Evaluating Startup Job Opportunities: Think Like An Investor

You’ve been approached by a hot new startup company that urgently needs your talents and asks you to come in to interview. The product and technology sound great, and you can’t stop thinking about how much money you’ll make when the company goes public or gets acquired. There are some risks involved, though. This may be a great opportunity—or it may not be. And that leaves you wondering: Just how should you evaluate a job opportunity at a startup company?

First, realize that failure rates for even the most promising venture capital–backed startups are high. What limited data is available suggests that about 7 in 10 venture-backed startups go out of business or return less than their investors’ original investment. Another 2 out of 10 have modest returns. And only about 1 out of 10 does really well and returns 5, 10, 20 or even more times the investors’ original investment.

Given the low success rates, it is important to try to improve your odds by doing your homework or, as venture capital investors like to say, your due diligence. One useful technique for trying to determine whether a startup will be successful is to approach the company as an investor would. Look at each job opportunity as a decision whether to invest in that company. Use the criteria that investors use to determine whether to commit the next several years of your life to that company.

A veteran venture capitalist succinctly and somewhat playfully describes the evaluation process as revolving around two key questions: “Can they build it?” and “Will anyone buy it?” The first question refers to the management of the company and product development or scientific team and whether they can actually build or develop the product proposed in their business plan. The second question refers to potential customers and whether they will, in fact, pay money for the company’s product or service.

Can They Build It?

Getting a sense of the management team that you’ll be joining or working for is an important part of your evaluation. Is this a veteran group with decades of experience in this product space and potentially multiple startups among them with successful exits? Or is this a group of really bright first-time entrepreneurs figuring it out as they go in a brand-new product space that they are creating? In the latter case, the experience and pedigree of the venture capital firm or firms invested in the company, and the experience of the outside advisors involved with the company, take on additional importance.

Is the company’s technology a reorganization of and improvement on existing ideas and thus evolutionary, or is it completely new and revolutionary? The point here is to differentiate whether developing the company’s product will require using existing technology with some identified and quantifiable technical challenges or whether developing the product involves research and experimentation with an unpredictable outcome. If the product is buildable with existing technology, then speed and stealth might be an important factor to hitting a market window. In thinking like an investor, you want to know what technical hurdles need to be overcome to complete product development. You want to try to figure out what the hard technical problems are and assess how likely it is that the development team will overcome them. (And maybe your talents can help them in an important way.)

Will Anyone Buy It?

The “Will anyone buy it?” question is often harder to evaluate than the “Can they build it?” question, especially if you are unfamiliar with the market space. Here you want to try to understand if the product solves a real problem or enables useful new capabilities, which sometimes become obvious only in hindsight.

The question of how many customers will buy the product is related, and presumably the venture capital investors have determined that the market size, however defined, is large enough to support a good-sized company. One thing that differentiates professional venture capital investors is the size of the potential market they will invest in.  For professional venture capitalists to invest, the company’s market has to be large enough to support the creation of a large company. Growing small startups into large companies quickly is how venture capitalists earn the high rates of return they promise the limited-partner investors in their venture capital funds.

In evaluating whether customers may buy the product, a quick internet search is always a good first step in understanding the landscape around the company’s product or service. Beyond that, in your discussions with the company, you can ask what steps have been taken to validate the market. What has the company learned about the value proposition for each targeted customer segment?

Depending on the stage of the company and product development, the answer might range from interviews with prospective customers, to feedback based on early hardware prototypes or early-release versions of web applications, to large-scale beta testing results. What has the team learned from its early interaction with prospective customers? Have there been course corrections? Are the company’s assumptions about price point bearing out now that customers have had a chance to interact with the product? If the product has been announced publicly, have there been any customer orders placed? How many users are on the platform now? These are all questions aimed at understanding if the product is gaining traction. Is anyone buying it? Has the company confirmed that customers will buy the product and now it’s just a question of scale and ramping up? You may not receive answers to some of these questions because the answers are confidential, but it doesn’t hurt to ask.

Funding Status

Getting back to the risks involved in working in startups, you will want to know the funding status of the company. Venture capital–backed startups are funded in stages to limit the risk to their investors. At each stage of the company’s development, investors supply another “round” of financing—for example, seed or startup rounds, growth rounds (i.e., Series A, Series B, Series C and so on) and possibly a mezzanine round to provide working capital prior to the company’s raising capital in an initial public offering (IPO). At any point along the way, if investors do not feel that the company has made sufficient progress or the company has not met its milestones, additional funding may be withheld with the result that the company may run out of cash and be forced to close down—at which point you would need to find another employer.

Important questions you can ask about funding status might be what round of funding has the company most recently received and how much longer (in months) is funding expected to last. Essentially, how much runway is left before the company needs to raise more cash from its current or potentially new investors? Another way you will hear this discussed is in terms of burn rate: How fast is the company spending its cash in the bank raised from investors in the last round of financing? It might be important to know what milestones need to be met before investors will put in the next round of funding. In fact, you might be a critical part of meeting those milestones.

On a Personal Level

Startup companies have a staffing life cycle that starts with a handful of founding entrepreneurs and progresses (hopefully) to a fully built-out, multi-departmental entity with dozens or hundreds of employees. Each of those employees is typically awarded ownership in the company as an incentive to work hard and to align the interests of employees with the interests of the company’s investors. While it varies by position in the company, the earlier in the life of the company you begin working, the more ownership (or equity) in the company you will receive as part of your compensation package. Thus, typically, the earlier you get in, the more upside you have when the company goes public or gets acquired.

It is usually also true that the earlier in its life you join the company, the more risk you are taking. The overall risk of the company failing typically decreases over time as product development risk and market risk are better understood. Risk is generally tied to the age of the company and funding round. When you join a company after its later funding rounds, the risk is reduced and so is the amount of equity available to new employees.

Companies often present their offers in terms of a number of shares. To figure out what those shares might be worth when the company is sold or sells shares in an IPO, you need to know the total number of shares outstanding. You can then divide the number of shares you received by the total number of shares outstanding to determine your ownership percentage in the company. From there, you can multiply your ownership percentage by a hypothetical value of the company when it is sold or goes public to find out what your shares might be worth someday. For example, if the company offers you a stock option on 40,000 shares, and the company has 8 million shares outstanding, you will own 0.5% of the company (subject to vesting). If the company is sold or goes public at a valuation of $300 million, your equity in the company will be worth $1.5 million (before tax).

While the approach described here can help you evaluate the company’s chances for success, it is also important to evaluate the impact you believe you can have on the company, which can increase the chance of commercial success for the company and financial success for you. On a personal level, how do you feel you can contribute to the success of the company? What skills and experience do you have that can help the team? These are great questions to consider before, during and after your interviews.

Also on a personal level, do you enjoy the people you would work with? While this is important in evaluating most job opportunities, it is even more important in startup companies because you will be spending a lot of time with your work colleagues. Work-life balance is typically not a hallway conversation in startup companies. Your life will be decidedly imbalanced—in favor of work.

One last thought on working in startups: Given the high failure rates of venture capital–backed startups, you may need to work in several startups before becoming a part of a truly successful and enduring company. Serial startups can increase your odds of bumping into a life-changing event. Many people enjoy the rush of the startup work environment and choose startup companies over larger, established companies regardless of volatile company outcomes and higher financial upside.

Use this investors approach to help you evaluate your next startup company job opportunity. Don’t forget to sell yourself during the interview process. And good luck.