Defining startups–what are they and how do we filter them?

Mushrooming Startups, lucrative capital gain examples, high failure rates, and increasing risk capital investments have underscored the necessity of defining startups. What are startups? Are all those companies in the first stage of developing new product startups? Besides, why do they suffer from high costs, limited revenue, and growing losses in rolling out their innovations?

To offset the loss, they ask for risk capital to finance their loss-making operation. Despite this, why do a few of them grow into highly profitable mega corporations, unleashing Disruptive Innovation effects on mature products and high-performing firms? How do they succeed in turning their loss into profit? Or is startup a game of increasing valuation by expanding the market through massive subsidies to their primitive products? What is the justification for pouring funds from angel investors and venture capitalists to turn their loss-making operations into unicorns?    

Those days are gone when personal or family savings could have been good enough to grow ideas from garages to profit-making enterprises. Startups have now been asking millions and billions to increase their valuation. Hence, venture capital investment in the USA has boomed from less than $30 billion in 2006 to nearly $350 billion in 2021 (source: statista). Similarly, the exponential growth of risk capital has surfaced globally. Notably, typical less developed countries have witnessed the growth of venture capital funding from zero to billions of dollars over the last 30 years. Besides, there has been messroom growth of startups. For example, the number of government-recognized startups has grown from 471 in 216 to 127,433 in 2024 in India (source: statista). Startup investment has also shown similar growth in India, rising from $5.3 billion in 2016 to $41.6 billion in 2021—an 8-fold increase over five years (source: Forbes).   

Impression about startups

There have been two dominant impressions about startups:

• From past successes—startups begin the journey in a humble form to turn their ideas of alternative products around emerging technology crore and grow through a Flow of Ideas in making their products increasingly better and cheaper. Consequentially, they succeed in offering better alternatives to matured products. They rapidly grow in revenue and profit by taking away customers of matured products from incumbent high-performing firms.   
• From the current wave of valuation gain race—digital technology core through the fusion of mobile internet, smartphone, cloud platforms, and software has opened up opportunities to reinvent an array of existing means of Getting jobs done. Hence, new enterprises have mushroomed to reinvent matured goods and services by changing their technology core with digital ones. However, unlike their predecessor, these newborn enterprises are after increasing customers by giving subsidies to their digital reinventions and turning that success into valuation growth. Such a thesis has created a mad race to increase valuation through subsidies instead of turning loss into profit and expanding the market through quality improvement and cost reduction through a flow of ideas.

The subsidy race to increase the valuation of newly formed enterprises promoting reinventions out of the digital technology core has raised the importance of defining startups. It appears that most of the freshly formed enterprises promoting business cases out of digital technology Reinvention possibilities are not startups. They are simply investors’ fund-burning furnaces in disguise of startups.  

Defining Startups—What are they, and how do you filter them?

Unlike in the past, there have been numerous startups all around the world. For example, according to The Economist, in 2023 alone, as many as 5.5 million startups have applied for business licenses in the USA alone. They are all candidates for risk capital investment. By the way, are all they startups? How do we know which ones will likely grow capital by a factor of 10 or so over the next 10 years and turn their loss into increasing profit? How to filter them to figure out investment prospects is a daunting challenge. Hence, to demystify this challenge, let’s attempt to define startups.

If we accept that any company in the early stage of operation engaged in developing and rolling out innovative products is a startup, it would be extremely difficult to figure out which one would likely grow your capital. Hence, we need to attempt to define startups by considering reoccurring patterns underlying highly successful startups. Notable examples are Apple, Sony, GE, Microsoft, HP, and MediaTek. By the way, Tesla, Uber, and many others have not yet succeeded as examples of successful startups.     

Underlying patterns of successful startups do not suggest that newly formed companies developing new products necessarily qualify as startups. Invariably, successful startups have pursued reinvention of existing matured products by changing the technology cores with emerging ones and fueling reinvention waves as Creative waves of destruction. Consequentially, their success has caused disruptive effects on matured products and firms.  Hence, startups are defined as early-stage companies pursuing the reinvention of existing products by changing technology cores and showing credible possibilities to unleash disruptive innovation effects on matured products and firms. Let’s validate this definition of startups by analyzing selected startups.

Startup Phases—setting the context of defining startups

As early as 1550, people started using the term upstart. However, in 1976, Forbes magazine first used the term startup. Broadly, startup refers to newly formed enterprises pursuing innovations to offer better alternatives to existing means of performing our jobs. There appear to be seven distinct phases of startups:  

