What is a startup?

Recently, I was talking about business with one of my co-workers. I enjoy chatting about innovation, strategy, products, and everything that has to do with commerce. In the middle of this conversation, I said something that prompted my co-worker to respond with something along the lines of "my brother worked at a startup that sold belts online...." Wait, what? A belt startup? I steered the conversation in that direction, and probed more into this belt startup. Had they reinvented the belt to be dramatically better than what we know today? Nope. Had they come up with a new manufacturing process that would revolutionize the belt market? Nada. Did they maybe come up with a business model that would allow them to dominate the market? Not at all. I guess they simply sell a wide variety of belts online, maybe they drop ship, maybe its fast-fashion.

What ensued was a friendly debate about the use of the word startup to define new companies. I argued this belt company is not a startup, my co-worker defended that it was.

The world is in an incredible cycle of innovation and entrepreneurship at the moment. I want to say that we are on a 10 year run, but on the macro scale its a lot longer, and a philosopher may say its a never ending run. Regardless of how you look at things, with more innovation comes more entrepreneurship, and over the past 10-20 years, more entrepreneurship has lead to more use of the term startup.

What is a startup, anyway? I mean, most of us could give an answer, but how specific would those answers be, and would we all agree?

Does it even matter? Absolutely not! I do, however, find it an interesting topic, and there are some very mild consequences to correct, or incorrect use of the term. Go into a bank for a loan, say you are a startup, and you'll get laughed out of the building. Walk into a venture capital firm and say you are a small business, and they'll laugh you out as well.

I believe that all startups begin as small businesses, but not all small businesses are startups. Let's explore!

When I first had this question, years before the debate about a belt company being a startup, the first thing I did was search for a definition that I could hang my beliefs on. You can find a whole lot of textbook definitions out there, some are meaningful and others just confuse the question even more. Then I came across the definition by Eric Ries, author of The Lean Startup (one of my favorite books on startups, entrepreneurship, and innovation):

A startup is a human institution designed to deliver a new product or service under conditions of extreme uncertainty.

This definition, short and to the point, is spot on. There are two subtle things in this definition that stand out. First, the mention of something being new, not doing the same thing others do. Then, the requirement that the conditions be extremely uncertain.

When I have this conversation with others, I tend to use a very simple example as a test for this definition: a bagel shop. Their product, bagels, is not new. Been around for a few hundred years and consumers have clear expectations of what a bagel is. If you are starting a bagel shop, you likely aren't creating anything new. You also aren't entering a market of extreme uncertainty. The market demand is well known, or can be. You know how many people are in the area around the shop, what your competition is, and more. The knowledge is broad and relatively easy to obtain.

So, if I open a bagel shop, am I a startup founder? No way! I'd be a small business entrepreneur. Being a small business owner is a difficult task, one that most couldn't or wouldn't have the guts to do. I applaud these folks, and admire their work. They are an important to the economy, and good for the community. They aren't startup founders though.

I do think that Eric Ries is missing one thing in his definition. I believe that in addition to the product being new and the conditions being extremely uncertain, startups also have the potential for massive and hyper growth, with the economies of scale to turn an investment into outsized returns.

Now, lets take a look at a company that I would define as a startup, Tesla. At first glance, you may be thinking that a car company isn't new, and the market isn't uncertain. However, I disagree! When Tesla started, they were in fact creating something new, a mainstream electric car, and more specifically, an electric sports car targeted at wealthy buyers. The idea that a high price sports car could be electric was new and wild. The idea that an electric car could have broad appeal flew in the face of the ugly and underwhelming electric cars that had hit the market before. The plan to then create other models of electric cars for the mass market while remaining sexy, and at affordable prices, was down right crazy when Tesla started. The newness of the product is also connected to the conditions of extreme uncertainty. Tesla cars would have just a fraction of the range of a gas powered car, something customers may struggle with. There was no charging infrastructure, like there is a network of gas stations. Setting up automotive manufacturing is an expensive, upfront investment that may not pay off. In 2003 when Tesla was started, the economy was still coming out of the recession from the dot-com bubble bursting and 9/11 changing America forever. Gas prices were actually low in 2003, so Tesla couldn't count on that for help.

Tesla started by doing something completely new. They were doing so under the circumstances of extreme uncertainty. And they had the opportunity to create immense wealth through rapid growth. They currently do about $12 billion USD in annual revenue, with a market value of over $50 billion USD, making them about as valuable as the big three America automakers, in just 15 years compared with the 100+ years Tesla's competitors had to grow into that valuation.

The founders and early executives of Tesla were taking a risk that no small business owner can compare with. Their likelihood of failing was high, and being successful would require very specific skills, many that can't be taught. If they were successful, the reward would be at levels that most can't fathom.

The bagel shop owner and electric sports car company founder are both entrepreneurs, and should both be applauded. They don't, however, face the same job, the same risks, or the same reward. One can walk into a bank for a loan, the other can't. One can build a nice business that throws off cash to make them wealthy, the other can make tens of thousand of others wealthy and change an industry in the process.

Nothing would make me happier than if you, the reader, were thinking to yourself at this point that a bagel shop could be a startup, if they did things differently. I love to think that any and every industry is ripe for the type of disruption that Elon Musk brought to the automotive world with Tesla. Its not that online belt retailers and bagel shops can't be startups, its that they typically aren't startups.

So, let me know when someone revolutionizes the world through bagels or belts, and I'll update this post. That said, I'll never equate being a small business owner with being a startup founder.