Understanding the Differences Between Startups and Conventional Companies

When people talk about startups, they often think of companies that are just beginning, with low funding and uncertain futures. However, there are significant differences between startups and conventional companies that go beyond initial funding levels. This article will explore these differences, focusing on how they are structured, the roles of their stakeholders, and their primary objectives.

Understand the Fundamentals

A startup is typically not as well-funded as a conventional company, but it's important to remember that every company began as a startup. The journey from startup to a large, well-established corporation can be marked by numerous challenges and changes in structure and objectives.

Startups and Risk Investment

The term "startup" is often associated with seeking public market risk investment. This means that investors, subject to the rules and regulations of the Securities and Exchange Commission (SEC), are betting on the potential success of the venture. This type of investment has certain tax implications that can be disadvantageous for the company and its shareholders, although these benefits may accrue to the venture capital firm's principals and investors.

Private Companies vs. Public Companies

In contrast, a newly formed company that is privately owned may have different investors and goals. Because it is not publicly traded, any potential profits would pass through to the shareholders under tax laws that favor deferred taxation. This structure allows the company to retain more cash for reinvestment into the business.

Comparing Business Models

The primary objective of a startup is to grow the value of the stock or options. This is driven by capital gains taxes that are lower than the taxes a privately owned company in manufacturing would face, such as over 60% in places like New York or California. The focus on growing stock value and continually raising capital means that startups are inherently geared towards rapid growth.

On the other hand, the goal of a conventional business is to generate revenue that exceeds costs, which can be reinvested in the business or distributed to management and shareholders. Unlike startups, where the focus is on growth, conventional companies often seek to maintain stability and a steady cash flow.

Risk Management and Compensation

Startups operate in a high-risk environment, where compensation for management and owners is often tied directly to the company's performance. Conversely, in conventional companies, management's compensation is not always closely tied to short-term results, reflecting the risk-averse nature of these organizations. Large corporations typically eliminate human resource risks and avoid risking the success of their operations by regularly removing risk-takers.

The Startup Ecosystem

The startup ecosystem is built on the idea of leveraging risk not only in technology but in the individuals involved. This can be a double-edged sword, as startups often invest heavily in talented but unproven individuals, betting on their ability to scale risky and unproven business propositions.

Most startups focus on software code, which can significantly reduce operating costs, particularly human resources. Some startups can eliminate entire departments or even industries, creating a transformative impact. This type of growth and the resulting multiples are what drive the startup ecosystem.

Conclusion

Whether a company is a startup or a conventional enterprise, understanding the differences in structure, objectives, and stakeholders is crucial. While startups take on significant risk, they are also driven by the potential for high returns. Conventional companies, on the other hand, are built for stability and long-term profitability.

Ultimately, the choice between a startup and a conventional company depends on one's risk tolerance, growth aspirations, and financial goals. Each type of business has its own unique challenges and opportunities.