Joining a Startup? Ask Questions like an Investor

I recently had a conversation with 2 close friend of mine looking to join an early stage startup and it was inspiring to be part of the experience. The zest and excitement for a new journey is contagious and fun to hear about.

While startups can provide potential career opportunities & autonomy that other larger companies can’t, its not all rainbows and unicorns. Lack of concrete remuneration, long hours, list of responsibilities outside your job scope are a few of the problems plaguing early stage employees. Not to mention the real daunting possibility of the startup going bust within a couple of years.

90% of startups fail within the first 3 years & of those which failed, 73% failed due to premature scaling

Premature scaling means spending money on marketing, hiring etc. either before you found a product market fit (where customers find value in what the product has to offer), working business model (where customers are acquired for less than the revenue they bring in) or in general spending too fast while failing to secure further financing.

Seasoned angel investors have a framework they use to evaluate startups worth investing in and remove cognitive bias in their decision making process like irrational exuberance, overconfidence or anchoring.

As potential employees, you don’t tend to look at yourselves as investors but the risk you’re taking is not much lower than an investor’s. The only difference is that you’re giving your time and future while they are giving monetary support and advice.

Before any investor puts her money into a startup, there are usually 3 broad questions that she will ask before any decision is made. (or some variation of this 3) These 3 categories of questions will determine (1) if the startup can survive before getting traction (2) how the startup will get traction (3) why the founders are the best people to drive the company.

As a potentially early stage employee, it is entirely your prerogative to ask the same questions:

  1. Business Fundamentals; Funding Plans, Monthly Burn Rate, Financial Runway
  2. Growth Plans; Startup Metrics, Funnel Metrics & Unit Economics
  3. Founding Team & Solution Alignment

Business Fundamentals

Funding Plans

Does the founder have a network of investors to rely on? The founders’ ability to secure additional cash injection is crucial to the survival of the startup. Typically, if the startup has secured funding from institutional investors in the previous round, the founders have a good chance to securing additional funding from these institutional investors or tap into their network to do so, provided the startup has been growing according to plans.

Depending on the stage of the startup, you will want to find out when the founders are looking at securing the next round of funding. For instance, a pre-series A startup usually will not have raised more than 18 months of runway so funding activities will have to start 12 months after the close of the last round.

Monthly Burn Rate & Runway

Cash is the fuel of every startup. The burn rate is the rate at which a company is spending its capital and is a measure of negative cash flow. Or in layman terms, the amount of money the company is spending out of its bank.

For obvious reasons, the burn rate of the startup needs to be low. The burn rate measures the efficiency and effectiveness of how the business is run.

As a potential employee, you’re looking for founders who practise financial prudence but understand the need for spending to get traction. Is the startup spending to solve for the needs of the customer? Depending on the nature of the startup, that could mean improving the product before hiring new salespeople.

At the same time, this also means that you might have to get involved in work outside your traditional job scope to help keep the burn rate low.

To find out more about Startup funding & burn rate management, check out Capshare’s tutorial on calculating burn rate.

Growth Plans

Startup Metrics

Is there a shipping product and an agile release cycle? Does the startup take on an iterative product approach towards their go to market strategy? If the startup has not developed a working prototype and is hiring for ‘Business Development Managers’, that is a major red flag because the BD managers have nothing to sell other than an idea.

The founders need to look at different metrics while measuring the product adoption journey. How much are the founders spending to acquire each user? How easy is it for the users to activate with the product? What does the retention numbers look like for activated users? If the startup is doubling down on marketing spend while having atrocious retention numbers (low double figures or single figures), that is a major red flag.

If you’re unfamiliar with the terms ‘Activation’ & ‘Retention’, check out Dave McClure’s Startup Metrics for pirates.

Product Market Fit

Do the founders understand the concept of Product Market Fit (PMF)? While most founders understand the importance of PMF, there are different opinions on how to measure it. Depending on the stage of the startup, you can look at 3 broad ways of measuring PMF.

  1. The Net Promoter Score
  2. Product Usage Pattern
  3. The Retention Curve

To find out more about the PMF framework, check out Brian Balfour’s amazing article on measuring PMF.

Funnel Metrics & Unit Economics

The founders need to acutely understand the metrics & unit economics they are working with in their space.

I will just be focusing on the unit economics of the 2 types of startups I’m more familiar with; Software-as-a-Service (Saas) and Ecommerce/Online Marketplaces (they are not the same but both have similar metrics).

For a SaaS startup, you’re looking for a good knowledge of funnel metrics. Funnel math works with an end result (how much revenue we need to bring in this year/month) and uses known or estimated conversion rates to work backwards.

If the startup wants to bring in a certain amount of revenue, it needs to know the average deal size and work out how many customers they need to bring in.

Taking it one step further (or backwards, depending on how you look at it), you will have to look at how many pre-sales deals are in the pipeline, the potential close rates of those deals and rep productivity.

Eventually this translates into the number of leads that are required to ‘feed’ the sales team and what sort of marketing activities can get the startup there.

Saas metrics are too complex to explain in a single section but if you want to find out more, check out this article for a high level overview.

For Ecommerce/Online Marketplaces, there are two leading indicators of the health of business — the the Gross Merchandise Value (GMV) & Average Order Value (AOV) of products.

The GMV indicates the total sales dollar value for merchandise sold through a particular marketplace over a certain time frame.

The GMV is most useful as a comparative metric over time, to measure the overall performance of the platform since the revenue of the business is a function of GMV, operating expenses and fees charged. Depending on the stage of the startup and initial base, for most companies, a month over month growth of 20–30% is very good.

The AOV is calculated as the total revenue divided by the number of orders.

For any transaction based business model, the AOV tracks the potential revenue the company can make off one single order. The actual margin the startup generates per order depends on the cost of goods & expenses or transaction percentage cut.

For more information on ecommerce metrics, here’s a great article from BigCommerce.

Founding Team & Solution Alignment

Why are the founders the best people to take their idea forward? At any point in time, you’re looking out if the founders are passionate about what they are doing and truly believe it is able to make lives better.

What are the current challenges in this market that will stop the startup from getting traction? The founders also need to have done their homework and are knowledgeable about the space they are in.

What is the unique value proposition the product is bringing to the market? The founders have to know what makes their idea better than the rest of the competitors. You’re also looking out for an awareness about why they are can understand the value and how to keep up that up.

Do they have deep domain expertise or experience working in a similar company before? One or more of the founders should be aware of why they are well suited to build the particular solution or personally understand the pain point they are solving.

Look for a balance between Agility & Stability

Startups are well known for acting quickly and pivoting but that often comes at the risk of changing direction too haphazardly. Once they grow beyond a certain point, changing direction quickly without planning can break momentum. Large established companies on the other hand become slow to act due to the rules, policies and management layers.

In my opinion, high growth companies are able to nail that balance between being stable, efficient, reliable with being agile and adaptive. This could be in the form of actively trying out innovation and experiments combined with the discipline of taking time to measure the performance of those experiments.

If you ever need help evaluating startup opportunities, feel free to reach out via LinkedIn or Twitter.