How to select a startup to join, Part II: Do your due diligence!
I’ve read somewhere that people spend more time researching a new sofa than a new house to buy. More time thinking how to save money on coffee than on a 30-year mortgage. It stuck me as typical examples of how we often underspend effort on more important decisions and overspend it on less important ones. Selecting a company to work for follows the same bias – people tend to join the company that happens to advertise on LinkedIn or respond to a recruiter email. While this approach to career move is not recommended in any situation, underspending effort on assessing a startup as a place to work becomes extremely dangerous as the risks are amplified.
A professional investor will never invest in a company without doing their due diligence. And they invest in a portfolio of companies. When joining a startup, you are investing your most valuable resource (time) and betting on just one company at a time. Do your due diligence as a professional investor would!
In my previous blogpost, I have discussed how to select a startup to join. I talked about 1. Joining a startup versus joining a small business, and 2. Pros and cons of joining a startup at different stages (seed, series A, series B, series C). In this post I will talk about assessing the startup, or doing “due diligence” in investor talk.
3. Diligently assess the startup you consider joining
Regardless of the startup stage, I would propose to evaluate the startups from the investor point of view, from your career goals point of view, from work environment point of view.
Investors like venture capitalists look at hundreds of companies before investing into one. They do it for a reason. By doing so you develop some pattern recognition and, if you are good, you calibrate and adjust your judgement once you get info on false positives and false negatives. Once they like a company, they do some due diligence – have deeper conversations with the team, look at financials, have customer interviews.
I am surprised that startup employees don’t do nearly enough to evaluate their target employers. If you choose to invest your time (and not LP’s money), perhaps you should be more diligent than a VC. The good news is that you don’t have to meet 100s of startups, you can make a list of startups by stage, industry, and location you are interested in.
Startup due dilligence from your investment point of view
1. Leadership team
If this is an earlier stage startup, you should primarily look at the founders. Do you believe they have what it takes to build a successful company? Perhaps, they have deep domain expertise or some very relevant experience. Perhaps, they’ve built successful companies before. Perhaps, they are very well connected or have some unique skills (e.g., good at selling, storytelling, are star developers, etc). Perhaps, they are just so driven that you are convinced they’ll do whatever it takes. Are they convincing enough in why they do what they do? Are they thinking long-term?
Some leadership red flags at earlier stages would be:
Founders are not operationally involved in the business, e.g., outsource it to hired managers or focus on own PR
Founders as a group lack some fundamental capability, usually one of the three: selling (to customers, to investors, to employees), building (product), and creating a good culture (usually in terms of authenticity, meritocracy, team spirit)
Founders look at employees as assets, e.g., I need to pay $X for person Y to do Z. A typical example could be business founders who believe they can just outsource the development to some contractors in another country. Or founders who believe they can hire a sales person who will miraculously figure out how to sell the product. Or founders who don’t have a convincing answer to “why would somebody join me?
Founders are immature or not emotionally stable. This one is hard to see, but you should know that being a founder is one of the most stressful jobs there are. There is a huge emotional toll on any founder (especially CEO) and being able to manage own emotions is often cited as the most important founder quality. If the person can’t work (and thrive) under that pressure and enormous responsibility, he/she is unlikely to create a successful company
At later stages you should apply (or extend) this leadership due diligence to senior management or your team management. Try to look at least 2 levels up: your direct manager, the manager of your manager. In any case, I would add looking at the founders if they still hold significant equity stake.
2. Problem the startup is solving
Do you understand what problem the startup is solving? Do you understand who the target market is? Do you believe there is a demand for their service? If not, can the company create the demand for their service? If you don’t know enough about the industry, find somebody who you trust to have a better judgment. Make sure you filter for their biases, e.g., if they work in a company that the startup is planning to disrupt.
3. Ability to execute and deliver
Do you believe the company has a reasonable chance to deliver on its promises? “Reasonable” would be subjective to you. 20% chance may be reasonable for a pre-seed startup, while you’d like to be 80% confident in the company for series C and up.
4. Market size
This is something VCs find very important. Is the market for their product big enough? I personally think this is not as important as it is perceived by the VC industry, because market sizes are always half-guesses and because good founders find a way to create markets or enter adjacent opportunities. However, keep in mind that if the founders don’t have a good story here, they won’t be very successful at raising institutional money. Also, if the market is small, the company cannot be a startup, they will be a small business
Can the founders build a moat around their solution, so that bigger companies or competitors don’t copy them easily? Typical moats can be technology superiority, distribution superiority, network effects, branding, ability to be very fast and agile. This could also be more soft factors like ability to create a winning culture or ability to hire the best people. Be wary of startups in capital intensive industries that don’t have enough access to capital. If a startup requires a lot of capital to build defensibility, the best funded startup often wins. This is often a problem in Europe and parts of Asia. Great startup may lose to their American or Chinese counterparts just because the latter can raise money and scale faster.
