Startups take novel approaches to solving what are often decades-old problems and, typically with significant financial backing from investors, attempt to grow at a very rapid pace.
First, let’s look at the unique financial system that powers startups. Startups are backed by investors known as venture capitalists (VCs for short). VCs differ from more traditional investors in that they invest at particularly early stages of a company’s lifecycle, taking on significantly higher risk in exchange for significantly higher potential rewards. This financing mechanism is a core part of the engine that makes startups work because it enables entrepreneurs to launch creative, ambitious businesses that are typically unsuitable for receiving funding from other sources, due to the risk profile that these companies present.
For the majority of startups, multiple rounds of venture capital funding are raised before the company hits profitability and financial sustainability. That is by design. Ultimately, startups aim to be sustainable from all angles, including financial. But in order to surpass incumbents and reach market dominance, a startup will often operate at loss in initial years due to spending on growth. These losses are regarded as near-term spendings that are made in order to gain large market share, but they must be done while pursuing a path to profitability.
Ridesharing companies like Uber and Lyft are prototypical examples of companies at that stage, but there are many other companies that have undertaken a similar path towards long-term sustainability and have already reached both a prominent market position as well as profitability. Beyond being able to price their products competitively, startups are enabled by venture capital to hire in-demand talent, build high-quality products and market those products to a wide audience.
But there’s a lot more that is innovative about startups than the way in which they are funded. While funding is important, there are several other (and arguably more important) contributing factors for a successful startup – including a strong founding team, idea and market opportunity.
The founding team is critical for a number of reasons, having to do with both the human side and the economic side of building a company. Building a company from the ground up is incredibly difficult, and this difficulty means that a startup will inevitably go through trying periods where the mettle of the co-founders will be tested, as will their relationships with one another. So they will need to have strong enough bonds to overcome those periods. Beyond interpersonal relationships, the founding team also needs to have unique insights into the market that they are entering. What is it that incumbents don’t understand that this team does? The way they leverage those insights to come up with their product or service is also key.
When looking at how entrepreneurs come up with the product that underpins their business, we see a number of different themes. Often, the founders have come up with a business idea because they’ve either experienced a pain point as a customer, achieved a technological breakthrough or both. From there, they begin to think through what a commercially-viable product could look like and they get to work on bringing that vision to reality.
That said, rarely do things pan out exactly according to plan, including the way in which a product is received by customers. The early days of a company are therefore seen as a period of intense customer development, and this phase is known as “finding product-market fit”. Essentially, it’s about reaching the point where a company has not only figured out a need in the market but also built a product that effectively satisfies that need. It can also go the other way around, whereby the company has an interesting, proprietary technology in its hands and must find a suitable commercial application for that technology.
This stage is where one of the key advantages that startups possess over incumbents presents itself. During this stage (and beyond), startups aim to iterate and try new things quickly, falling in line with the Silicon Valley adage “Fail fast and fail early”. Incumbents, meanwhile, are often focused on existing product lines and fail to experiment in the areas where the startup is tinkering. This difference in speed and foresight is why one will often hear investors say that their most successful portfolio companies are those that execute fastest. Large, traditional businesses have core product/service offerings that are high-quality and sustainable in nature over time but do not deviate from the norm. In other words, they find something that works and do it extremely well. In contrast, startups look for the whitespace, the gap that allows for innovation.
Once product-market fit has been reached, the company is ready to put their foot on the gas and step into hyper-growth mode, where they aim to take the market by storm and bring their innovation to the masses – armed by a proven product, significant funding and a strong team. This has played out in virtually every industry including transportation (i.e. Uber, Lyft), in healthcare (i.e. novel pharmaceutical drugs), media (i.e. Spotify) and many others. Ultimately, it’s a mix of entrepreneurial bravado, creativity and hustle that propels these companies to the forefront of their industries.