What is a startup

A coffee shop and a software company open in the same week. Each has two founders, a bank account, and ten customers. Only one of them is a startup. The difference is not the technology, the age of the company, or the money in the bank. The difference is one decision that the founders make at the start.

A startup is a company designed to grow fast

Paul Graham is a cofounder of Y Combinator (YC), a startup accelerator. In September 2012, he wrote an essay with the title “Startup = Growth”. Its first sentence is the definition that this course uses:

“A startup is a company designed to grow fast.”

A new company is not always a startup. Graham also lists what a startup does not need. It does not have to use technology. It does not have to take venture money. It does not have to plan an exit, such as a sale to a larger company. In his words, “The only essential thing is growth.”

Many startups use technology, because ideas for fast growth are often technical. Software can sell to a million customers almost as easily as to a thousand. But the technology is a tool. The design for growth is the definition.

A small business has a different goal

A small business is a company that its owners do not design to become 100 times larger. A café, a plumber, a dental clinic, and a local agency are examples. Each one can be a very good business. It can pay its owners well for many years.

Graham says that a simple idea such as “bar + neighborhood” is sufficient for a small business. A café needs a good location and good coffee. It does not need a new idea. Graham also says that the niche of a small business “both protects and defines” it:

The niche protects it. A café in a different city cannot take its customers.
The niche defines it. The café can serve only the persons who come through its door.

A startup makes the opposite choice. It looks for a market so large that the company can grow for years, and it accepts more risk in return.

Question	Small business	Startup
What is the goal?	A good business of a stable size	A business that becomes many times larger
What limits it?	Its location, or the hours of its people	How fast it can find and serve customers
Example	A café on a busy street	Software that any café in the world can buy

Sort it

Startup or small business?

Pick one label for each company. Ask one question: did the founders design it to grow very large?

A café on a busy street
Appointment software that any dental clinic in the country can buy online
A design agency with two partners
A bakery that takes orders through its own mobile app
A marketplace that matches truck drivers with loads across the country
A new kind of battery for car makers worldwide, with no revenue yet
A profitable firm of 12 consultants
An online invoice tool for small businesses, with sales up 6% each week

Sorted: 0 of 8
Correct: —

Pick a label for each company. Each answer shows the reason.

Growth compounds

Graham gives targets for the companies in YC. He measures the growth rate each week:

5% to 7% a week is a good rate.
10% a week is an exceptional rate.
1% a week is too slow. Graham writes that it is a sign that the founders do not yet know what to do.

These numbers look small. A week is short, and 5% is a small step. But the growth of each week applies to a larger base than the week before. This is compound growth.

Predict first

A company grows 5% each week for one year. How many times larger is it at the end of the year?

Type a guess before you continue. A guess first, even a wrong one, makes the answer easier to remember.

Graham’s essay gives the result of one year at each weekly rate. Our calculation agrees with his table:

Growth each week	Growth in one year
1%	1.68 times
2%	2.80 times
5%	12.6 times
7%	33.7 times
10%	142 times

The formula is short:

Growth in one year = (1 + weekly rate)^52
At 5% a week       = 1.05^52
                   = 12.6 times

Now compare two companies over four years. Each makes $1,000 of revenue a month today. Company A grows 1% a week. Company B grows 5% a week. Move the rate of company B and look at the gap.

Simulator

Two companies, two weekly growth rates

Both companies make $1,000 of revenue a month today. Company A grows 1% a week. Pick the weekly growth of company B.

Weekly growth of company B5%

Years of growth

Company A: $7,922; a month, after 4 years
Company B: $25.55M; a month, after 4 years
B in one year: 12.6x; 1.05^52
B against A: 3,225x

Company A, 1% a week
Company B, 5% a week

At 5% a week, company B grows 12.6 times in one year. After 4 years, it makes $25.55M a month, 3,225 times the revenue of company A. The two weekly rates differ by only 4 points.

Paul Graham calls 5% to 7% a week a good rate for a startup in Y Combinator.

Four years are 208 weeks. This is the calculation for the two companies:

Company A = $1,000 × 1.01^208
          = $7,922 a month
Company B = $1,000 × 1.05^208
          = $25,549,018 a month

Graham gives “$7,900” and “$25 million” for the same example. A difference of 4 points in the weekly rate gives a result more than 3,000 times larger. The math is not a forecast. It shows why a small change in the weekly rate is important.

Work it out

A startup makes $20,000 of revenue a month and grows 2% a week. What is its revenue a month after one year (52 weeks)?

Work it out

Company C grows 7% a week. How many times larger is it after one year?

You can practice more growth math in the lesson on growth rates.

Why venture money fits only some companies

A venture capital fund, or VC fund, gets money from large investors and buys shares in young companies. The fund makes money only when those shares become cash. This occurs when a larger company buys the startup, or when the startup sells its shares to the public.

Most young companies do not become very large. Thus a VC fund looks for the small number of companies that can become very large. One very large success can pay for many companies that do not succeed. The lesson on the power law shows this math, and how VC funds work shows where the money of a fund comes from.

This gives a simple test. A VC fund invests only when the company can become many times larger. A café that makes a steady profit is a good result for its owners. It is not the result that a VC fund needs.

Venture money is not the only way to build a company. Many founders pay for their company with their savings and their revenue. This is bootstrapping. The founders keep all of the company, and revenue sets their speed. The lesson on alternatives to venture capital compares the options.

Is your company a startup?

Three questions show the design of a company:

Can the product sell to a very large market, or only to the customers near you?
Can the company serve ten times more customers without ten times more people?
Do the founders measure growth each week, and do they want it to be fast?

If the answers are yes, the founders designed the company to grow fast. It is a startup, and venture money can fit it. If the answers are no, the company can still be a very good business. It is a small business, and the money of its owners and customers fits it better.

A company can also change its design. A small agency can build a product from its work and sell that product to the whole world. The day that the founders design the company for fast growth, it becomes a startup.

What this means for the rest of this module

VC funds want a legal structure that suits companies that can become very large. The rest of this module comes from that fact:

The company is a Delaware C corporation, because investors know that structure and can buy shares in it.
The founders hold shares, and the shares give each person a percentage of the company.
The founders earn their shares over four years, because the company needs years of work from them.
Each founder files a tax form in the first 30 days, because the shares can become valuable.

The next lesson, setting up the company, starts with the first item.

Quiz · question 1 of 5

Test what you learned

According to Paul Graham, what makes a company a startup?

In this lesson you will learn