## 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 was fortunate to have the 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 rate1, 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 "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 annual revenue (or monthly active users) graph, growth figures invariably 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. Joining a company that is growing at breakneck pace might be the smartest decision you can make early in your career. Such a company will offer many opportunities to take charge and grow into leadership roles, and will attract many other intelligent, ambitious young people -- co-workers who may become valuable lifelong connections (future business partners, hires for key positions, friends). Finally, as many have said, getting a win on your record early in your career is highly 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 may 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 an enterprise that fails as a founder than as employee #50. #### Number of employees IBM has 350,000 employees today, and its market cap has hovered around$120 billion for the last twenty years. When WhatsApp was acquired by Facebook for 20 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 (very rough) 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} By this formula, the 10th employee of a startup can expect to receive 1% of the company, the 100th employee can expect to receive 0.01% of the company, and so on. (You might be suprised at how fast the fraction ownership falls off for larger headcounts.) This can now be used to calculate your potential upside. If you join a 100-person startup valued at500 million, and work there for four years, you'll be granted shares constituting about 0.01% of the company, as just stated. If the company is then acquired for 5 billion, you will stand to make: \begin{aligned} \text{Equity payoff } &= \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, unanticipated dilution, liquidation preferences, and other factors that often conspire to reduce the actual payout. The first 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). As more anecdotal evidence, it correctly predicts the equity I was offered at a few startups, interviewing for entry-level roles. 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 very rough 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 Silicon Valley loves to lionize its founders. To be a successful founder is to be a statesman, a crusader, a messiah -- the enlightened champion of a new way of life. In fact, early CEOs often paint themselves into the founding story of a company (1, 2) to buy further legitimacy: the idea being, to be the real deal, you have to be there from the beginning. And yet the Valley's most revered "founder-CEOs" (the most venerable job title in Silicon Valley) are also at times its most polarizing, its most reviled. Given more time (and space), I'd like to sit down and filter through the hype, and really evaluate whether founders matter. Do one or two people at the beginning of a startup's history, who do a tiny fraction of the total work that goes into building a massively successful company, really deserve that much credit? How disproportionate is a founder's influence on the eventual success and failure of the company? And what founder qualities are necessary for, and, more interestingly, indicative of a startup's future success? Or are we really just misattributing to skill what is truly explained by luck? For now, though, let's start with a simpler question. What kinds of past experience indicate that a founder might build a successful company? • Pivotal role in a very successful company - This is rare, but could be a strong signal when true, mostly because (1) promising companies tend to recruit strong early employees and managers, (2) hypergrowth can be a formative experience, (3) clout from a previous success makes it easier to raise money and hire employees, and (4) an early employee at a successful company has already "seen it all", and so may have strong, personal motivations for starting another company. Perhaps the best known example of this effect is the PayPal Mafia. Other examples include Dustin Moskovitz (a co-founder of Facebook) and Adam D'Angelo (Facebook's first CTO), who each went on to start high-profile companies, Asana and Quora, respectively. Dustin and Adam combined 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. Obviously, there is survivorship bias in these stories, so take this advice with a grain of salt. • The fourth-time founder, aka the serial entrepreneur - I have 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 (PayPal, SpaceX, Tesla), Jack Dorsey (Twitter, Square), and Steve Jobs (Apple 1.0, NeXT, Pixar, Apple 2.0). Entrepreneurship is a difficult journey, and the greatest founders tend to treat their companies as their life's work. A long history of minor 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 for500 million) is 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.

#### Strength of early employees

Steve Jobs once said that the success or failure of a startup depends on the first ten employees... If anything, it's more like the first five. - Paul Graham, Wealth

I often use the following (very coarse) heuristic for judging the quality of a startup. I go on LinkedIn, and jump from profile to profile, looking at the schools they've attended and the companies they've worked for. I consider it a pretty big red flag if most attended schools and worked for companies I've never heard of.

In my experience, the best startups have many employees who attended well-known schools and came from other well-known companies. This was true of early Google and early Facebook, and is true today of the most valuable private companies. If a startup doesn't have employees with these kinds of credentials, it says to me one of two things:

1. The founders do not have a network that extends to such employees.

2. The startup cannot convince highly credentialed employees to come work for them.

The first is more benign than the second. Great founders come from lots of different places, and some may just not be connected to this rather restricted pool of potential hires. After the startup becomes a certain size, however, and reaches a certain level of notoriety, this excuse becomes a little weaker.

The second reflects a little less favorably, but is understandable. Recruiting accomplished people is really, really hard. It's hard to convince people to turn down offers at Google, Facebook, Uber, Airbnb, etc. to come work for your shitty company that might fail. But that is exactly the task of a great founding team. They must be accomplished and inspiring enough that smart people want to work for them,3 and clear enough in their articulation of the company's vision to convince smart people that they have a chance at success.

The one thing that distinguishes students at top schools (and employees at top companies) is that they tend to have the most options for what to do in the future, and often the highest opportunity cost for picking any one thing. So if you can convince Google engineers to join your company, you are either really good at creating hype, or are genuinely offering an amazing opportunity.

Note that I'm definitely not suggesting that great early employees come only from good schools, or that all (or even most) students at good schools would make great early employees. Both of those statements are patently false. What I am saying is this: being able to recruit from top schools, or from top companies (e.g. ex-Google or ex-McKinsey employees), is a decent signal that a company prioritizes hiring strong people, and is successful at it.

One could imagine a better metric for evaluating early engineering hires -- say, a documented record of involvement in successful software projects. Many in the tech industry, especially the vast majority who work on closed-source codebases, however, don't have such a portfolio. Moreover, this metric doesn't apply to non-technical employees. There's also an efficiency argument. A high level of due diligence is completely warranted for the founders of a company (i.e. picking a startup just because the founders went to Stanford is a terrible idea), but may not be necessary for getting a sense for the backgrounds of the early employees.

You might also ask: why does hiring strong early employees matter so much anyway? It matters because it is the early employees who will serve as your mentors, and often take on many of the leadership positions within the company. Besides the founders, the early hires will be the party with the biggest influence on the company's destiny. Relaxing hiring standards is tempting, but the consequences are subtle and self-perpetuating. Rowdy and misogynistic early employees, for example, will very likely build a company that is rowdy and misogynistic.

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. 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. From Ben Horowitz's excellent book about the trials and tribulations of starting a company, The Hard Thing About Hard Things.

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