## How to Pick Your Next Gig: Evaluating Startups - Part I

14 Aug 2017

This blog post is based on my experience interviewing with a range of tech companies during my junior year at Princeton. At the end of the process, I had to make a choice between a large public company, a then recently-minted unicorn, and a then-Series B startup with 100 employees based in San Francisco.

This piece attempts to codify how I went about making my decision, and in particular, lays out a methodology for how to evaluate startups. Though I’m writing primarily for recent college graduates, I’ve tried to make the discussion generally applicable to anyone looking to work for a small company.

Choosing a company to work for is an investment. While a venture capitalist might put in a large amount of money and a small amount of their time (i.e. in monthly board meetings) into a portfolio company, as an employee, the primary asset you invest is your time.

The returns you make can take a number of forms - career advancement, personal growth and fulfillment, and financial payoff. Making any decision comes with an opportunity cost - the foregone returns of another choice you could have made.

Finally, unlike a venture capitalist, as an employee, you commit to work at a single place, so you can only make one investment at any given point in time. So while Marc Andreessen might be okay with a 1-in-10 hit rate,1 you have to set the bar a little higher.

All of this is not to paint the decision as a paralyzingly difficult one, but to place it in its proper context - as a prospective employee, you are an investor, and you evaluate companies as much as they evaluate you.

The brand recognition of a company, the capital raised, the prestige of the investors, your friends' opinion - all of these might matter, but perhaps only as secondary signals of a company's future prospects. What, then, should you look for, and how much weight should you put on each factor?

Here's a laundry list of potential criteria that you might consider in evaluating a startup:

In the remainder of the post, I'll address each of these in turn, and provide a "star rating" to indicate how strongly you should consider each factor when making your decision.

I assume that you are interested in some combination of the following: personal growth, career growth, and financial upside. A convenient truth is that these three goals tend to be tightly correlated, and joining an early-stage, fast-growing startup with strong founders and talented employees is likely to satisfy all three.

This post is about how to identify such companies.

### The criteria

#### Current traction

One fact that makes evaluating startups as a prospective employee particularly difficult is that most key metrics are not public information. Statistics such as the number of monthly or daily active users (MAUs/DAUs), annual revenue, and months of runway are often not even known to current employees, let alone available on the internet.

Moreover, the founders and upper management are unlikely to share this information in the interview process, but if you do get the chance to speak with them, it is definitely worth a shot to ask.

Even if these numbers are known, they may not actually be the strongest signals. Revenue, for example, is often an irrelevant measure for early-stage, consumer-facing companies (e.g. Facebook in 2008), while number of clients may be too coarse a metric for early-stage, enterprise tech companies (for many years, Palantir only had one customer: the US government).

You also have to be careful about companies cherry picking statistics that paint them in a favorable light. A mobile app company may choose to reveal total downloads, but not monthly active users, or their shockingly high churn (i.e. uninstall) rate.

A famous example where these metrics sharply conflicted is Draw Something, a social drawing app, which, along with its parent company OMGPop, was acquired by Zynga in March 2012 for $180 million. Within two months of the purchase, daily active users had fallen by a third, from a peak of 15 million on the day of the sale to 10 million by early May. Draw Something relied on aggressive growth hacking, via close integration with Facebook, and sacrificed the opportunity to build a sustainable product for rapid growth. The result? One of the greatest "pops" of the social-local-mobile app era. #### Growth rate This one is tricky. Growth figures, especially when measured over only two data points (metrics today vs. metrics last year), are often hard to evaluate, unless absolute numbers are known as well. A representative from Facebook could have reported a 2150% growth in revenue in 2005. While Facebook was indeed growing incredibly fast at that time, that particular statistic is meaningless, as revenue was nearly zero in 2004. This is not just a straw man argument. Various startups that I've interviewed with have claimed that they "doubled in revenue since last year," or even that they've been "doubling in revenue every year" when the company has only been in existence for 3 years, without providing a clear estimate of current revenue. You should ask yourself why a company is choosing to share growth numbers, but not any absolute figures. It's likely because growth statistics are a lot more flattering to the company. But you should know: being a derivative of the yearly revenue (or total users) graph, growth figures will almost always contain less information. Of course, don't be pedantic. If a founder mentions that their service has over a million users, and is sporting 200% year-over-year growth, but won't give exact numbers, you probably have enough information to judge that the business is growing rapidly. Cynicism aside, joining a company that is growing at breakneck pace is one of the smartest career decisions you can make early on. Such a startup will offer many opportunities to take charge and grow into leadership roles, and will be replete with intelligent and ambitious young people - colleagues who may become your business partners and co-founders one day. Finally, as many have said, getting a win on your record early in your career is incredibly valuable (1, 2), and as I discuss in the last section, early hypergrowth is one of the strongest signals that a company will do very, very well in the future. Of course, true hypergrowth is rare, and identifying such companies when they're relatively small and unheard of is challenging. But your alternative is the even harder problem of trying to turn around a slow-growing company as employee #50. On the flip side, joining a startup that "fails" a year or two after you join is not as bad as you may think. Assuming the startup had clear potential and a high hiring bar, no one will hold it against you that the company didn't do as well as hoped. This attitude may not hold outside the San Francisco Bay Area, or the United States, but what is most threatened by spending time at a company that flounders is not your CV, but just that: your time. Staying at a company with no clear growth prospects for five years translates to five lost years you could have spent growing and learning. Note that this idea that a failed startup does not equal a black mark on your career holds for both the founders and the employees. That said, you are probably less likely to regret time spent working on a problem you deeply care about as a founder than as employee #50. #### Number of employees Cisco Systems has 70,000 employees today, and its stock price has hovered between$15 and $30 for the past 16 years. When WhatsApp was acquired by Facebook for$19 billion in February 2014, it had 55 employees.

