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March 25, 2006

Nine Questions to Ask a Startup

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Most of the information that you can find about recruiting is for the employer, not the employee. (I'm as guilty as this as anyone: for example, The Art of Recruiting, I and II.)

Let's turn the tables, switch modes, and balance the scales by discussing what a hot candidate should ask a private, venture-backed startup before making the leap to “infinity and beyond” as Buzz Lightyear would say. Nota bene: there is a definite order in how to do this: First, get the job offer, then ask these questions!

1. How many outstanding shares of stock are there?
Most companies make offers of dazzlingly large amounts of stock options. After all, 100,000 shares sure sounds like a big number--especially if the company goes public at, say, $20/share and then googles on up to $400/share like you're being led to believe. That's $40,000,000--you could buy Larry Ellison's house with that kind of money!

The number of options that you're offered is a meaningless number unless you know the total number of outstanding shares of stock. With these two pieces of information, you can calculate the percentage of the company that your options represent--and that's what counts. For example, 100,000 shares of 1,000,000 total shares is a lot better than 250,000 shares of 10,000,000 total shares.

You could simply ask what percentage you're getting, but that's a little crass, and some people may misinterpret crassness for a lack of good judgment. :-) However, just because you know what percentage of the company you're getting, don't make yourself crazy with delusional thoughts of how much you're worth.

Here are some “Guyed”lines for a startup that has already raised its first round of venture capital of $1-3 million with no more than fifteen employees. Don't just latch onto the top end of the range because there are many variables to consider including salary, cash bonuses, geographic location, and most important of all, your perceived value.

  • Senior engineer: .3 - .7%
  • Mid-level engineer: .2 - .4%
  • Product manager: .2 - .3%
  • Architect, i.e., the “main (wo)man,” though an individual contributor: 1 - 1.5%
  • Vice presidents: 1.5 - 3%
  • CEO, i.e., “adult supervision” brought in to replace the founder: 5 - 10%

(I know I'm going to regret providing these guidelines...those of you who read this blog in an RSS feed will be amused by how these numbers will change.) :-)

One more thing about these percentages: as the company becomes successful and grows--and perhaps raises more capital to fuel the growth--your percentages will go down. It's better to own a small percentage of a large company than a large percentage of a small company.

2. What is the monthly burn rate?
“Burn rate,” as commonly understood, is net cash flow. (In most cases, “net” isn't even necessary to mention because there are no revenues.) You want the answer to this question in terms of cash--not some bull-shitake, pro-forma paper-profits calculation unless you can pay for your rent with paper profits.

3. How much cash is in the bank?
This is a straightforward question. Now take this answer and divide it by the monthly burn rate. This will tell you how long before the company runs out of money. If the answer is less than six months, be cautious unless the company already has signed term sheets for the next round of financing. If it doesn't, assume it will take at least six months before another round of financing closes.

4. When will the company achieve positive cash flow?
You should ask this question because you'll probably be told that there are months and months of cash or that another round of financing is “looking good.” If the answer is years away, then you're signing up for more risk because venture capitalists aren't the most patient, loyal people. More risk is okay-it takes years to build a great company--but you should know what you're getting into.

5. When will the product ship?

This is just another way of asking about positive cash flow. Obviously, positive cash flow before shipping is improbable, but if the company is saying that positive cash flow will occur shortly after shipping, something is fishy, or the management is clueless. My advice is that you add six months to the “worst case” date that because nobody ever ships on time.

6. May I talk to any of the outside investors on the board of directors?
If the outside investors are as positive about the company as you're being told they are (and assuming you're truly a superstar applicant for a senior-level position), then the company should agree to this. If it doesn't, then either the investors are getting “tired,” or you're not that important. Indeed, if you are a superstar, you won't have to ask because the management will ask a big-name board member to call you.

7. May I talk to several beta sites?
This question is another reality check: the company is probably spinning a tale about how all the beta sites love the product. (In my career, every company has always told me that beta sites “love the product.”) If you're told you can't make contact, then either the company doesn't want to bother future customers (which is reasonable) or you're not important (which is possible). Of course, it could even be that the product sucks, so the company is afraid of you talking to beta sites. It would be nice to know if it's the last reason.

8. How much of a “liquidation preference” do the investors have before common shareholders get anything?
Suppose the company has raised $25 million and the liquidation preference is only $25 million (it could be multiples of $25 million depending on how the investors negotiated the terms of investment). This means that the investors get their $25 million back before the employees get anything. If the company is acquired for $25 million or less, then the employees get nothing. If there's a massive liquidation preference, your options may never be worth anything.

9. Are there any intellectual property issues or lawsuits pending?
This is a housekeeping question. To put it mildly, it'd be nice to know that the company's intellectual property is free and clear, and that there aren't any lawsuits that could tank the company. If you don't ask, don't expect the company to volunteer such information during the recruitment process.

Finally, a word of caution: the management may interpret these questions as evidence of a lack of “believing” or a failure to understand “the big picture.” (It merits repeating: Get the job offer first and then ask these questions.) On the other hand, you might impress the management with your knowledge of how startups and finance really works. Welcome to the complex and contradictory world of startups...

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Comments

Found this blog pretty useful while negotiating.

One more thing that was worth finding out is the commitment of the founders towards the startup.
If they happen to be professors on a sabbatical, what's their plan after the sabbatical? Do they hold too many positions at the same time?

Also, their track record wrt previous startups if any is worth considering.

Does "outstanding shares" include the total # of options granted or the total # of options actually exercised?

This is great stuff, Guy. It took me most of my working life to figure out that a job interview is - or at least should be - a two way interview. The company is interviewing you but you should also be interviewing the company.

