FAQ - Small Business - 001

What is the difference between a startup business and a small business?

A "startup" business, as that term is used in Silicon Valley parlance, does indeed differ from a typical small business venture. Though both are founded and run by risk-taking entrepreneurs, and though both face common sets of issues and problems, the startup business has some distinctive characteristics: it is often formed by a group of founders who consciously pursue a business model designed to have an exit within a few years; it is characterized by stock incentives that are generally forfeitable (even to a large degree by its founders) until earned in the form of sweat equity; often very little cash or tangible property is contributed in the normal case to start the business; often potentially valuable intellectual property (IP) is assigned to the business at inception as part of the company formation; tricky tax issues come into play relating to services being contributed to the startup; equity incentives are offered to what is often a loose group of consultants or early-stage employees, who typically defer or skip any salary or cash compensation; as the team is assembled, the IP developed, and the opportunities for the business model exploited, the founder group will seek outside funding, initially perhaps from "friends and family" but most often from angel investors and possibly VCs. The startup business venture will show promise, get funded, and take its shot at success within a fairly short period - typically not exceeding a year or two for the first critical assessment - or the founders will fold it up and do other things.

Thus, a startup business will often need a very different corporate setup at company formation than will a conventional small business - one that provides for a forfeiture risk, in whole or in part, of stock held by founders, for the capture of IP by the company, for setup of equity incentive plans, and the like. Because of the robustness of the corporate vehicle for startup business funding, a business startup venture will more often than not adopt a corporate format, as opposed to the LLC format that is so widely used for more traditional small business ventures. But there are no hard-and-fast rules and a startup business might decide that the LLC format is best for its needs. Though many variations are possible, the overall patterns are unmistakable: viewed generally, while the legal needs of a startup business and those of a conventional small business will in many ways overlap, they do indeed often differ, at times radically so, at key points as well.

For a detailed discussion of this issue, see the related faq on "What are the distinctive legal aspects of forming a startup business with a founding team?" in the FAQ - Startup Business section.

G.G.

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