Evidently, headcount alone says little about a company's quality. But the number of employees, combined with the most recent valuation of the company, can give you some idea for how much money you stand to make if you join.

Here's the heuristic. Stocks generally vest over four years, and if you stay the four years, your ownership of the company will amount to the following:
\begin{aligned} \text{Fraction ownership } = \frac{1}{\text{(Number of employees)}^2} \end{aligned}

This can now be used to calculate your potential upside. If you join a 100-person startup valued at 500 million, and work there for four years, you'll be granted shares constituting \begin{aligned} \text{Fraction ownership } &= \frac{1}{\text{(Number of employees)}^2} \\ &= \frac{1}{\text{(100)}^2} \\ &= 0.01\% \end{aligned} of the company. If the company is then acquired for5 billion, you will stand to make:
\begin{aligned} \text{Value of equity } &= \text{Fraction ownership } * \text{Exit valuation} \\ &= 0.0001 * \text{\5,000,000,000} \\ &= \500,000 \end{aligned}
(Here I'm not considering the strike price of your stock options, i.e. how much you'll need to pay the company to exercise them.)

What evidence do I have that this is true?

This equation, when shifted by one, predicts that a startup's first employee will own 25% of the company, a very reasonable estimate for the eventual ownership stake of a solo founder (1, 2). Moreover, it correctly predicts (to within about 50%) the equity share I was offered at the one company to which I applied for a full-time job on graduation. (Its output was a bit conservative.)

Finally, it fulfills a key mathematical constraint that we might expect any equity distribution scheme to satisfy, namely that the total ownership of every employee in the company should sum to 1.2

Take this formula for what it is: a heuristic for your ownership stake in a startup. In particular, percent ownership alone says nothing about your potential upside. To estimate upside, you need to consider a span of possible trajectories that the company could take after you join. If you join a company that goes under, or is acquired for peanuts, it won't matter if you own 1% of it or 0.01% of it. 1% of 0 is still 0.

For more precise predictions, please see this calculator, which takes different inputs, but offers upside estimates for a range of possible company outcomes.

#### Strength of founders

Full disclosure: this is the only criteria in this list that I gave the full five stars to. And for good reason too. As venture capitalists have said for time immemorial, it is the founding team, of all aspects of a company, that has the strongest bearing on its eventual fate.

As a quick exercise, consider these short bios of the founders of the five most valuable tech companies in the world today:

• Facebook - Mark Zuckerberg began programming in middle school, going on to build an intelligent music player, Synapse, that AOL and Microsoft bid up to $1 million to buy, during his senior year of high school.3 At Harvard, Zuckerberg established a reputation for building social tools for his peers, some of which became wildly popular. The traffic from one application he built, Facemash, created a server outage at Harvard, while the systems and data breaches involved brought him to the brink of expulsion. • Amazon - Jeff Bezos studied electrical engineering and computer science at Princeton, graduating near the top of his class, and as president of the Princeton chapter of a national space exploration club. Bezos began his 8 year career on Wall Street at financial infrastructure startup, Fitel, eventually rising to become the then two-year-old hedge fund D. E. Shaw's youngest vice president. • Microsoft - Bill Gates began programming in 8th grade on a computer donated to his high school, which he used for everything from writing games to developing a payroll program for the donating company. At age 17, he started a venture with Paul Allen which built software to regulate traffic at street intersections. While at Harvard, Gates solved a minor open combinatorics problem, and developed a interpreter for the BASIC language for the newly-released Altair 8800 mini-computer. • Alphabet - A computer science and mathematics major at the University of Maryland, Sergey Brin began his PhD studies in computer science at Stanford in 1993. A computer engineering major at the University of Michigan, Larry Page began his PhD at Stanford in 1995. In the first two years of his PhD, Brin published work on approximate search in databases and copyright violation detection. In 1995, he joined Page on BackRub, a project focused on exploring the link structure of the rapidly growing World Wide Web. • Apple - In high school, Steve Jobs dabbled in creative writing and film, and began working with hardware enthusiast Steve Wozniak on various hobby electronics projects. Jobs enrolled in Reed College in 1973, but dropped out after just 6 months at the school. After experimenting with monastic and communal lifestyles in India and Oregon, Jobs took up a contract project for Atari, enlisting the help of Wozniak to construct a hyperoptimized circuit board for the arcade game Breakout, a deal that earned the pair$5,000.

