South Africa’s small business sector currently sits at an interesting intersection. On one side, there are the traditional businesses labelled as small to medium-sized enterprises (SMEs), while on the other side are the new kids on the block, the tech startups. These two types of businesses represent different business models, innovation points, funding and scaling journeys.
So, the question lies: What are the differences between SMEs and startups? And why are there so many differences?
Many people might think that having such polarising small businesses might present a disadvantage for South Africa, however, that is not necessarily true. Both sets of ventures contribute greatly to the economy, attract investment and create jobs, solving problems unique to South Africa.
In this article, we look at what makes SMEs and startups different, how they can leverage off each other’s journeys and how they approach funding.
What are SMEs and Startups?
Before we can outline the key differences between SMEs and startups, we need to know how each one is defined.
SMEs: SMEs are considered to be established businesses with consistent revenue, focused on stability and steady growth. The growth path of SMEs usually has a more local focus, with most not expanding beyond the borders.
Startups: Startups are companies designed to grow rapidly through innovative, scalable technology. Startups aim for high-impact, global scalability, typically seeking external venture funding.
Key Differences Between SMEs and Startups
Here are some of the differences between SMEs and startups.
1. Growth and Innovation
SMEs: Prioritise steady, sustainable growth. Innovation within SMEs is usually incremental, improving existing products and services to better meet customer needs. These businesses often operate in traditional sectors such as retail, manufacturing, and services with an emphasis on reliability and consistency in quality.
Startups: Synonymous with rapid growth and disruptive innovation. Startups focus on creating scalable solutions that can quickly gain market traction, operating in sectors like fintech, e-commerce, and health tech, and are designed to expand swiftly with the backing of large capital investments.
2. Risk and Stability
SMEs: Businesses such as these tend to present as lower risk profiles, with business models that focus on stability and long-term viability. They are more likely to achieve steady, moderate growth, ensuring they can weather economic fluctuations more effectively than high-risk tech startups.
Startups: These ventures operate in high-risk environments. Startups’ failure rate is high, with many startups not surviving beyond the initial years. However, those that do succeed can achieve exponential growth and significant market impact.
3. Operational Focus
SMEs: SMEs usually have more structured operations with established processes and a clear hierarchy. The focus is on optimising efficiency, maintaining quality standards, contributing to local economies and creating jobs.
Startups: Startups usually have much leaner operations with a great focus on agility and rapid iteration of their products or services. Emphasis is placed on talent acquisition, especially in STEM fields, and often operate in collaborative environments like co-working spaces and incubators.
4. Market and Customer Base
SMEs: Typically have a localised customer base, focusing on meeting the needs of their immediate market. They build strong relationships with their customers and rely on reputation and word-of-mouth for growth.
Startups: Aim to disrupt existing markets or create entirely new ones. Their customer base is often global, thanks to digital platforms that allow them to reach a wide audience quickly.
5. Funding
SMEs: Depend on traditional financing methods such as bank loans, retained earnings, and sometimes government support aimed at small business development. Their funding needs are generally lower than those of tech startups, focusing on operational expenses and gradual expansion.
Startups: Typically require substantial early-stage investment to develop their innovative products and scale rapidly. They rely heavily on venture capital, angel investors, and sometimes government grants.
Funding Journey: SMEs vs Startups
The funding journeys for SMEs and startups differ primarily due to their goals. Below, we outline how they differ.
SMEs
- Initial Stage: Funded primarily through personal savings, bank loans, and family to establish operations.
- Growth Stage: Growth is generally funded by retained earnings (reinvesting profits).
- Investors’ Role: Lenders (banks) provide capital but do not typically take an active role in management or demand equity.
- Role of Investors: Lenders (typically banks) provide capital but do not typically take an active role in management or demand equity.
- Alternative Finance: Use of government grants and alternative lenders (e.g., in South Africa) for working capital.
Startups
- Initial Stage: Founders often fund the concept through personal savings, or “bootstrapping”.
- Seed Stage: Funds are raised from friends, family, and angel investors to build a Minimum Viable Product (MVP).
- Growth Stage: Startups seek venture capital (VC) to scale rapidly, usually sacrificing short-term profits for market share.
- Role of Investors: Investors take an active role, providing guidance and demanding high returns on investment (ROI)
- Funding Type: Equity financing (diluting ownership in exchange for capital).
How SMEs Can Start Thinking Like Startups
If you are interested in running your SME like a tech startup, here are some tips for the pivot:
1. Shift Focus from Stability to Scalability
To become a startup, the business must pivot from its goal of sustainable profit to exponential growth. This can mean developing a product/service that leverages technology that can rapidly scale without a high corresponding increase in operational costs.
2. Adopt an Innovative Business Model
It may sound difficult, but you need to develop a new, unproven, and disruptive business model, rather than just trading in an existing market. An example of this would be if an SME that offers consulting services launches its own software-as-a-service (SaaS) tool.
3. Embrace ‘Lean’ Methodologies
Startups operate with high uncertainty and focus on finding a repeatable model, whereas SMEs often follow established processes. To start thinking like a startup, do the following:
- Testing and Experimentation: Launching MVPs to test new markets rather than investing in large, untested initiatives.
- Agility: Moving away from rigid, slow-moving routines to adopt lean, rapid-testing, and data-driven customer feedback loops.
4. Change Funding Strategies
Traditional SMEs often fund growth through bank loans or cash flow. To fuel the rapid growth of a startup, you need to seek venture capital (VC) or angel investment, which often means accepting high-risk, high-reward scenarios and giving up some equity.
The above points are meant to help SME founders think more like tech startups. This kind of mindset can help SMEs stay adaptable in an ever-changing digital world, and access other types of funding that have benefits that may not exist in traditional funding.