This is great stuff, Guy. It took me most

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Guy,great post. We could sure use your help in saving the public schools in America. We need someone that can think outside the box and sell the dream. You continue to provide a great service to us all. You are the "Earth,Wind, and Fire" of the business community.

Great post. As a lawyer, I especially like #9 because that seems to be the one that is missed until the lawyers come in and that should not be the case. Gee, did I forget to tell you there is someone out there who claims to own our one product?

I'm glad you threw #8 in there Guy. It explains why there are so many people working for their third and fourth start-up in California.

I am getting jaundiced and tempted to advice people looking to join a startup to focus on the paycheck and what they will learn or accomplish regardless of the pay-out. Make sure you think it will be worthwile to work there even if it only lasts a month.

Great post Guy! Perhaps the next in the series could outline the questions to ask when you are joining a PRE funding company. Oh, the things that I have learned...

Interesting post. A lot of those questions look like questions that Angels and VCs will ask, too. But potential employees are investing something far more important than the Angels and VCs - their time.

Great info. Some really good things to think about especially for me who has the allure of wanting to be apart of a start up, but still need to keep in mind the reality of the world around me.

BTW, saw the article from the SF Chronicle Sunday regarding Apple's up coming 30 years.

Ehhhh, I would say ask (2) and (3), what your salary will be, and what hours you're expected to be at the office. Stock is a bonus, unless you're the CEO. Additionally, I would ask what the employees do together. I'm all for "when in Rome, do like the Romans", but if (for example) having lunch brought in every day and having bizzare alcohol rituals on Friday stretching from morning until people are calling cabs or wives at 8pm isn't your thing, the job's not worth it. Many startups take on cult-like atmospheres, and if you're not looking for a cult to join, best not to join one.

Another key question to ask the company, which will definitely have a significant effect on the value of your shares:
What differentiates you from the dozen or so competitors out there?

For me personally an inadequate answer on this one is a deal breaker...

Good reminder about "when" to start asking these questions. Having been on the recruiting side, when candidates start asking these sorts of questions on the first interview, you basically want to show them the door. Too much, too soon is a big mistake. Make sure there's a signed offer on the table, timing is everything...

I have one thing I'd like to add that is related to number 1 and number 8.

It is also important to know what happens if the company is purchased by or merged with another company. What happens if the other company terminates your employment, hires you but requires that you move more than 40 miles, or hires you and leaves you in place? Do your options immediately expire, do they automatically vest, are you paid in cash for the value of your shares, are your options converted to that new company's stock, is your vesting schedule changed at all, and in general what happens?

Quite a few startups end up being acquired by others and you want to make sure you've considered what happens with the stock options you've been granted and those which have already vested. Even if the startup has an IPO, that doesn't mean it won't be bought or go through a merger.

Great post, Guy. A few thoughts from the perspective of an entrepreneur at an angel-funded startup. First, once you have your percentage number, it's nice to know what to do with it. What does 0.5% of a company mean anyway? One approach is to look at some comparable companies in the space. Figure out how many rounds of financing they took beyond the first (r), and divide your percentage by 2^r, which reflects the additional dilution that later investment will bring. Now figure out how much these companies typically exit for, and multiply your share percentage times that exit number for a very rough thumbnail of how much that kind of exit might net you.

Second, note that angel dollars can come in piecemeal and often with a much shorter than 6 month lead time. If you're interviewing at a company that's angel funded (instead of post-series-A as you outline in your article), it's not terribly uncommon to find less than six months of cash in the bank.

Third, note that all the exit numbers are meaningless if you're a key employee. If the company gets sold and the new company needs you, everything becomes negotiable. That includes VC liquidation preferences--sorry to spill the beans on that one Guy! If you are moving into a position where you can scuttle or devalue the deal by failing to move to a new company, you have negotiating leverage that you can use to ensure you exit with a reasonable piece of the pie.

Thanks for the great article.

The first most important question in my opinion is about what the company is building ( i.e it's product ). It's very important that you are satisfied & convinced with the idea first before getting into other details. If you believe in the idea & the team which is executing ( this is very important as most good ideas fail because of poor execution ), then you can even compromise on others.

Caution : Also, the one who is going to interview is going to be very optimistic & all the answers are going to be very convincing.

Great piece, Guy! I wish I'd seen something like this 5 years ago!

I especially like # 5 (When will the product ship).

I have often asked something like, "What is the one thing that could seriously improve the product or propel us forward?" An earnest response offers a glimpse of what life is going to look like if one says "yes". It also provides some insight into whether these guys can really make it happen.

-h

Great stuff on 'overhang' -- this is a topic that people on both sides of the VC table need to think about.

Many VCs seem to think of it as a coup to get a term sheet with an absurd multiple liquidation preference. But really, it's just a recipe for demoralizing your founders and getting them looking for the closest, fastest exit.

Smittie, I always believed in "reverse interviews", i.e. the candidate driving a good portion of the dialogue, focusing on the company's business rather than on him/herself. It worked for me most of the time, and where it did not - well, I was better off not being there:-)

#8 is a real good one, thanks, Guy, I would not have thought about it.

I think this is a topic that gets short shrift in the blogisphere. I'd like to see a few more posts like this that can help startup employees know where the moneys going to go.

This is great stuff, Guy. It took me most of my working life to figure out that a job interview is - or at least should be - a two way interview. The company is interviewing you but you should also be interviewing the company.

Once I did figure that out I then realized that I didn't really know what questions to ask or how those questions would be perceived. It's really cool to have someone who's been on the other side of the desk let this working stiff know what the truly important questions are.

Aloha

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