Five Ways Tech Startups Are Different from Other Small and Medium-Sized Enterprises

Tech startups need incentives and policies tailored for their unique circumstances.
Tech startups need incentives and policies tailored for their unique circumstances.

By Aimee Hampel-Milagrosa, Paul Vandenberg

Though there are many similarities between tech startups and other small businesses, they need to be treated differently from a policy and regulatory standpoint.

Technology-based startups are the rage. They are the enterprises of the digital age and precursors to some of the largest firms domestically and globally. Google, Amazon, Alibaba, and Gojek are famous examples. Startups are dynamic and innovative. They start small and thus begin life as small and medium-sized enterprises (SMEs). But they are different from traditional SMEs and require a distinct set of supports from government and other players.

Tech startups are young entrepreneurial ventures that bring new and innovative technology-based products and services to market. They offer solutions to consumers and businesses; often to problems we didn’t know existed. The business model is normally scalable, meaning activity can expand rapidly because solutions are offered on the internet and can reach a large customer base. In Schumpeterian terms, startups are creatively disruptive as they shake up the business world through innovative services and new business models.

Revolutionary startups like Tesla and SpaceX aside, startups are heavy on skills and light on physical assets because they don’t make physical products. They recruit bright people with valuable skills and create opportunities for them to innovate and add value to the enterprise. Entrepreneurs – founders, as they are called – think big and are determined to see their ideas grow.

Startups make up a very small portion of the SME population. By one estimate, 213 million SMEs operated globally in 2020, of which 1.35 million (less than 1%) were tech startups. However, due to their potential to grow large and the innovation they bring, they garner the attention of policymakers. They are different from traditional SMEs and require a distinct set of policy and program support from government and the wider startup ecosystem.

We believe there are five major differences between startups and SMEs and the implications for policy.

First, most tech startups are digital. They concentrate on internet and platform technologies and have spawned a range of new sectors – fintech, e-commerce, agritech, greentech, and others. Recently, the COVID-19 pandemic has given a big push to healthtech (telemedicine, wellness), edutech (online learning) and solutions that support business communications (telemeeting and conferencing). For policy, government needs to provide or encourage private players to provide a robust digital infrastructure that is accessible and low-cost and yet protects privacy and intellectual property.

Second, startups need patient capital – not credit. The latter must be serviced through interest and repayments, but early-stage startups have little or no revenue. They are focused on prototyping and development and many – even successful ones – run at a loss for many years. In contrast, SMEs require finance that directly supports production (capital equipment, supplies, inventory) which, in turn, generates revenue. Therefore, equity and grant financing are more suitable for startups. Equity is provided for the longer term and therefore is considered more “patient”.

Recognizing this difference, governments can create a clear, supportive, and low-tax regulatory environment for venture capital and angel investors. They can also top up private venture capital for co-investment. In addition, early-stage grant funding can be provided for promising ideas. Many governments do provide grants, although there is debate about whether it is a good approach.

Governments can create a clear, supportive, and low-tax regulatory environment for venture capital and angel investors.

Third, startups need early support services. Silicon Valley, New York, London, Beijing, and Boston are the world’s top five startup ecosystems not only because they provide superb digital infrastructure and venture finance, but also because they support easy access to legal, accounting, human resource management, and other services. Startups register businesses on the get go and need these elements settled early so that they can scale up quickly. Legal guidance is also needed to register innovative solutions where no product classification category yet exists.

Fourth, the technology talent of startups need support on business development from incubators and accelerators. A startup begins with an innovative idea from founders who are creative with technology. However, they are often inexperienced in how to run a business. The idea needs to be shaped into a marketable product and a profit-making enterprise. For this, incubators and accelerators are important. They are programs – sometimes also providing workspace – that offer advice, training, networking, and mentoring. Some offer seed funding while others provide links to potential investors. Incubators and accelerators help startups experiment, get feedback on their technology, and rapidly iterate new versions better suited to the market. Governments can establish (or financially support) incubators and accelerators and recognize that they are distinct from the business development services needed by SMEs.

Fifth, tech startups need skilled talent. Owing to their digital nature, startups require staff with expertise in science, technology, engineering, and mathematics (STEM). Talent acquisition is a key challenge for startups, prompting the need for governments to provide educational opportunities to generate a stream of skilled graduates. The constraints are not only on the supply side. Strict immigration rules, stiff competition for talent with large firms, and the high cost of living in tech hubs are issues that also arise. Innovative policies that make it easier for tech startups to attract talent – such as relaxed immigration laws, and favorable tax treatment of employee benefits – are creative ways to create an enabling startup ecosystem.

Governments should continue to support SMEs for the important contribution they make to the economy. Concurrently, policymakers can build a supportive ecosystem to address the unique challenges faced by tech startups.