Hundreds of thousands of business applications are filed every month for everything from new restaurants to landscapers to companies pushing the latest tech. But what makes one of these companies a startup? Is it simply the act of launching a new business?
Not quite. According to a common definition, a startup business is a newly formed company created to develop an innovative product or service and bring it to market, often with the goal of rapid growth and scalability. Other businesses, by comparison, may be designed to serve an existing market and may prioritize sustainable revenue over growth.
This guide takes a deeper look into what makes a startup business, how they are funded, and what challenges they commonly face.
Key Points
• Startups are built around innovation and scalability, often using new technology to introduce unique products or services with the goal of rapid growth.
• Unlike traditional small businesses, startups frequently rely on external funding such as angel investors or venture capital instead of immediate revenue.
• Startups typically operate in high-risk, fast-changing environments and must stay adaptable, learning quickly and pivoting as market conditions evolve.
• There are multiple startup types, including scalable, social, buyable, and offshoot startups, each with different growth and exit goals.
• Startups progress through defined funding stages and face common challenges such as securing capital, finding customers, hiring talent, and scaling efficiently.
Key Characteristics of a Startup
Startups are defined by a unique set of traits that distinguish them from traditional small businesses. Understanding these characteristics helps explain how startups operate, grow, and navigate risk in competitive markets. The key features of startups include:
• Technology and innovation: Startups typically introduce new products or services that don’t yet exist in the marketplace. Often these innovations rely on new technology to power them.
• High potential for growth and scalability: By design, startups are looking to grow quickly by offering a unique product that is able to tap into a large market. Business plans for startups should include plans for the scaling of the business, including how the business expects to attain the funding and resources necessary for growth.
• Reliance on external funding: Many new small businesses may depend on self-funding or traditional sources of capital, such as small business loans or business lines of credit. A startup, on the other hand, may depend on outside sources of funding, such as angel investors or venture capital to fuel growth.
• Adaptability: Startups often function in dynamic environments and operate with limited resources. At the same time, they are looking for products that meet the demands of the market. The ability to learn from failures and quickly pivot as market conditions change helps these businesses succeed in finding opportunities and out-maneuvering slower competitors.
• Potentially higher risk: Startups often require significant capital to get off the ground, and it’s no guarantee that the product or service they offer will provide a return.
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How Startups Differ From Small Businesses
Startups and small businesses are often grouped together, but they are built with very different goals in mind. Startups are typically focused on innovation and disruption, often entering the market with a new product or service while still refining a scalable business model. Their primary aim is rapid growth, frequently targeting national or global markets rather than serving a single local community.
Small businesses, on the other hand, usually operate with proven business models and prioritize steady revenue from the start. They tend to serve established local or niche markets and focus on long-term stability rather than aggressive expansion. Because of this, small businesses are more likely to rely on traditional debt financing or equipment financing, while startups often seek outside investors willing to take on higher risk in exchange for potential high returns.
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Types of Startups
Startups come in a variety of forms, each with its own set of goals. Here are several examples:
• Buyable startups: A buyable startup is a company built with the end goal of being purchased by a larger company. These startups may put more focus on the innovative products or services they offer and less on developing their business for the long-term. Examples include WhatsApp, which was purchased by Facebook, or Postmates, which was bought by Uber.
• Social startups: Social startups may be nonprofit or for-profit companies that are focused specifically on solving social issues, often through technology. TOMS Shoes, which donates a pair of shoes for every pair sold, is a good example of a social startup. Warby Parker uses a similar model with glasses.
• Scalable startups: Scalable startups focus on business models that allow for rapid growth in customer base and revenue. They often use technology to handle high demand efficiently so costs stay low even as the company grows exponentially. For example, Spotify uses a subscription model to deliver content and scale efficiently.
• Offshoot startups: An offshoot startup is a company that spins off of a larger, more established parent company. For example, PayPal was acquired by eBay before spinning off to become a payment processing giant of its own.
The Stages of a Startup
Launching a business can be expensive. Startups often receive funding in stages. In the very earliest stage, known as pre-seed funding, the startup often relies on relatively informal sources of funding, such as personal savings or loans from family. At this stage, founders are developing their idea, doing market research, and creating prototypes.
Angel investors may get involved at this stage, as well. These are wealthy individuals who invest their own money in a company in exchange for equity, perhaps also offering expertise and mentorship. Startups may also turn to more formal sources of funding, such as startup business loans or microloans.
Once an idea seems to have legs, the next round is seed funding. Angel investors may continue their funding at this stage, and venture capital firms may step in as well. Venture capitalists are companies that invest pooled money in startups in exchange for equity. In addition to capital, they often provide guidance.
From here, startups may go through several rounds of funding, known as Series A through Series E funding as the company grows. New sources of capital may be available at each funding stage, such as private equity, which involves investing in privately held companies.
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Challenges Startups Commonly Face
Starting any business can involve challenges. Here are several that startups commonly face:
• Funding: Securing the capital needed to get a business off the ground and keep it growing is perhaps the number one challenge startups face. Entrepreneurs must work to convince investors that their idea is worth pursuing over and over again through each round of funding.
• Competition: No good idea arises in a vacuum. It’s likely that there will be other startups out there with similar concepts and products to offer all vying for market attention, customers, and funding.
• Finding customers: It’s one thing to have a great idea, but it’s another to actually get it in front of people who are willing to use it. Reaching new users and building trust can be a critical challenge of getting a product or service off the ground.
• Talent: Startups must build teams of exceptional employees to carry out their vision. This is especially critical when companies are small and the skills of every team member really count. However, startups are inherently risky, so it can be challenging to convince talent to join an emerging company, especially if a large part of their compensation — such as stock options — depends on the success of the company.
• Scaling: The goal of most startups is growth. Scaling means increasing revenue at a faster rate than costs grow. Achieving this is not always easy and involves carefully managing growth, building scalable infrastructure, and maintaining quality.
The Takeaway
Understanding what defines a startup helps clarify how these businesses differ from traditional small companies in purpose, structure, and growth strategy. Built around innovation, adaptability, and scalability, startups aim to test ideas quickly and expand rapidly while navigating higher levels of risk. By recognizing the characteristics, stages, and challenges startups face, entrepreneurs can better decide whether the startup model aligns with their goals and resources.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is the official definition of a startup?
There is no single official definition, but a startup is generally defined as a young company created to develop a new product or service under conditions of uncertainty. Startups typically focus on innovation, testing a scalable business model, and finding repeatable ways to grow in emerging or evolving markets.
How is a startup different from a small business?
While startups are designed for rapid growth and market disruption, other small businesses typically function within an existing market and are focused on sustainable growth and operations.
What are the stages of a startup?
Startups are broken into stages based on funding. There is the pre-seed stage when an idea is just getting off the ground, the seed stage that kicks off the business, and possible Series A through Series E rounds of funding as the business grows. Ultimately, the goal of a startup is usually a sale of the business or an initial public offering.
How do startups get funded?
Startups may receive funding in a variety of ways, from personal savings and small business loans in the early stages of development to angel investors, venture capital, and private equity through other stages of funding.
Do all startups aim for rapid growth?
No, not all startups aim for rapid growth. While many pursue fast scaling and large markets, others focus on sustainable growth, niche audiences, or lifestyle goals. These startups may prioritize steady revenue, profitability, and long-term stability over aggressive expansion or venture capital funding.
Photo credit: iStock/RealPeopleGroup
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