What a startup is (and what it is not)

A startup is a company designed to grow very fast. That is the main difference between a startup and a normal business.

A restaurant, a plumbing company, or a law firm can be profitable from day one. They grow at a steady pace, serve a local market, and the owners take home profits as they earn them. These are sometimes called "small businesses" or "lifestyle businesses" (though the second term is slightly dismissive).

A startup, by contrast, is built around the assumption that it can capture a very large market if it grows quickly enough. The product is usually software or technology-driven, which means the cost of serving one more customer is close to zero. A restaurant needs more tables and more cooks. A software company can serve its millionth user on the same servers it used for its ten-thousandth.

Because startups prioritize growth over immediate profit, they almost always lose money in their early years. Sometimes for a very long time. Amazon was founded in 1994 and did not post a consistent annual profit until 2003. Uber, founded in 2009, did not become profitable until 2023.

Venture capital

If a startup is losing money on purpose, it needs cash from somewhere. That is where venture capital comes in.

Venture capital (VC) is money invested by specialized firms into startups they believe could become extremely valuable. VC firms raise their own funds from wealthy individuals, pension funds, university endowments, and other institutional investors. They then deploy that capital into startups in exchange for equity -- a percentage of ownership in the company.

A typical deal works like this: a VC firm invests $5 million into a startup and receives 20% ownership. The startup gets cash to hire people, build the product, and acquire users. The VC firm gets a stake that could become very valuable if the company succeeds.

VCs expect most of their investments to fail. The model works because the ones that succeed can return 10x, 100x, or even 1000x the original investment. One massive winner (like an early bet on Google or Facebook) can pay for dozens of failures.

Well-known VC firms include Sequoia Capital, Andreessen Horowitz (a16z), Benchmark, and Accel.

Funding stages

Startups typically raise money in a series of rounds, each larger than the last. Each round corresponds to a stage of the company's development.

Pre-seed. The earliest stage. Often just the founders, an idea, and maybe a prototype. Funding might come from the founders' savings, friends and family, or small angel investors (wealthy individuals who invest their own money). Amounts range from $50,000 to $500,000.

Seed. The company has a working product and possibly some early users. Seed investors are angel investors or early-stage VC firms. Typical amounts: $500,000 to $5 million.

Series A. The company has demonstrated some traction -- real users, revenue, or strong growth metrics. A larger VC firm leads the round. Typical amounts: $5 million to $20 million.

Series B. The business model is working, and the company needs capital to scale. More employees, more markets, more infrastructure. Typical amounts: $20 million to $60 million.

Series C and beyond. The company is established and growing. Later rounds (D, E, F) happen when the company needs even more capital before going public. Amounts can reach hundreds of millions of dollars. At this point, investors may include private equity firms, hedge funds, and sovereign wealth funds alongside traditional VCs.

Each round involves issuing new shares and setting a new valuation for the company (more on both of these below).

Valuation

When people say "Uber is a $10 billion company," they are referring to its valuation. This is not the amount of cash the company has or the revenue it generates. It is the estimated total value of all the company's shares.

Valuation is determined during funding rounds. If a VC invests $10 million for 10% of the company, the implied valuation is $100 million (because 10% of $100 million is $10 million). This is called the post-money valuation.

Private company valuations are a negotiation, not an objective measurement. Two reasonable people can disagree about what a company is worth. The number reflects what a specific investor was willing to pay at a specific moment, given the information available.

Public company valuations, by contrast, are set continuously by the stock market based on millions of transactions every day.

Below-cost pricing and subsidized growth

Many VC-backed startups deliberately sell their product or service below cost. The goal is to acquire as many users as possible, as fast as possible, even if every transaction loses money.

Uber is the most cited example. For years, Uber subsidized rides so they were cheaper than taxis. Drivers were paid more than what riders paid, with Uber covering the difference using VC money. The strategy was to make Uber so ubiquitous that riders would become habitual users and drivers would become dependent on the platform. Once dominant, Uber could raise prices and reduce driver payouts.

This pattern appears across industries. Food delivery apps (DoorDash, Uber Eats), scooter companies (Bird, Lime), and cloud services (many early SaaS companies) have all used below-cost pricing funded by venture capital.

The risk is obvious: if you never reach dominance, you just burned through billions of dollars. MoviePass, which offered unlimited movie tickets for $9.95/month, ran out of money and collapsed.

Blitzscaling

Blitzscaling is a term popularized by Reid Hoffman (co-founder of LinkedIn). It means prioritizing speed of growth above everything else -- above efficiency, above profitability, above even good management.

The logic: in markets with strong network effects (where the product gets better as more people use it), the first company to reach critical mass often wins the entire market. Second place gets nothing. So the rational move is to grow as fast as humanly possible, even if the company is chaotic, the product has bugs, and customer support is nonexistent.

WeWork is an example of blitzscaling taken to an extreme. The company leased office buildings at enormous cost, renovated them, and rented desks to freelancers and small companies. It grew from 1 location in 2010 to over 800 locations globally by 2019. Its valuation peaked at $47 billion. Then it filed for bankruptcy in 2023, because the underlying business never justified the scale.

Blitzscaling works when the market really does have winner-take-all dynamics. It is catastrophic when it does not.

Growth hacking

Growth hacking refers to creative, often unconventional strategies to acquire users quickly and cheaply.

Viral loops. The product itself causes users to invite other people. Dropbox gave users extra storage space for every friend they referred. Hotmail added "Get your free email at Hotmail" to the bottom of every outgoing email. Each user became an advertisement.

Referral programs. PayPal literally paid users $10 to sign up and $10 for every friend they referred. It was expensive, but it grew the user base exponentially. Once PayPal had enough users, it stopped the program.