6. Traction and performance
Looking at sales, profits, expenses, and financial projections is typically a big part of investor due diligence, especially past series A. While it is probably inappropriate to ask for financials, you’d be surprised how much you can learn from just googling, making implications, and asking people from the industry. Also be direct and just ask the founders and management: what are your sales, what was the growth like in the last 3 months, last 6 months, last X years? What is your churn? Are you profitable? When are you planning to be profitable? How many active users? The metrics would differ by industry, you can get inspiration from this Y Combinator video Nine Business Models and the Metrics Investors and then ask the founders smart (and unexpected) questions.
A major element of commercial due diligence is understanding whether customers like the product. It is both the question of customer quantity and the quality of their relationship to the startup. How many customers have they acquired? Are these customers happy? At the end of the day, if there are no customers, there is no business no matter how great the tech or the team are. If you know the industry, you may know some of startup's customers and ask for feedback. If not, look for online reviews and ask the interviewers! Try to ask them about a random customer, not about the one they use in all of their marketing materials and cases.
8. Startup's financing
When joining a startup, you should understand their financing situation. Generally, startup financing is a combination of external investments (e.g., VC money) and profits from operations. For many startups before series B, external financing will be the main “income” source.
Ask them about their last financing round and their future financing round. Ask them how much they've raised so far and what the burn rate is. A red flag would be:
A startup that hasn’t raised much money; this depends by region, but in the US/UK if they haven't rasied at least $500K, I would not recommend joining unless you are one of the founders or have a very clear reason on why this is the best opportunity
A startup that has a less than 9-12 months of runway left (months it can support itself financially) without clear and realistic fundraising plans. It takes at least 6 months to raise series A and beyond, keep this in mind when talking to founders
For later stage startups, you may want to know about their “exit plans”: are they planning to continue growing or are they planning to exit (most often, sell to a larger corporate)? If an early stage startup is extremely well funded, you may be lucky to combine the benefits of an early stage startup with a lower financial downside.
Startup due dilligence from your career objectives and personal preferences point of view
9. Nature of your work
I won’t elaborate too much on it, as it is usually intuitive to candidates. What I would like to highlight - make sure that what you like to do (and do best) is crucial for the startup at this stage. Also - I wish I didn't have to say this - some startups hire people because they can, and have no clear idea of why that job is needed. Some startups hire because they have to, e.g., in hope that you will come and create a miracle. In early stage startups, people tend to be generalists, so some startup job descriptions sound like to have to do everything and excel at everything. Make sure to clarify priorities for the company, this will inform you about what's most important in this role.
10. Your goals
You should define these before you talk to startups! You can adjust your golas as you learn about the options you didn’t know existed, but you should definitely take time to decide what are the 2-5 things that you would like to do. I’ve mentioned a few examples of goals and startups when I talked about Anna, David, and John. You don’t need to have a job title in mind: a goal could be “gain experience with broader architecture design”, “learn about AI/ML in salestech”, “get a way into blockchain industry”, “be able to work on things that I work on in my spare time”. [The last one is my favorite]
I wish I didn’t have to say this, but culture is not about dogs in the office and artisan coffee. These are the things later stage startups do to pretend they are still cool. [well, this is an opinionated statement, so apologies for this]. All the perks is what is highly visible and gets into the news, but make sure to look beneath the surface. Culture is about the values in the company that are manifested in how people behave and how engaged they are. Unfortunately, I am negatively surprised at how many startup do it wrong and mess up their culture.
In earlier stage companies, founders shape the culture, so make sure you do good diligence on the founders and you agree with their real (vs stated) values. Do the founders really care about their employees? Do they explain “what’s in it for you” to join them? Do they explain to you how your stock options work? Do they take time to answer all your questions? Do you trust them personally?
Later stage startups tend to become more political. Make sure you test for this. There is some level of politics that is unavoidable, but you would likely want it to be less than in a large corporate environment.
Read Glassdoor reviews, see if you have any connections to the employees via your network. A good way to test culture would be to ask for an informal conversation with an earlier employee. You can ask to see the office and 10 minutes of a regular day at work. If you are applying for a senior position, you can ask to spend a day with the team or work on a short project together.
That’s it. Do remember that everything I’ve said is somewhat a generalization. Every startup is different and you may be able to find examples that don’t fit the patterns above.
Happy exploring and happy hunting!
Do leave any comments if you see some omissions or would like to share relevant experiences! And do share your situations if you’d like my response on the most appropriate startup stage for you.
System2Labs is a full-stack growth consulting firm focused on B2B startups. We take a holistic approach to growth: from high-level growth strategy, to going deep on any specific sales and marketing topic. We help companies get things done: the result of our work is a working sales engine and concrete tools, not a tool or PowerPoint deck or generic advice. If you have any questions about choosing or implementing your sales ideas and would like to avoid common mistakes, get in touch!
Founder and CEO, System2Labs