So, you’re about to be hired by that hot new startup. Great, congratulations. But wait, congratulations may be a little bit too early. Young companies can - and do - have all kinds of problems and you need to be fully aware of the risks and the potential issues that such a company has before you decide to sign on the dotted line.
Below a short list of questions that you should be able to ask of any company that is younger than 2 years or that is still clearly in a mode where the income does not exceed the expenses.
- How large is the monthly expense?
This gives you an idea how much money the company needs per month on the income side to remain in the same situation that they are in today (assuming they do not aggressively hire, and because they are hiring you there is already an indication that this may be changing).
- How much money is there currently in the company accounts?
The cash reserves are a good indicator how strong the company finances are when combined with the monthly expense and earnings. A large cash reserve is always better, anything below 3 months operating costs is well into the danger zone, anything larger than a year is a luxury.
- How much does the company currently earn per month?
The company cash reserves are - during a growth phase - typically depleted and the rate at which this happens is the difference between the company expenses and the company earnings. So a company that has 100K in the bank, spends 50K per month and makes 10K per month (gross) has less than 3 months to live before it will need new capital if it does not change course rapidly and would be a bad bet for a new employee (especially if they leave behind another job). A company that has 100K in the bank, spends 30K per month and makes 25K per month still has 20 months of runway.
- What is the trend of the earnings, are the earnings increasing or decreasing?
If the earnings are increasing month-to-month then the company will eventually reach the point where they are break even (or they may choose to become even more aggressive about growing), if the earnings are decreasing month-to-month the company will have problems attracting new funding if required and will sooner or later run out of operating capital.
- How many customers generate that income?
If the income is generated by only one or two customers, the company basically has a runway that should be discounted by the probability of either one or both of those customers leaving. If that probability is high - or if the contracts are about to expire or any other circumstances - the runway is essentially equal to the cash reserves divided by the expenses. A minimum of three, relatively equally divided income streams are required for any kind of stability. To lose 50% (or in the case of a single customer, 100%) of the income is the kind of blow that can be an existential threat materializing with zero notice. If the cash reserves are huge compared to the burn rate (for instance, just after a funding round) and the company has just started to roll out a product this may be a lesser issue.
- Does the company have any major liabilities that can affect how much money is available?
If there are liabilities that are large in comparison to the amount of money in the bank and the monthly income this can materially alter the amount of runway the company has.
- Has the company ever missed payments to salaried employees?
Missing salary payments are - in my book - a thing that a company should simply never ever do, if it does happen it should be due to some natural disaster or another event in the ‘acts of god’ category, anything else is not acceptable and if it has happened in the past it is a sign of bad management and sloppy financial planning.
- What level of experience does the management have with running a corporation?
If the management is very young check to see who they have as advisors, mentors and coaches and make sure that these people have an active role. Being young is not the same as being in-experienced, it is definitely possible to have young, competent and honorable management, but frankly that combination is relatively rare so the younger the executives of the company the more care you should take to make sure that the questions answered above are answered to your satisfaction. At the same time, even older, experienced managers should not be given the benefit of the doubt simply because they are older and appear more experienced. It’s a difficult thing but in the end this part mostly revolves around trust.
Now, the answers to these questions are important, but what is also important is whether or not you get an answer at all. Start-ups can be (for valid reasons) skittish about giving out such critical information, but if you don’t receive a direct answer there may be some alternative questions that could give you an idea of where you stand, one alternative that rolls the first three questions into one that may be easier to answer is:
- Does the company have more or less than 6 months worth of working capital?
That’s a question that the CEO of a company about to hire someone should be comfortable answering. If the answer to any of the questions above is not what you expected or not what you would like to see you should weigh carefully whether you want to uproot your life and to join them, especially if you are leaving a position of relative stability and your life-style requires a regular income stream. If you have substantial savings, if you like adventure and excitement in your life and if the thing they are doing is so interesting to you that you are prepared to take extra risk then by all means go for it.
But realize this: just like one company has the obligation to do due-diligence on their counterparty before doing any substantial investment, an employee that makes a deal with a start-up has some responsibility to make sure they are not endangering their own situation by trusting too much in the publicly visible part of the company. It would not hurt to get the answers to these questions in writing, so that you know exactly where you stand when you make your decision.
If the company is unwilling to answer your questions that is of course their right, but a non-answer is also an answer of sorts.