While their biographies may sound impressive, none of these accomplishments are particularly uncommon, and I challenge you to hold the founders of your potential employer to the same high standard. Can you write a 2-sentence bio of each of the founders that reflects a similar caliber of achievement?

In your description, try to focus on concrete accomplishments, as opposed to proper nouns. Instead of writing, "Sarah graduated from Harvard as a public policy major, and worked at Goldman Sachs for two years," write: "Sarah graduated from Harvard, where she worked to develop novel financial instruments allowing emigrants from oppressive regimes to remotely liquidate their assets, even testing her research in a live study based in Syria. While at Goldman Sachs, she helped to expand the bank's portfolio of consumer fintech companies, and personally oversaw late-stage financing for three bitcoin and blockchain-related startups."

This second Sarah would make a great founding CEO or COO for a blockchain-based, smart property startup. Sarah is a self-starter, with a history of building new things and sticking with them until they see adoption. She has a demonstrated interest in shaping the future through invention, as opposed to simply an interest in advancing herself. She has also successfully faced competition - it is not easy to get accepted to Harvard, and it is not easy to get a job at Goldman Sachs.

So Sarah may have what it takes to beat the odds that the company she'll start will get killed - by its burn rate, by disputes between its founders, by its failure to find product-market fit, by its competitors, by shifts in the market.4

What kinds of past experience are signs of a great founder?

• Pivotal role in a very successful company - This is rare, but a very strong sign when true. Two great examples are Dustin Moskovitz, a co-founder of Facebook, and Adam D'Angelo, Facebook's first CTO, who each went on to start extremely well-run companies, Asana and Quora, respectively. Dustin and Adam combine front-line experience in a rocket ship, with a genuine thirst to build companies of their own - both were in some sense sidelined at circa 2008 Facebook, which only had room for one real leader at its helm. Asana emerged as an internal project at Facebook, and Adam left two years of equity at Facebook on the table to found Quora, strong circumstantial evidence that the problems they chose to tackle were relevant and valuable.

• The fourth-time founder, aka the serial entrepreneur - I have more mixed feelings about this one. Being a serial entrepreneur is considered a great resume item in some circles, and there are of course a few examples of wildly successful born-again founders - notably, Elon Musk, and even Steve Jobs, who founded NeXT Computer between 1980s Apple and iPod/iPhone-era Apple. Entrepreneurship is a difficult journey, and the greatest founders tend to treat their companies as their life's work. A long history of eight-figure acquisitions doesn't speak very well to a founder's dedication, and their ability to navigate difficult times. At the same time, an exceptional past result (e.g. a company sold for $500 million) is very strong evidence of caliber and ability to execute. • Domain expertise - This is valuable, but probably not strictly necessary. This Y Combinator-backed waste management company recently raised a$12 million Series A round, and includes a founder whose family has been in the waste recycling business for four generations. That sounds splendid to me, and is an attribute that investors often assign big plus points to. But being an outsider can sometimes constitute a great advantage as well. Elon Musk had no formal experience in rockets or electric cars when he started SpaceX and Tesla, two areas that seem to have extremely high barriers to entry. Moral: we probably overestimate how hard it is for smart people to immerse themselves in new, hard problems they care about.

Continue reading: Part II of Evaluating Startups

### Footnotes

1. The number one rule of startup investing is that nearly all of an investor's returns are concentrated in a few big winners. As of 2012, three-quarters of Y Combinator's 10 billion portfolio value was concentrated in two companies: Dropbox and Airbnb. This, combined with the difficulty of identifying the biggest winners in their infancy, means that early-stage investors go out of their way to court a large number of companies with a small chance at astronomical success. 2. My heuristic for your expected ownership stake in a company, reproduced here: \begin{aligned} \text{Fraction ownership } = \frac{1}{\text{(Number of employees)}^2} \end{aligned} holds the following nice property that we might expect of any equity distribution scheme: \begin{aligned} \text{Total ownership } &= \int_1^\infty \text{Fraction ownership} \\ &= \int_1^\infty \frac{1}{n^2} \text{ dn} \\ &= -\frac{1}{n} \bigg|_1^\infty \\ &= 1 \end{aligned} 3. There's a caveat here: the offers from Microsoft and AOL were more like acqui-hires. Zuck (and his co-founder, Adam D'Angelo) would have to defer college, and agree to work at the acquiring company. 4. With this statement, I am perpetuating the very imprecise misconception that "most startups fail". There are two problems with this aphorism - the definition of "startup" and the definition of "fail". If we define "startups" as companies that have at least raised a Series A round, and "fail" as the failure to make any money for the founders, then the statistics begin to look a lot better. Many, many companies get acquired in the5-200 million range. Many of these deals are not publicized, since in some cases, the product is shut down after the acquisition, and in other cases, the investors who backed the company in its later rounds of funding lose money. Such acquisitions still aren't failures, in any reasonable sense of the word, for the founders, the early investors, and the early employees.

Startups can be risky, but you have to be precise about what you mean by "risk" and "failure". If "risk" means not making as much money as you could, not growing as much as you could, and not advancing in your career as much as you could, then an extremely stable but low growth potential opportunity could be risky as well.