That’s the default answer from soon to be founders and entrepreneurs.

It’s obvious to them that a need exists and the prospect of reaching millions of users and customers is intoxicating.

But as my colleague Jeffrey Tobias says, it’s a mistake to think that a startup is a small business.

His point, quite rightly, is that small businesses have limited growth potential.

Startups, on the other hand, are limited to the size of the addressable market.

And it’s this nuance that first-time founders rarely consider.

At the heart of the difference between a startup and a small business is the number of units of value that can be generated per person over time.

The small business reality

The punchline is that a small business relies on people to create value.

Cafes, hairdressers, professionals service firms and hotels to name a few need people to make them work. The business models are relatively well known and because people can only work a limited number of hours each day, the value they can create is also limited.

Small businesses can optimise processes to give their people more time to create value but this only goes so far. And of course some people can generate more money than others but at some point, everyone needs to sleep.

The cash flow generated by small businesses can also be significant but its limiting characteristic and its key asset are people.

The startup ambition

Startup equals growth. Y Combinator founder Paul Graham coined this phrase.

He went on to say that ‘for a company to grow really big, it must (a) make something lots of people want, and (b) reach and serve all those people. Most businesses are constrained by one of those two items. If your business is not constrained by (a) or (b) then you’re in startup territory.’

There is are two important nuances that live within Paul’s philosophy, both of which relate to making something that lots of people want.

Making something that lots of people want is a process that takes time and experimentation. A switch doesn’t get flicked to reveal the thing that lots of people want. It takes the compounding effect of being in market for ten years, a high calibre dedicated team and luck to make something that lots of people want.

However, there are clues to short circuit the journey. Y Combinator, for example, has developed a reputation for backing founders who have built products that have a disproportionately large number of fanatical lovers of their product soon after the company is founded. I wrote about how to focus on those people recently.

The second nuance is more deceptive to founders. And it has to do with the difference between fixing a problem and solving a need.

Most founders become founders because they see an opportunity hiding in plain sight. Those opportunities are usually rooted in problematic experiences and here’s the punchline:

Fixing a problem is not the same as meeting a need.

Fixing a problem usually helps a specific group of people to resolve a frustration.

Meeting a need results in the creation of a magnetic attraction between user and product and an aspiration for others to engage.

And this issue usually doesn’t reveal itself in the early days of a venture. This is because the founder isn’t far enough into the journey to have evidence of meeting a need and the magnetic attraction that follows. The other reason is that their excitement for the idea is so great that they won’t let themselves see the difference.

In any case, the early days of a venture see founders trying to find evidence from desk research to support their thesis that the market potential for their idea is massive.

Notwithstanding the bias that can come from researching and finding data that fits the original thesis, the size of the opportunity is only half of what you need to know. The other half is the rate at which the opportunity should be captured to create or secure a large portion of the market.

Calculating that rate takes founders from vague top-down opportunity analysis to part (b) of Paul Graham’s philosophy, how to reach and serve all those people.

While this can also be solved with time and growth-focused experimentation, asking whether a venture will scale is actually asking how many team members will it take to reach and serve all those people. In other words, how many users and paying customers can one person serve?

Case in point: Slack

Consider Slack, maker of the popular messaging service. Slack has 1122 staff and as of September 2017 has over six million daily active users, with approximately two million of those users being paid.

This means that every Slack staff member is each serving over 1,780 paying customers. This isn’t a traditional metric but it makes the point that companies that scale make something a lot of people want and can reach and serve them.

Technology played a significant role in Slack’s ability to scale which begs the question, can non-technology companies scale? I think the answer is yes but they are in a small minority.

One last thing…

Be ok with a thriving, cashflow-driven small business. It can create an extraordinary lifestyle for you and your family. But there is enough evidence when you start to know you are starting a small business. Move to optimise quickly knowing that growth is tied (and limited to) the number of people you employ.

If you fit ‘startup’ run as fast as possible to understand your product’s fanatical lovers. They will teach you more, quicker, than anyone else.