Several times in my career, I have worked either at startups or at companies that were just past the startup phase and beginning to scale. One of the big challenges, at least in the tech industry, is that some of the folks with the in demand skills you need to grow the company are working for big, boring companies that they perceive as safe. It was not unusual for candidates to get far into the hiring process and then start to get cold feet about their perception of the risk involved in leaving the giant company. While cleaning out a notebook, I came across an email reply to one of these candidates from about seven years ago that I saved, knowing that I would probably need it again. I've changed it up a little bit to remove any private data and make it easier to follow. I talk about it mostly from a services company perspective, but I intersperse some thoughts about product companies.

Many candidates approach the question of risk from the wrong angle. There definitely is a correlation between the age of a company and it’s likelihood of existing as a going concern five years out, but failure rates are not nearly as high as some might expect, and (more importantly) most of the quoted stats fail to take into account startups that no longer exist as a result of a planned exit, well executed. See https://www.linkedin.com/pulse/20140915223641-170128193-what-are-the-real-small-business-survival-rates/.

While all of my data on this is anecdotal, I believe there is little correlation between the longevity of a business and the likelihood of it providing stability and opportunities for growth for an individual employee. Just ask any of my friends who got cut in any of the rounds of layoffs at Nortel, Cisco, or IBM over the years. Job security and opportunities for career advancement don’t come from size, they come from growth. 2024 Update: Announcements so far this year from IBM (113 years old), Nike (60 years old), and UPS (117 years old) feed into my confirmation bias on this even if they don't formally validate the hypothesis.

When evaluating the risk of a startup as a potential employee, you need to consider four things:

1. Does the firm have the right leadership?
2. Does the firm have the right financial structure?
3. Is the firm adequately funded?
4. Is the firm in a growing market?

Leadership

In many ways, right leadership is the critical question. You want to validate that key leaders have successfully grown a startup to the next level past where it currently is (or beyond) at least once, preferably multiple times. If they have done it in different industries or different kinds of startups, that's even stronger evidence that they didn't just get lucky. The specific roles that you want to see a track record in differ a little bit by type of business (a strong engineering lead is critical at a product company, a strong delivery lead is critical at a services company), size, and funding model (if the business is going to need additional injections of capital, someone better have real experience in finance). For every startup, the CEO and the sales leader (in the smallest startups, this is usually the same person) better be able to show evidence that they can both grow the business, lead a team, and delegate. Otherwise, they will become the barrier to growth.

Financial Structure

The great thing about a service business in the early days is that you can earn relatively high margins with tiny amounts of capital expenditure. The highest cost is labor, but in a well run services business almost all of the labor cost turns into revenue. It’s not like a factory where you have high fixed costs or a retail operation where you have lots of money tied up in inventory. The downside for services businesses is that it's near impossible to maintain a gross margin over 35%, at least in the typical time and materials billing model. Digital product companies have high R&D initially, but once they have product market fit, their gross margin should hypothetically continue to grow until it is almost 100%. In reality, there will always be support costs and enhancements to the product will be needed, but for companies with mature products, 70+% gross margin is easily achievable.

For a services business, it's relatively easy to scale your costs to your projected revenue. As a candidate, make sure the company isn't hiring too far out in advance of the work. The problem is the lag time from hiring an employee to the point where you get paid on invoices for that employee. At this point, offshoring and nearshoring are pretty common. Even in a startup, having access to low cost nearshore / offshore labor can create a huge cost advantage, which can free up bench time for expensive market folks. You just need to make sure that you will add more value than an offshore resource would. That extra value is almost certainly going to come from your ability to interface well with the customers driven by common language, culture, and timezone. To that, you need to add the ability to be the translation layer to the nearshore / offshore employees to maximize the value they create.

Adequate Funding

As an outsider, this can be the hardest thing to get a detailed, honest answer about. What you really want to know is this: at the current burn rate, assuming no growth in sales, how long can the firm operate as a going concern. The answer is going to be different for product companies vs. service companies. It's not unusual (but by no means necessary) for early stage product companies to be cash flow negative until they find product market fit. I've never been at an early stage product startup, but to me the red flag I would look for would be taking on capital to attempt to scale before they have achieved PMF. Jason Cohen has some really good thoughts on how to get to product market fit.

Services companies have to be very careful about growing faster than cash flow. They don't have the gross margins of a product business, so it's tough for money you make later to offset overspending early on. The lag mentioned above between when a services company makes a hire through when that employee is onboarded, billing on a project, the first invoice is sent, and the first check is collected can be as long as 6 months. For a startup, it better be a lot less. Once a professional services company is past the very earliest days, growth should largely be funded out of free cash flow. It's probably a good idea as a candidate to ask how the company will manage cash flow crunches due to slow paying customers. In one of my earliest startup experiences, there was more than one pay period where the accountant went around and asked each employee, "How much of your check do you actually need this pay period?" That was fun.

As an aside, if you want to get a good visceral sense of what the challenges of cash flow management can be like for a high growth startup, I would encourage you to read Phil Knight’s memoir, Shoe Dog.

Market Growth

We easily have at least another twenty years of growth in the move to digital. The digital marketing / customer experience submarket that we are starting from is past the gold rush stage that it was in 15 years ago, but there are still hundreds of firms with deep pockets out there that need to make a transition to digital or update digital experiences that they last touched 5-10 years ago. A growing market makes almost everything easier. There's much less pricing pressure from customers and a lot of validation for the company's value proposition. 2024 Update: This is still true. It seems almost certain that I will retire before I stop being surprised by businesses running inefficient manual processes or homegrown digital experience and commerce tools that badly need to be replaced by something modern. One estimate published in 2020 predicted a 10.9% CAGR for DXP platform revenue. That's a decent proxy for growth in service firm revenue as well.

Conclusion

Risk aside, startup life isn’t for everyone, and there’s absolutely no shame if you decide that it isn’t for you. If you want a steady life of small but predictable increases to your base pay, predictable work load, and occasional opportunities to work on something really, Giant Boring Company can be a great place to be. If you want to build something from the ground up, learn something new every day, and be part of a team of highly driven folks who are obsessed with creating something awesome, you probably aren’t going to get that there.

Questions about stability and such are important, but I think the big question you really need to be asking yourself is “Who am I?” Startups are amazing and exhilarating and frustrating all at the same time, but it takes a special kind of person to thrive in an early stage startup. The hiring team at the company is going to make the call on whether you have the right technical experience, but you’re the only one who can make the call about whether you the drive and passion for it.

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