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Startup or Small Business: Which One Are You Running?

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Starting Up

Startup or Small Business: Which One Are You Running?

If you are familiar with the tech space in Kenya, South Africa or Nigeria, you are at least very familiar with the buzzwords, ‘startup’ or ‘small business.’ But have you ever asked yourself if these words mean the same thing?

What is the difference between a startup and a small business? Is a startup and small business the same thing? Do you interchangeably describe your entity as both depending on the context?

There’s an important distinction between what constitutes a startup, and what qualifies as a small business.

South African entrepreneur and public speaker Vusi Thembekwayo in a twitter thread has shed light on the difference between a startup and small business. He further dives more into why there’s need to build a startup and not small business.

Below is the outline of his Twitter thread.


“There is a big difference between a small business & a startup. Over the years building MyGrowthFund, I can’t tell you how many entrepreneurs I have come across that don’t understand this…and you have to understand if you to growth & funding. 

South Africa’s obsession with small business as a solution to chronic levels of unemployment has created this mindset of “starting a business”. The mindset itself is good.

 

But the question is this, “start a business for what reason?”

Most people that start a business just want to survive & put food on the table. So their businesses are built to provide an income to the founder & their families.

This is not bad. But this is not a start-up. It’s a small business. The idea that the business must provide a source of income for the founder & create jobs as a primary reason for existing by definition means that the business must be profitable.

This is the first major difference between startups & SMEs. SMEs must be profitable. So the founder of the SME usually uses personal savings (savings, 2nd mortgage, pension etc) to fund their business.

But because they have to pay back that debt, the business must generate sufficient cash flows to meet the interest charge of the debt. So the founder must make a profit. How else can they sustainably meet the debt obligations?

Read: In Debt? Use These 5 Simple Strategies to Get Out

Clicks South Africa Example

This is a trap. But to understand why, I have to illustrate: 

A small business will never outprice a large business. Its Economics 101. Remember those lectures at university or college? Yeah? You shouldn’t have bunked them.

The basic reason big businesses become big is bargaining power. They get better prices at better terms from their suppliers. The bigger they get, the better their free cash flow (if they manage the working capital cycles efficiently). 

Remember Clicks_SA

I have seen hundreds of tweets asking the question of why doesn’t Clicks diversify their supplier base & create more shelf space for small black businesses. This is the Clicks share price movement over the past 5years. Impressive Yes?

Clicks SA

A big part of the gain in the share price for Clicks has been how efficiently they have managed their working capital. Without going through the details of the Clicks Balance Sheet, here is the high-level picture:

The black is the Total Assets.

Clicks SA

Part of the growth in their Total Assets is growth in inventory (which is financed by their suppliers because of their trade terms) & cash (the holy grail).

Clicks SA 1

Here is a summary of their financial performance over the past year. Source: Analysts Report, Clicks Group.

Now have a look at the Balance Sheet. If you’re a non-financial person, don’t panic. Cast your eye on the line-items “inventory” as well as “cash & cash equivalents”. Big jump in cash right?

Clicks SA 2

Why?

Simple. Clicks have large companies as its suppliers that can carry the load of supplying them on credit (what retailers call “terms”) for an extended period.

So when Joe Soap with a small business wants shelf-space at Clicks, you simply can’t meet the terms. Remember, yours is a small business. it must generate positive cash flows to pay for your operating costs & a profit to keep you a going concern.

So the small business owner cant play financiers to a retailer for the sake of revenue growth. I have perhaps over-simplified what is a very complex issue. But this is a thread, not an academic thesis.

You get the point.
The small business needs profits to stay a going concern & positive cash flows to meet its current liabilities. 

The startup is very different.

Read: 8 Business Ideas You Can Easily Start Today While Still Keeping Your Day Job

The Amazon Example

Let’s take the now overused example of Amazon. Classic startup tail. Look at their Revenue to Profit Margins ratio. Spike over the past few years. Why?

Amazon

Amazon is built to accumulate market-share (even if you make losses). This is what we in venture investing call “Scale”. They will enter a new market (new product, new customer or new geography) & run losses, as long they gain more customers. 

Once they have sufficient scale (and they have forced out their competitors) they will then normalize prices and reap the profits from the position of a market-leading incumbent.

In this classic start-up tale: profits are bad! (at least while you scale).

 

So to summarise:

Small businesses require profits. A startup wants a market share.

Startups see loss-making a strategy for scale. So they raise funding to finance their losses & accelerate growth.

Why is this important?

Simple. South Africa is obsessed with small & medium-sized businesses. The research shows different.

If you want mass scale in job opportunities, build more startups, not SMEs. 

Whose got this right? Israel, Morocco and Rwanda… and did I mention Israel? They have nailed this formula over the past couple of years. If the startup fails, no lengthy liquidation process. Close it. Tie it up legally. Quickly. And start another. 

We MyGrowthFund have just announced our partnership with VenturesSahara to build their next generation of pan-African startups.

So don’t forget: an SME is not necessarily a startup.

If you want to scale FAST, have a mass impact, & exponential growth, choose the startup model.

Back to your regular scheduled program.

Asante Sana.

Cover Image Credits: Shutterstock

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CEO and Founder at Founder360° Magazine.

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