The Three Types of Start-Ups

At OpenRain Elite Web Software we’ve seen all the popular combinations of startup business models when evaluating new projects. Here is a breakdown of the three most common startup models based on financial structure, the pros and cons of each, and recommendations on which one to choose for your new venture.

 

1) The Pop-Start

The pop-start–short for “popular startup”–is the stereotypical venture capital (VC) or Angel backed venture wherein an initial product prototype is created with a small angel fund, pitched to investors once (barely) operational, and subsequently funded for $1M+ in a second, third etc. round to fund growth to a profitable status. As each round is collected, additional personnel are generally hired immediately to kick off additional production development in a (hopefully correct) high-velocity direction.

Pros

  • Should you raise enough in your initial rounds and find the right people, you’ll be able to keep the company operational in the early growth stages without incessant worry on keeping positive cash flow, which, depending on the idea, may not be possible.
  • Fast growth once the big investment dollars roll in.
  • A minimum of personal risk since only the initial angel round will likely come from close ties. 

Cons

  • Tons of investor pitches and marketing/sales-speak on vaporware which will drive technical people insane.
  • Legal issues from the get-go. Expect difficult negotiations with second round investors and costly legal fees.
  • You’ll have to put up cash for airfare, lodging, marketing materials, legal fees etc. up front for possibly dozens of remote meetings. The costs add up fast.
  • Large amounts of constant pressure from investors.

This is for you if…

  • Your idea requires a substantial capital investment to get off the ground, such as $100K in federal licensing costs or $500K in manufacturing equipment for a first line of production product. You legitimately need this funding to get off the ground, and the amount is too large to put up yourself.
  • Your exit strategy is getting bought out by Google for $100B.
  • You can afford the risk of working on this full time, with little (or no) compensation up front and no gaurantees on a second round of funding.

 

2) The Weekend Warrior

The proliferation of online services for company creation has allowed many dreamers to create legitimate legal business shells in free time for hundreds of dollars. The weekend warrior start-ups are those who believe in the idea, but cannot financially afford to quit day jobs.

Pros

  • Low risk. If the company fails, you still have your day job.
  • Low cost. You still have the income from your day job, so eating small operational costs should be easy. If you’re supporting a large family on a single income, this may be your best option.

Cons

  • Making progress is painfully slow since it’s an “in my spare time” project.
  • People will not take your business as seriously since you are not committing your livelihood to it.
  • The logistics of getting things done off-hours can be challenging, such as finding the time for calls during business hours without interfering with your day job.  

This is for you if…

  • You can only commit yourself to working nights and weekends.
  • You cannot accept large financial risk.
  • You do not require large capital investments to reach financially sustainable operation.
  • You can accept the fact that progress and growth will be slow.

 

3) The Self Serve

Self Serve businesses are full-time owner operated organizations which grow based on their own performance, rather than external investment. They are self-funded, full-time ventures which put the responsibility of success squarely on the owner(s) since there is often no formal governing board. OpenRain’s web development business started this way, and continues to be entirely self funded.

Pros

  • No pressure from investors.
  • Full-time personal investment gives you time to put operations in order.
  • Will be taken seriously by potential clients/customers.

Cons

  • Self-funded. This can be mitigated by limiting personal credit exposure, but there’s no getting around the fact that initial operating costs will need to come out-of-pocket, and losses may personally bite you regardless of the precautions you take.
  • Personal pressure to constantly generate income since your personal income will be determined by the performance of the company.

This is for you if…

  • External funding is not appropriate or necessary for your idea.
  • You (and you business partners) are comfortable operating the entirety of a business amongst yourselves, our are able to invest in quality people to fill in the holes as soon as possible. Technical work, finances, marketing, sales, human resources, operations and 8000 other miscellaneous tasks will crop up needing someone’s attention. And that someone is you.

3 thoughts on “The Three Types of Start-Ups”

  1. Great post Preston. I think there is a critically important sub-category of the Pop Start. The “angel version” requires under $5 million, but you can also enjoy an early exit – possibly within a few years. The “VC verions” requires more than $5 million of investment, but is limited to those companies that will exit, as you suggest, for over $100 million. My recent post clarifies these two important differences in the Pop Start: http://www.angelblog.net/Is_Angel_Or_VC_Financing_Best.html

    I hope this is helpful to your readers. Keep up the great writing.

  2. Thanks, Basil. You make some great points in your article.

    I see the possibility of early exit as both positive and negative. If founders are content to sail away on a golden parachute, more power to them. Some founders will want to stay, however, which may clash with some investors requirements to bring in an executive leadership team of their own and oust the initial founders since most of the equity will be held by the large investors after the first couple rounds.

  3. Preston – that’s a very popular perception. Of course many founders will want to stay with their creation. In practice, if someone comes in and buys the company, they almost always REALLY want the founders to stay. If you talk to big companies that acquire small ones, they will tell you that the biggest asset is the people. Statistically, the greatest probability of the founders leaving is when VCs invest. I have been part of a lot of exits. I have never seen a founder regret a good sale. In my experience early exits are always a good thing http://www.angelblog.net/Early_exits_are_a_good_thing.html

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