1. Preindustrial era of startups (before 1760)—for millions of years, human beings have been pursuing ideas of alternative means of getting jobs done. Hence, humans have a long history of developing new businesses out of innovations. In the preindustrial age, innovations were limited to shaping metal and other naturally occurring objects through intuition, tinkering, and Craftsmanship. Hence, they could not create a flow of ideas for refinement, limiting the advantages of scale and scope. For this reason, the pre-industrial era witnessed many small firms (startups) growing out of innovations.  
2. Startups during the mechanical era (1760-1870)—the development of mechanical technology, engineering, and science for refining steam engines led to an era idea of reinventing products and production processes. Due to the role of science, technology and engineering, startups pursuing reinvention succeeded in creating a far greater flow of ideas than their predecessors. Consequently, startups became far larger corporations, creating a larger market than ever.     
3. Electrical era (1870-1945)—although ideas of reinvention out of electrical technology started through tinkering and craftsmanship, startups pursuing those ideas rapidly graduated to systematic exploitation of science and engineering for advancing and exploiting electrical technology possibilities.  The electrical technology core appeared to be far more amenable to progression than their mechanical counterparts. As a result, startups pursuing ideas of reinvention of matured products by changing the mechanical technology core with electrical started rapidly growing and reaching far greater heights than the previous phases of startups. 
4. Post-WWII era for startups (1940—1965)—during WWII, the USA patronized an array of R&D projects for sharpening weapons. Hence, new technologies were invented, forming a fertile ground for ideation and business development.  Consequentially, during the post-WWII, many graduates, scientists, engineers, and professors pursued the journey of forming businesses out of reinventions through leveraging technologies developed during WWII. Hence, a new startup boom began, notably creating a cluster of High-tech firms along Route 128 of Boston. 
5. Semiconductor and personal computer era (1950-2000)—the invention of the Transistor in 1947 and subsequent advancement, notably the inventions of the integrated circuit and lithography technique, led to forming a seedbed of reinvention ideas. During this era, startups found a far greater number of products as targets of reinvention through the adoption of semiconductor technology core.  Moreover, due to the very long runway of making transistors smaller, better, and cheaper, it offered higher scale advantages. Besides, growing microchip density led to the developing software software-intensive technology core around personal computers, which became extremely powerful technology core to sprout startups due to the massive flow of ideas and zero cost of copying software.   
6. Digital age (2000-2020) — the fusion of smartphones, internet, cloud computing, and software formed a new technology core. It opened the opportunity for ideate to reinvent many goods and services. As a result, there has been a surge of startups for digitization globally.
7. Pursuing AI machines (from 2020)—the development of sensors like cameras, high-performing data analysis algorithms, connectivity, and GPUs facilitating machine learning through training has augmented the digital technology core. As a result, the possibility of reinventing products and processes by replacing the role of humans with machines has become a hotbed of ideation. Hence, a new wave of formation of enterprises with the idea of replacing human’s cognitive role in operating and making products has started to unfold.

There has been a sharp contrast between the first five and the latter two phases of startups. During the first five phases, the focus of increasing the valuation of startups was to improve the technology core and redesign products so that the market expands and loss gets transferred into profit due to quality improvement and cost reduction through a flow of ideas. However, unlike in the past, during the latter two phases, beginning with digitization, the focus has shifted to increasing the valuation by offering subsidies to expand the customer base. Besides, investors have suffered from a hype cycle and crossing the chasm challenge due to misleading early progress. Since 2000, the focus of startups has been to increase valuation for raising investments to subsidize.

Detecting reoccurring patterns for defining startups

Let’s dissect examples to detect reoccurring patterns for defining startups:

1. Microsoft—despite beginning the journey from the passion of programming, Microsoft’s success came from unleashing Creative Destruction that affected how office work is done. It changed the technology core of preparing documents, printing, and crunching business data.  Consequentially, it unleashed creative destruction effects on typewriters and many other industrial products. Subsequently, it also disrupted corporate minicomputer makers.  
2. Fairchild Semiconductor—this startup pursued the journey of scaling up transistor invention to reinvent computers and signal processors by changing the vacuum electronics technology core.
3. Sony—Sony’s success did not come from setting up a chain of radio repair shops. Instead, it has become a startup success story due to its success in reinventing radios, televisions, cameras, and a few other consumer electronics products by changing their technology cores with solid-state devices. Its reinvention wave unleashed disruptive innovation effects on various companies, starting from RCA to Kodak. 
4. Apple—Apple’s success did not come from designing and developing new personal computers like the Apple 1 and Apple 2 and giving subsides to create market for them. Instead, Apple reinvented the personal computer user interface by changing text-based commands with Xerox’s graphical user interface. Its rapid growth is attributed to unleashing disruptive effects on text-based personal computers and expansive publishing machines.   
5. Amazon—certainly, creating a market of related books by taking orders from the Internet and sending them through postal services did not make Amazon’s e-book idea a startup success story.Instead of keep giving subsidies to retailing books through postal services, Amazon focused on reinventing the way of publish, deliver and read books.
6. Tesla—Tesla has embarked on reinventing automobiles by changing the internal combustion engine with electric batteries, motors, electronics, and software. Despite the appreciation of stock prices by many folds, Tesla has yet to unleash creative destruction wave of electric vehicles, which will be causing disruptive effects on incumbents like Toyota. 
7. Uber—App-based ride-sharing has become a taxi service. Hence, it has so far failed to disrupt car ownership. Despite making promises and burning billions of dollars in offering subsidies to its premature products, Uber has yet to find a suitable technology core to fuel the creative destruction wave, let alone unleash the disruptive innovation effect.  

