It is common to view startups as being homogeneous.  In his book, The Origin and Evolution of New Businesses, Amar Bhidé makes the case that business initiatives can be classified according to three parameters: initial investment, irreducible uncertainty, and likely profit.  In turn, each class of initiative can be characterized by a set of initial conditions.  Those typical endowments will provide us with some insight regarding the relative amount and kind of investment capital that is consequently available to each.  The purpose of this section is to summarize some of the highlights of Bhidé's framework. 

Per Bhidé, an initiative is a conscious effort to generate new sources of profit that may or may not succeed.  Initial investment refers to the irreversible commitment of funds, time, reputation, or other resources – including the opportunity cost of the founders.  Uncertainty refers to immeasurable and unquantifiable risk, which may be contrasted with the precisely quantifiable risk of, for instance, a coin toss or roulette wheel.  Uncertainty is irreducible to the extent it cannot be resolved without actually undertaking the initiative.  The route of the meticulously planned Apollo 11 mission had less uncertainty, for example, than that of a hitchhiker's cross-country trip.  (Total risk, then, is a function of initial investment and uncertainty.  A small investment with high uncertainty can be less risky than a large investment made with relatively low uncertainty.)  Likely profit refers to an objective third party's best guess of the value of the cash flows expected from undertaking an initiative.

So, given the preceding definitions, the following illustrates five types of business initiatives along the three axes of initial investment, irreducible uncertainty, and likely profit:

Most new businesses lack a competitive differentiation.  They don't really earn a significant profit; they provide a wage to their proprietors.  These marginal businesses – most consulting practices, contractors, cleaning services, restaurants, beauty salons, and the like – make up 90% to 95% of business startups.  The cost of launching such a business is low, as is the level of uncertainty.  Even though there are a lot of marginal businesses, they tend to come and go without much of a net impact in terms of innovation, wealth creation, or economic development.

Revolutionary ventures are the stuff of legend.  Irreducible uncertainty, initial investment requirements, and likely profit are all high.  FedEx is a classic example of a revolutionary venture.  So, too, was the ill-fated Iridium.  (Recall that Iridium had to spend umpteen zillion dollars to launch a ring of satellites around the globe before it could find out if there was actually a market for a new kind of global cell phone.  In Iridium's case, uncertainty was resolved in a rather painful manner.)  Revolutionary ventures make for great stories, in large part because they are exceedingly rare.

Corporate initiatives leverage big companies' ability to tap large pools of capital.  The flip side is the requirement for rigorous analysis, exhaustive testing, and stringent financial controls.  Of course, all that is very expensive, so corporate initiatives are untenable unless the likely profit is commensurately high.  Some economic developers out here in the boondocks can't help but aim for this big game.  But, the truth is, most corporate initiatives are still bagged by the urban mainstream.

Over the last decade, VC-backed startups have captured our collective imagination.  Nevertheless, Bhidé makes a compelling case that VC-backed startups have more in common with corporate initiatives than they do with gritty entrepreneurs working out of a garage.  Experienced management; a large, growing market; thorough planning; and the opportunity to make a significant initial investment are all desirable traits to a venture capitalist.

The last category, promising startups, is the most interesting to us.  Promising startups are very similar to their marginal business brethren in two respects: the initial investment is modest as is the likely profit.  However, promising startups differ from marginal businesses in a very important way.  With promising startups, there is at least a small chance of a big profit.  That’s because promising startups cluster in market niches characterized by technological, regulatory, or other uncertainty.  Alternatively, they cater to the “fuzzy” wants of customers – trendiness, elegance, responsiveness – that is difficult to define, measure, or emulate.  As a consequence, promising startups face a "heads I win, tails I don't lose very much" scenario.

In summary, there is more than one kind of startup.  Each type is adapted to a different set of initial conditions, which lead to different developmental trajectories.  Marginal businesses, while plentiful, don't have much net economic impact.  Revolutionary ventures and corporate initiatives are very rare on the economic frontier.  So, from here on out, we'll focus on VC-backed and promising startups.

Not all startups are created equal.

Businesses are born with different endowments, which play a big role in shaping the set of viable growth and financing strategies available to them.  The following table, too, is adapted from Bhidé:

Somehow, we have come to perceive that VC-backed startups are the norm.  As a consequence, we spend a great deal of effort attempting to emulate their planning, differentiation, team building, and financing strategies.  The hard truth is that VC-backed startups are exceptional.  Per the respected MoneyTree Survey, there were a total of 511 seed-stage venture capital deals done in the U.S. in 1996.  That number grew to a whopping 814 in 1999 at the peak of the dot com boom before plummeting to just 252 last year.  To put those numbers in perspective, Bhidé’s research indicates that in 1996 alone, just the five most popular businesses (construction, restaurant, retail store, cleaning services, and real estate) accounted for 105,840 startups!  In other words, VC-backed startups comprise a mere fraction of a percent of all startups.  Even among the 2001 Inc. 500, only 3% reported raising startup capital from venture capitalists.

Most promising startups are launched with meager funds because (a) the founders don't have a verifiable track record, (b) the company has neither proprietary technology nor a novel idea, and (c) the market potential for the product or service is speculative.  Approximately 50% of the 2001 Inc. 500 reported startup capital of less than $20,000.  But, with little to lose, they can afford to take on highly uncertain markets, which offer the possibility of a big win.  Early on, opportunistic adaptation, a tolerance for ambiguity, effective bootstrapping, and a network diverse enough to facilitate access to an evolving set of resources are keys to success.

Consider the case of Microsoft in 1975.  Started by two inexperienced entrepreneurs, the company was founded on a shoestring to create a BASIC language for the Altair kit computer.  Microsoft’s initial product was undifferentiated, and nobody had more than a hunch regarding the potential for the personal computer.  If they had failed, Bill Gates and Paul Allen could have found a job or gone back to school.  But, by targeting a highly uncertain niche, they put themselves in a position to win.  (Things worked out just fine for them, as it turned out.)

To read an article in Inc. magazine on Bhidé click here.