What Is a Startup?

The term startup refers to a company in the first stages of operations. Startups are founded by one or more entrepreneurs who want to develop a product or service for which they believe there is demand. These companies generally start with high costs and limited revenue, which is why they look for capital from a variety of sources such as venture capitalists.

Key Takeaways

  • A startup is a company that's in the initial stages of business.
  • Until the business gets off the ground, a startup is often financed by its founders and may attempt to attract outside investment.
  • The many funding sources for startups include family and friends, venture capitalists, crowdfunding and loans.
  • Startups must also consider where they'll do business and their legal structure.

Understanding Startups

Startups are companies or ventures that are focused around a single product or service that the founders want to bring to market. These companies typically don't have a fully developed business model and, more crucially, lack adequate capital to move onto the next phase of business. Most of these companies are initially funded by their founders.

Many startups turn to others for more funding: family, friends and venture capitalists. Silicon Valley is known for its strong venture capitalist community and is a popular destination for startups, but is also widely considered the most demanding arena. Startups can use seed capital to invest in research and to develop their business plans. Market research helps determine the demand for a product or service, while a comprehensive business plan outlines the company's mission statement, visions and goals, as well as management and marketing strategies.

Dotcoms were a common startup in the 1990s. Venture capital was extremely easy to obtain during this time due to a frenzy among investors to speculate on the emergence of these new businesses. Unfortunately, most of these internet startups eventually went bust due to major flaws in their business plans, such lacking a path to sustainable revenue. However, a handful of companies survived when the dotcom bubble burst. Both Amazon (AMZN) and eBay (EBAY) are examples.

Many startups fail within the first few years. That's why this initial period is important. Entrepreneurs need to find money, create a business model and business plan, hire key personnel, work out intricate details such as equity stakes for partners and investors, and plan for the long run. Many of today's most successful companies—Microsoft (MSFT), Apple (AAPL) and Facebook (FB), to name a few—began as startups and ended up becoming publicly-traded companies.

The first few years are very important for startups—a period during which entrepreneurs should concentrate on raising capital and developing a business model.

Special Considerations

Location

Startups must decide whether their business is conducted online, in an office or home office, or in a store. The location depends on the product or service being offered. For example, a technology startup selling virtual reality hardware may need a physical storefront to give customers a face-to-face demonstration of the product's complex features.

Legal Structure

Startups need to consider what legal structure best fits their entity. A sole proprietorship is suited for a founder who is also the key employee of a business. Partnerships are a viable legal structure for businesses that consist of several people who have joint ownership, and they're also fairly straightforward to establish. Personal liability can be reduced by registering a startup as a limited liability company (LLC).

Funding

Startups often raise funds by turning to family and friends or by using venture capitalists. This is a group of professional investors that specialize in funding startups. Crowdfunding has become a viable way for many people to get access to the cash they need to move forward in the business process. The entrepreneur sets up a crowdfunding page online, allowing people who believe in the company to donate money.

Startups may use credit to commence their operations. A perfect credit history may allow the startup to use a line of credit as funding. This option carries the most risk, particularly if the startup is unsuccessful. Other companies choose small business loans to help fuel growth. Banks typically have several specialized options available for small businesses—a microloan is a short-term, low-interest product tailored for startups. A detailed business plan is often required in order to qualify.