are still looking for a repeatable and scalable business model that will create revenues that exceed their expenses. Therefore, a startup is any business that has not yet reached profitability.  Once they reach profitability, they lose their status as a startup and are, in fact, businesses.

A startup is any business that has not yet reached profitability

All of this can be very confusing to a new entrepreneur because, in reality, a startup comes in two primary types, a new market startup or an existing market startup. What is really important to understand for the entrepreneur is the distinction between the two types. The knowledge, skills, and startup capital required to launch a new market startup are very different than the knowledge, skills, and capital required to launch an existing market startup.

New Market Startup

What is a new market startup? In a new market startup, there are no users and no competitors. A new market startup is what many founders dream of when they think about starting a business. They have visions of becoming the next Microsoft, Amazon, or Facebook and becoming a billionaire. However, a new market startup is also extremely risky and requires lots of money to reach profitability.

Most entrepreneurs go into business because they aspire to become financially free and break through the income ceilings they are subject to being corporate employees. Additionally, they also aspire to enjoy a greater work/life balance, time flexibility, and location independence. The truth is that most new startup founders will rarely achieve these goals by launching a new market startup.

Here are a few major challenges that a new market startup founder will have to deal with.

Personal Financial Challenges

As a founder of a new market startup, you will likely make less money than you did when you had a corporate job. Instead of making money hand over fist, you will be spending your own money and lots of it. You will draw down your savings, take on personal debt, and pay everyone else before paying yourself.

Time Challenges

New market startup founders are not only forced to endure financial hardship but to toil away for many years, in the hope of making life-changing lottery money, that will come from either an acquisition or an IPO.  Only a very small percentage of new market startups will ever see any success. Instead, these founders will find themselves working more hours than they ever worked before. As a new market startup founder, they will be answering phone calls and doing video conferences before the sun comes up and well into the evening. Weekends and holidays will be nonexistent, and they can forget about any kind of vacation.

When and if they finally reach their first inflection point and start adding investors to the mix, they can take all the stress and exhaustion they have experienced so far and double or triple it. Now, it’s not just customers and employees they have to cater to. They have to cater to shareholders and board members as well.

Money Rising Challenge

Generally, a new market startup prioritizes growth, scale, and market share over profits. To achieve these goals, the founder needs to tap into financial markets, raise capital, and build the business in a way that seeks to ensure category domination before competitors can jump in.

Because a new market startup will almost always lose money for several years, it will need to be funded by angel investors or through venture capital firms. The founders’ compensation is limited to their salary as employees as any discretionary income is poured back into the business. That said, they hold an illiquid equity stake in the venture that has the potential of a life-changing windfall in the event of a successful exit. It is this life-changing windfall that attracts many unqualified founders to try to launch a new market startup.

Customer Education Challenge

There are also many challenges when creating a new business category. When I was an Invisible Fencing dealer in the 1980s, the company was a new market startup. Because it was a new market startup with a brand-new product concept, customer acquisition costs were very high. I had to spend a lot of time and money to make prospects aware of the solution that we offered since no one had heard of it before. When you have a new product or service that no one has heard of, you cannot rely on any organic traffic until you build up brand awareness.

Customer Discover Challenge

When it comes to a new market startup, customer discovery is also much harder. You can’t just go outside and ask people direct questions such as “Would you like this feature?”. Rather, you will need to find out how they spend their day and be able to share what the world’s going to be like if they buy your solution.

Your biggest challenge in a new market startup is to figure out how you will acquire customers. Since what you are offering is new, your revenues will most likely be either nonexistent or very flat for the first couple of years until the market recognizes your offering and adopts your solution. Hopefully, this will occur before you run out of money.

If you are lucky enough to have survived to see some prospects adopt your solution, you now have to shift gears to cross the chasm of adopters between the early adopters who value technology and performance and the majority of adopters who value solutions and convenience.

What I can tell you from experience is that most entrepreneurs are not cut out to be new market startup founders, which represent a very special breed of entrepreneurs. Unfortunately, TV shows like Shark Tank make it look like all startups are new market startups. Rather than succumb to the popular myth that all startups are somehow new market startups, most entrepreneurs are far better off trying to start an existing market startup.

Existing Market Startup

There is another type of startup called an existing market startup. This is the realm of most small businesses. An existing market startup is far less risky than a new market startup. Founders of an existing market startup start with the intention of producing income for the owners rather than trying to build a large complicated and risky business while enduring many hardships along the way. The goal of an existing market startup is to create a product or service that solves a problem while pursuing the clearest path to profit in the short and medium term. When successful, an existing market startup has the potential to produce passive income, leading to greater autonomy, freedom, and wealth for the owners.

As the founder of an existing market startup, you are far more likely to create a lifestyle business or micro business that will provide income for you and your family. Moreover, you get to choose the type of business you want, whether or not you want to work remotely, and how much you want to travel. You are the one in charge. No investors or board of directors to cater to. With hard work and a bit of luck, you will no longer be a startup and your income can eventually get to the point of being passive or semi-passive. Moreover, you even have the potential to sell your now profitable business and make enough money to retire. This is exactly the path that I followed when I built and sold my documentation and training businesses, one to a public company and another to an individual seeking a lifestyle change.

Customer Discovery

In an existing market startup, some users already use the type of product or service your business offers. Some competitors already exist in your market. Users can tell you the basics of the competition such as price, performance, customer service, etc. There are known channels that create customer demand. If you want to, you can actually go out and talk to users to see what they want.

In an existing market startup, your job is to mainly have a better offering to take market share away from the competition. Because you operate in a known market, you can develop marketing material for your sales channels from day one. The biggest problem is that you are not the only business in your market category.

There are two subcategories for an existing market startup.

Existing Market with Incumbent

In an existing market, if there is an incumbent or a dominant player, attacking them head-on might be suicidal. I heard of an axiom that says that you need about four times the sales and marketing budget of an incumbent to win over their existing market. Being a small business, you are better served by relying on a different strategy than the head-to-head competition.

You might decide to one-down the competition and be a low-cost provider by whittling down or limiting the features of your offering to create a less featured, but lower-cost alternative solution. You might decide you know a lot about a small niche segment of the incumbent’s customer base that the incumbent is ignoring. The incumbent might have a generalized offering, but you might know something about that niche that’s large enough for you to attack with a dedicated set of features or services.

For example, since women will soon become the richest demographic, what if an auto repair shop focused on servicing cars owned by women and included educational materials about how cars operate and how repairs are performed – something that many men clients are likely more aware of than women? Or what if they offered a waiting area that included a play area like McDonald’s so that moms with kids could have their child entertained while they waited for an oil change or tire rotation?

Market Clone

Another existing market startup is to clone an existing business model used in another country. Remember, there is no prize for originality. Juice boxes and Barbie Dolls are examples of products that were offered in other countries and simply introduced to the US consumer.

Conclusion

The word “startup” has become ubiquitous in the American vocabulary, however, there is no common understanding of the definition. After considering several definitions of a startup, my simple definition is that a startup is any business that has not yet reached profitability.

Basically, there are two types of startups, a new market startup or an existing market startup.

Most entrepreneurs are ill-equipped to be founders of a new market startup.

So before you embark on your entrepreneurial journey, you need to know exactly what you’re signing up for. Otherwise, you may end up in a scenario where you make investments of time and money that sound great at the time but do not advance you toward your true goals. Therefore, before you quit your day job to start a new business, start by asking yourself: “What does success look like?”

How do you define a startup?