Entrepreneurship is one of the oldest, and often least understood, areas of business. As a professor of entrepreneurship I am constantly looking for teaching points that commonly misunderstood by students. The first point that we cover in my course deals with the main types of entrepreneurship for new businesses. In this article, I discuss the difference between a lifestyle business and a startup venture.
Many people don’t understand or fail to differentiate between a lifestyle business and a startup venture. A lifestyle business is a small business that typically begins as a “mom-and-pop” shop. Better said, a lifestyle business is a typical small business with a slow and gradual growth plan. The purpose of the business is to provide an occupation and income for the founders into the future. Perhaps it is easier to explain the concept of a lifestyle business by comparing it to the startup venture.
Profit in the Lifestyle business vs the Startup Venture
A startup venture is a high-growth, fast-paced business. A startup, rather than providing a source of employment income, is more of a growth-based project. An entrepreneur forms a startup with the purpose of growing the venture as quickly as possible with the expectation of selling the business or going public within a specified number of years (generally 3-7 years). The entrepreneur plans on capitalizing on the venture by selling the business for a substantial profit.
A lifestyle business hopes to “turn the corner” and achieve profitability as soon as possible. A startup venture generally does not become profitable for several years. The startup entrepreneur is charged with spending the revenue of the business on growth, rather than achieving any sort of return to investors. The entrepreneur, as well as the investors, hope to receive a favorable return on their investment at the point in time when the venture is sold or goes public.
Funding the Lifestyle Business and the Startup Venture
The most important aspect of a lifestyle business or a startup venture is funding. Even the most well-planned growth path cannot happen without adequate funding. The entrepreneur generally finances a lifestyle business with personal funds, small business loans, and loans from friends and family. A startup venture may begin in the same way; however, the business forms in anticipation of seeking outside capital from strategic investors. These investments come at various stages in the life of the startup and fund the venture at the various stages of growth.
Structure of a Lifestyle Business and the Startup Venture
The structure of a startup is generally much different than a lifestyle business. In the lifestyle business the owners will typically retain the entire ownership of the business and organize the levels of control and responsibilities among the owners.
Startups generally have more complex ownership and control structures. The more complicated structure requires multiple forms of stock in order to provide the balance of control and ownership that an investor will require. The startup will likely need to use some form of equity incentive to hire competent members of your startup team. Plainly stated, you may not have sufficient cash flow to pay these team members the value of their services. Further, these new team members may join the business for the sole purpose of being part of the sale of the business. Allowing these team members an equity share in the business is normally achieved through stock options or stock vesting schedules that depend largely on the performance of the new member.
Other Considerations in the Startup Venture
In the lifestyle business, the entrepreneur or entrepreneurs typically found the business without emphasis on intellectual property rights or elaborate ownership or control agreements. Again, their primary goal is to establish a profitable business – rather than growing a venture for future sale.
The above situation in startup ventures often leads to tricky tax situations. A new team member receives an interest in the business in exchange for services performed to the business, rather than some form of capital contributions. The receipt of equity in the business may be treated as ordinary incomes to the extent of the current value of the equity. Remember, the business likely holds any intellectual property, such as design patents, trademarks, and business processes. Awarding a new team member an interest in the business also awards an ownership interest in the valuable intellectual property around which the business operates.
Conclusion: Understanding the difference between the startup and lifestyle business is important, company formation for a startup differs significantly from that of a small business. A small business setup can often be simple. A startup setup is much more complex. This difference has legal implications affecting the choice of entity as well as structural choices made in the setup.