What is a Startup & How do Startups Work?

Startups are companies that aim to disrupt industries and make a difference in the world. They also want to do this at scale. Startup founders have a vision of giving society something that it doesn’t yet have. This includes generating high-quality valuations that will lead to an initial public offer ( IPO), and an incredible return on investment.

Understanding Startups

Startups are young companies that have been founded to create a new product or service and bring it to market. Customers find them irresistible.

Startups are founded on innovation and seek to solve the shortcomings of existing products, or create new types of goods and/or services. This disrupts established ways of doing business and thinking for entire industries. Many startups are “disruptors” in their industries.

While you may be most familiar in Big Tech with companies such as Facebook, Apple, Netflix, and Google (collectively known as FAANG stocks), startups include companies like WeWork. Peloton, and Amazon.

What is Startup Management?

Startups work like any other business at a high level. A team of employees works together to create a product customers will love. The way that a startup does this is what sets it apart from other businesses.

Repeated businesses duplicate what has been done before. An existing restaurant may be franchised by a prospective owner. This means that they use an established template to help them run a business.

Startups aim to invent a new model. This could be in the form of meal kits such as Blue Apron and Dinnerly that offer the same food but with a different approach. This creates a market that is larger than individual restaurants: tens to millions instead of thousands.

Startups Strive for Growth and Speed

Startups are distinguished from other businesses by their speed and growth. Startups strive to quickly build upon ideas. This is often done through iteration, which allows them to improve their products by analyzing usage data and feedback continuously. A startup may start with a minimum viable product (MVP), which it will then test and improve until it is ready for market.

Startups are not only looking to improve their products but also to expand their customer base. This allows them to increase their market share, which then allows them to raise more money. Then they can grow their audience and products even further.

All this innovation and rapid growth is often implicitly or explicitly in service of a final goal: going public. A company that opens up to public investment creates an opportunity to cash out early investors and reap the rewards. This is referred to as an “exit” in startup parlance.

How are Startups Financed?

Startups usually raise funds via multiple rounds of funding.

  • The bootstrapping preliminary round is when the founders and their family invest in the company.
  • The seed financing comes next from “angel investors”, high-net-worth individuals that invest in early-stage companies.
  • Next are Series B, C, and D funding rounds. These funding rounds are primarily managed by venture capital firms that invest tens of millions to companies.
  • A startup might decide to go public and make available outside capital via an IPO, acquisition by a special purpose acquisitions company ( SPAC), or direct listing on a stock market. A public company is open to anyone. Startup founders and early investors can sell their shares to get a huge return on their investment.

It is worth noting, however, that startup funding is limited to individuals with large financial resources. These are called accredited investor, because of the Securities Exchange Commission’s belief that their high net worths and incomes protect them from possible loss.

Everyone wants to see the more than 200,000% return Peter Thiel received on his investment in a small startup called Facebook. However, the overwhelming majority of startups fail according to a report by UC Berkeley researchers and Stanford researchers. Early stage investors can expect 0% returns on their investment.

How do Startups succeed?

Many startups will fail but not all. Startups must have many stars aligned and answer crucial questions in order to succeed.

  • Are they passionate about the idea? The execution is everything. If the team isn’t willing to do everything necessary to support it, even an excellent idea can fail to connect with its audience.
  • Are the founders experts in their field? They should be able to understand everything in the area they are operating.
  • Do they have the time and energy to do it? Many early startup employees work very hard. MetLife and U.S. Chamber of Commerce conducted a survey in 2018 that found that most startup owners work 14-plus hours per day. A startup that isn’t willing and able to dedicate most of its waking hours to a new idea may not be able to succeed.
  • Why is this idea so important? If it is, has anyone tried it before? What makes the startup’s team unique in being able to crack that code?
  • What is the size of the market? This determines the potential market for a startup. While niche technology companies may be more successful than their competitors, what ends are they aiming for? Financials may not be large enough to sustain a business in a small market.

Startups that can answer all these questions may have a chance of being among the 10% of companies in early stages to survive.

How to Invest In Startups

Unfortunately, startup investing has not been widely made available to the general public.

Accredited investors are required to gain access the best early stage startups or venture capital funds with the highest chance of Thiel-level returns. This means that you must have an annual income of $200,000 and a net worth of at least $1,000,000, excluding your primary residence. If you are a registered investment advisor, you may also be eligible to claim accredited investor status.

You don’t have to fit one of these criteria. However, there are still options. Crowdfunding sites such as WeFunder and Seedinvest let anyone put down a small amount in exchange for a share of a startup. Seedinvest offers pre-vetted opportunities, and an investment minimum $500–50x lower than what is expected of accredited investors who want to invest in startups.

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