These examples unveil patterns in detecting factors for defining startups. Let’s look into those factors further.

Factors defining startups

To qualify as startups, early-stage firms engaged in developing new products must score well in eligible for the following defining factors:

1. Emerging technology cores—their products should be around emerging technology cores, having a long run way of advancement. For example, Netflix’s new way of video delivery was around emerging streaming technology.
2. Amenability of technology for improving quality and reducing cost—invariably, all emerging technology core surfaces in primitive form. However, to create startup success, they must be able to progress to making newly designed products increasingly better and cheaper. For example, due to such characteristics, microchips and image sensors have propelled many startups to success. 
3. Reinvention of matured products—how far the prospective startups’ innovations are reinventions of matured products, having a considerable market, has significant implications on startup success. The degree of difficulty in further improving mature products and the scope of stepwise migration of matured products to reinvention wave play an essential role in the success of reinvented products. For example, despite the promise, Tesla has failed to be a disruptive force, as Toyota has gradually been migrating automobiles to plugin EVs through intermediary steps like mild hybrid, full hybrid, and plug-in hybrid.
4. Uniqueness as a potentially better alternative–the newly designed products must have robust and unique quality and cost characteristics to take over the market of matured incumbent ones. Due to its inadequacy, many startups, including Tesla, pursuing reinvention have been struggling, 
5. Decision-making Dilemma faced by incumbents—invariably, incumbent firms offering matured products are in a stronger position than prospective startups in technology, seed capital, brand value, complementary assets, and many other factors. Unless incumbent firms suffer from decision-making errors, it would be more or less impossible for startups to unleash disruptive innovations. 
6. Non-consumption market and potential scale, scope, and network effects—irrespective of the greatness, the mainstream market is going to reject the initial version of reinventions. Hence, startups’ success depends on the availability of accessible and exploitable non-consumption market segments, badly demanding an alternative. In the absence of this accessible non-consumption market, many high-potential startups get dead in possibility gaps, known as Death Valley.
7. Rise of reinventions as creative waves of destruction—for success, reinventions must grow as creative waves of destruction. However, to grow primitive emergence into a creative wave of destruction, there is a need for a systematic flow of ideas, distilling from unfolding technologies, consumer preferences, externalities, and other sources. 
8. Speed, non-replicable internal competence, and patents—for fueling the reinvention wave faster than all other competitors and creating a late-stage entry barrier, notably to incumbent firms offering matured products, startups must focus on the non-replicable internal capacity of technology advancement and patent portfolio. Due to its deficiency, Tesla has been failing to unleash disruptive innovation effects on incumbent automobile makers.   
9. Disruptive innovation is affected by decision-making errors—due to primitive and loss-making emergence of reinvention, often, incumbent firms offering profitable matured products suffer from decision-making dilemmas, leaving the opportunity to new entrants. Such a reality is vital for candidate startups to unleash the creative destruction wave to mature product markets for causing disruptive innovation effects on incumbent firms.    
10. Timing for unleashing synchronized response—due to the need for a synchronized response from multiple actors, timing plays a vital role in determining whether early-stage firms’ reinventions will grow as a creative wave of destruction. For example, due to timing, Netflix succeeded in turning a discarded video-on-demand idea into a startup mega-success story.

How do startups grow far faster than mature firms?

There have been two dominant theses of growing valuation of startups:

• Quality improvement and cost reduction through a flow of ideas—the market of matured products grows very slowly due to the maturity of the underlying technology core. On the other hand, due to the high-amenability of progression of the emerging technology core, there is a scope for advancing the market of reinvented products far faster than matured existing products. Hence, startup success stories have been created after leveraging technological advancements to expand the market and increase the valuation.
• Increasing customer base through subsidies—there has been a new trend of increasing the valuation of early-stage firms by subsidizing their primitive reinventions. Instead of creating scale, scope, and network effects by advancing technology possibilities, they are busy raising funds to subsidize their innovations to increase customers so that valuation goes up. As a result, growing VC fund burning has made only 8% of unicorns profitable. Plagued with the wrong thesis, these early-stage firms appear to be rotten potatoes in the startup basket. Unfortunately, many of them, like Uber, have become poster children of startups.     

Are all newly formed enterprises startups?

There is a growing number of early-stage companies designing products with emerging technology cores like mobile internet, software, cloud, and AI. However, do they get reasonably good scores in startup defining factors? If they do not, they are not startups for sure. Startup investing must consider factors defining startups for their screening and funding decisions. Unfortunately, instead of paying attention to these success factors, incorrectly perceived startups have been after subsidizing their primitive products to acquire customers to increase their valuation so that they can raise more funds to burn.  Unfortunately, most newly formed enterprises pursuing innovations are fund-burning furnaces in the disguise of startups, which has created the demand of defining startups.