Startups vs Small Business – Why understanding the difference is crucial

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Startups have become the buzzword over the past few years in India as policy makers realized that there was no way the economy, as it exists now, can generate enough jobs.

It is estimated that while around 12 lakh young people were entering the job market every year, pre-Covid, our formal economy was generating only around 1 to 1.2 lakh jobs per year.

Which is why, encouraging these employment seeking youngsters to become job creators instead of job seekers, is such an attractive option for the government.

The announcement of the Startup India scheme by the Prime Minister in his Independence Day speech from the ramparts of the Red Fort signalled the seriousness with which the government was taking this up.

A series of steps, from defining and recognizing startups to nurturing the growth of the startup ecosystem have been taken, and we can say with confidence that the foundations for job creation have been laid.

However, for the system to flourish, it is very important to distinguish between a startup and a new small business. The reason is that the support required for them is very different.

The requirements for starting a small business are very similar to that of large businesses, except for the scale of resources required – an unmet need or a gap in the demand and supply of a product or service that can generate a reasonable surplus, and the resources to set up the business.

So what is different for a startup?

The difference has been beautifully described by Peter Thiel, the famed Silicon Valley based founder and investor, in his book Zero to One where he said “Positively defined, a startup is the largest group of people you can convince of a plan to build a different future.”

In other words, this means that the startup is not just expanding an existing solution or business model by expanding its coverage (globalization), but is creating solutions that did not exist earlier (technology). Technology in this context is not limited to computers or software, but is anything that provides a new and better way of doing things.

One of the ways to differentiate the two lies in the business model. For a small business, it is essential that it needs to be able to generate a surplus from every client to survive and grow. And growth is linear depending upon the ability to add a substantial amount of resources – be in money or manpower.

For a startup, the ability to scale up very quickly at low incremental cost is essential and profitability generally is expected only after achieving a certain amount of scale.

For example, a traditional HR consultancy will need human resources to cater to the need of its clients, and in order to increase the client base, will have to add employees and as expected, the expense is high, not to speak of the uncertainty of the quality of the new resources and their ability to retain existing clients and attract new ones

However, a HR consultancy startup developing Artificial Intelligence based HR solutions would usually begin by offering its solution free of cost to enable the AI software to learn, and then once the system is reasonably efficient, start charging for their services.

Here, till they are in a position to charge their clients, the firm needs funds to stay alive – funds that come from angel investors and venture capitalists, and instead of profits, they are expected to live with considerable losses till that time.

There is another difference – once the efficiency is established, the firm can add on thousands of clients at a minimal marginal cost, in other words, scale up exponentially and at almost no additional expense.

This basic difference necessitates different support systems for small businesses and startups, and simply registering every new small business as a startup may actually be disadvantageous for both startups as well as small businesses.

While every small business may not survive in the long term, it is an accepted fact that 90% of startups will fail. As this failure is expected and accepted, venture capitalists have a thumb rule that every investment, if it succeeds, should have the potential to return at least 20 times the sum invested. This way, even if one in ten investments succeed, the fund can still turn in a profit for its investors. Which is why, expecting VC investment in a new small business can be a fruitless dream.

There is one other crucial difference for policy makers to keep in mind. By their very nature, successful startups bring huge efficiencies to existing systems and one potential fallout is a decrease in employment – the exact opposite of the objective of the mission Startup India. One team of 30 smart young people can create solutions that can destroy 3 lakh jobs, and this is the reality that our government needs to understand.

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