Affiliate programs. Companies pay third parties (bloggers, influencers, comparison websites) a commission for every customer they send. This shifts the cost of marketing to performance-based payouts rather than upfront advertising spend.

Platform hijacking. Airbnb famously built a tool that let hosts cross-post their listings to Craigslist automatically, siphoning users from an established platform onto their own.

The term "growth hacking" is sometimes criticized as just marketing with a different name, but the emphasis on measurable, scalable, product-integrated techniques distinguishes it from traditional brand advertising.

Unit economics

Unit economics are the revenues and costs associated with a single unit of the business -- usually one customer or one transaction. These numbers determine whether the company can ever be profitable at scale.

Customer Acquisition Cost (CAC). How much the company spends to acquire one customer. If a company spends $100,000 on marketing in a month and gets 1,000 new customers, the CAC is $100.

Lifetime Value (LTV). The total revenue a company expects to earn from a single customer over the entire time they remain a customer. If the average customer pays $20/month and stays for 30 months, the LTV is $600.

The fundamental rule: LTV must be significantly higher than CAC for the business to work. A common benchmark is that LTV should be at least 3x CAC.

Burn rate. How much money the company loses per month. If a startup spends $500,000/month and earns $200,000/month, its burn rate is $300,000/month.

Runway. How long the company can survive at its current burn rate before running out of cash. If the company has $3 million in the bank and a burn rate of $300,000/month, it has 10 months of runway. When runway gets short, the company needs to either raise another round, cut costs, or shut down.

Stock options and vesting

Startups often cannot compete with large companies on salary, so they offer equity as part of the compensation package. Employees do not usually receive shares directly. Instead, they receive stock options -- the right to buy shares at a fixed price (the "strike price") at some point in the future.

If the strike price is $1 per share and the company later goes public at $50 per share, the employee can buy shares for $1 and immediately sell them for $50, netting $49 per share.

If the company fails or never goes public, the options are typically worthless.

Vesting is the schedule on which options become available. The most common structure is four-year vesting with a one-year cliff:

• The cliff: The employee receives nothing for the first 12 months. If they leave before the one-year mark, they get zero equity. This protects the company from giving shares to people who leave quickly.
• After the cliff: 25% of the total options vest at the one-year mark. The remaining 75% vest monthly over the next 36 months.
• Full vesting: After four years, all options are vested and the employee can exercise (buy) all of them.

Some companies also have an exercise window -- a deadline after leaving the company by which you must buy your vested options or lose them. This can be as short as 90 days, which forces departing employees to come up with the cash to buy their shares or forfeit them.

Dilution

Every time a startup raises a new round of funding, it issues new shares. This means existing shareholders (founders, early employees, earlier investors) own a smaller percentage of the company, even though the number of shares they hold has not changed.

Example: A founder owns 1,000,000 shares out of 2,000,000 total (50% ownership). The company raises a Series A and issues 500,000 new shares to investors. Now there are 2,500,000 shares total. The founder still has 1,000,000 shares, but now owns 40% instead of 50%.

This is dilution. It is not necessarily bad. Owning 40% of a company valued at $50 million ($20 million) is better than owning 50% of a company valued at $10 million ($5 million). The goal of raising money is to grow the value of the company faster than the ownership percentage shrinks.

By the time a startup goes public, founders who started with near-100% ownership might hold 10-20%. Early employees who joined with option grants of 0.5-1% might hold 0.1-0.3% after multiple rounds of dilution.

The exit

An exit is the event where early investors and shareholders convert their equity into cash. There are three main outcomes.

Acquisition. Another company buys the startup. Instagram was acquired by Facebook (now Meta) for $1 billion in 2012, just two years after launch with 13 employees. YouTube was acquired by Google for $1.65 billion in 2006. Acquisitions can range from a few million dollars (sometimes just to hire the team, called an "acqui-hire") to tens of billions.

IPO (Initial Public Offering). The company lists its shares on a public stock exchange (like the NYSE or NASDAQ), allowing anyone to buy and sell shares. This is how the earliest investors and employees cash out. When Spotify went public in 2018, its initial valuation was about $26.5 billion. When Snowflake went public in 2020, early investor Berkshire Hathaway saw massive returns.

Going public comes with significant obligations: quarterly earnings reports, SEC regulations, public scrutiny of finances, and pressure from public market investors who may have shorter time horizons than VCs.

Failure. The company runs out of money, cannot raise more, and shuts down. There is no exit for anyone. The investors write off their stake. Employees' options become worthless. Any remaining assets are sold to pay off creditors (people the company owes money to), and equity holders typically get nothing.

Some companies land in between: they sell for less than the total amount invested (called a "down round" exit or "fire sale"), meaning investors with preferred shares may get some money back while common shareholders (founders and employees) get nothing.

Why most startups fail

Depending on the study, somewhere between 75% and 90% of VC-backed startups fail to return the money invested in them. Outright shutdowns are common. The reasons vary, but the most frequently cited ones are:

• No market need. The company built something nobody wanted. This is consistently the number one reason in post-mortem analyses.
• Ran out of cash. The company could not raise the next round of funding and did not have enough revenue to sustain itself.
• Wrong team. Co-founder conflicts, lack of key skills, or inability to hire the right people.
• Outcompeted. A larger or better-funded competitor captured the market first.
• Pricing/cost issues. The unit economics never worked -- the company could not acquire customers cheaply enough or charge them enough to cover costs.
• Bad timing. The product was too early (the market was not ready) or too late (the market was already saturated).
• Regulatory problems. The company's business model ran into legal barriers it could not overcome.

The VC model is built around this failure rate. It does not need most investments to succeed. It needs a small number to succeed spectacularly. A single investment that returns 100x the original amount can compensate for 20 investments that returned nothing.