Startup vs. Small Business: What type of business are you forming?

“I’m the CEO of a new startup.”

As a conversation starter, this tends to be a pretty good statement to get someone’s interest peaked.  For some reason, being in the startup business tends to be pretty sexy, as far as business-building goes (wow, never thought I’d use the words startup and sexy in the same sentence, but there you have it).

On the other hand, forming a small business seems to have less of a ring to it.  I’m not sure why, but perhaps it has to do with what I saw on television — the general store owned by Mr. So-and-So or the Repair Shop down the street or insert your own random thought on a small business.

But the truth of the matter is, why does the phrase “startup” conjur up something different than a “small business?”  A startup tends to be a small business, by its very definition.  But oddly enough, they don’t have the same cache.

To Startup or Small Business… that is the question.

So what’s the difference?  In their book Engineering Your Startup, James Swanson and Michael Baird separate the businesses into two categories: (i) Income Substitution Businesses and (ii) Wealth Building Businesses. Generally, a small business will fall in the category of income substitution, while wealth building entities are more likely to be startups.

According to Swanson and Baird,

“people who simply do not want to work for someone else can easily startup a small income-substitution business such as a one-man computer repair service shop.”

This would qualify as an Income Substitution Business.  On the other hand, if you wanted to build a business that would be a national franchise or desired to create software allowing for repairs to be made remotely, then this model would be a wealth building business.

The terms “startup” and “small business” are sometimes used interchangeably, but in practice there is a difference between the two.  According to the Career Action Center,

“a start-up is a small company, most often with a high-tech focus, that is in the early stages of development, creating a product or service, or having a product or service needing manufacturing and/or marketing.  They are looking to grow through possible venture capital funding, initial public offerings (IPOs) or acquisition by larger companies.”

On the other hand, a small business tends to have a more narrow focus and is not limited to high-tech applications.  A small business may not have growth goals similar to a startup and may have no plans to grow larger than its small business size.

Does it matter?

That’s probably the better question here… does it matter if you say you are the forming a startup or a small business?  Perhaps smarter minds would differ, but I happen to think it does matter.  It may not be the difference between success or failure, but it matters.

Here’s why?  The use of the right description of your business and your goals sets the tone for your interactions with outsiders.  It is like knowing the secret handshake or the proper lingo.  Having the handshake and lingo will get you in the door (but don’t plan on staying long if that’s all you’ve got).  Why do most startups incorporate in Delaware?  Sure, there are the practical reasons (cutting edge law, most lawyers know it, ease of filing), but I think one of the other main reasons is it signals to outsiders such as investors, potential employees, executives, partners, etc. that you know what you are doing.

Same goes with the difference between calling your business a small business and a startup.  In all honesty, if you intend to build a business that, in all reality, will employ less than 20 people, most likely your concerns will be different than a technology company intending to build its product or service into the market leader for a market or sub-market.  One isn’t necessarily better (in fact, forming a small business probably is less risky and someone who has run the numbers may tell you that the odds of a successful outcome are higher), but you should probably know what you are planning to do and signal that to outsiders.  This prevents you from hiring the wrong types of folks (i.e. a programmer looking for a long term payout from some booming options) or spending time rubbing elbows with investor-types that aren’t in your wheelhouse.

In addition, small businesses tend to have different financing needs (which can be a good thing) and usually will have a more narrow market, either geographically or in scope.  Below are some of the basic differences between the two types of businesses:

Conclusion: Know thyself.

I’ve seen a number of people who have a business plan for a startup that would be much better off as a small business.  That isn’t to say that I bat 1000% on good ideas… but there are ideas that fit the ’startup’ mold and those that just probably don’t.  For example, a consulting organization (even one that will consult on high tech issues or use high tech people) probably isn’t a startup in the traditional sense of the word.  The consulting business can prove very successful, create tons of cash flow and may even spin of an interesting technology for a startup.  But, few VCs will fund a pure consulting company.  So spending all the time, energy and resources making a VC-ready business plan for a small business isn’t a good use of time.

So, the long and the short of it is to figure out what type of business you should form based on your experience and idea, not the type of business that is sexier, hipper or sounds better at those elbow-rubbing parties.  A well-run small business may pay off multiple times over from a hot new biotech startup or innovative software startup.  And that’s just the way it goes.

Truth is, each of us probably wants to get into the restaurant on Hollywood Boulevard where all the celebs are hanging out, let’s call it Club Startup.  Yup, Club Startup is the sexy, hot hangout.  Tip the bouncer, give him the handshake and maybe you’ll get in.  Or maybe not.  But don’t go sittin’ in line if you really don’t want to go there.  People like me may be better off not waiting in that line if I’m not going to get in anyways.  Me, maybe I’ll just have Miller Lite…