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A large portion of compensation from startups is in the form of equity or stock options (often at the cost of lower salary). It's also not good on your resume (at least early on in your career) to be at a place for a short period of time, and this is especially a risk for a startup whose long-term existence is uncertain. What is a reasonable course of due diligence before accepting an offer?

Let's assume that this is for a person who is not a startup valuation expert, and also that this startup doesn't yet have a public product (i.e. an app) that one can try for oneself.

What questions should I be asking, and what level of detail should I expect in their answers? What are major red flags or green flags that might come up in the interview process? Is it worth subscribing to a product like PitchBook? And if one joins, what are red flags and green flags to stay alert for?

I don't mean red flags or green flags in the Workplace StackExchange sense -- let's assume the work environment is great. I mean whether the startup is on track to be a successful company, to make up for the lower compensation and added risks.

Betterthan Kwora
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What you should consider with a compensation package that includes shares is "what happens if the shares end up being worth nothing?" This is true for startups and major companies traded on the public market. Equity in a private company (not publicly traded) is worthless unless that company goes public or gets sold. Should either of those scenarios happen, then your equity is worth whatever it represents based on the value of the company at that time.

This other question discusses reviewing financials for a startup when you're already an employee, but there may be some good bits of info in there for you too.

In my opinion, it's best to think of equity, shares, or options as a potential "maybe someday" bonus. You need to focus on if you'll be able to pay your bills and have a job that allows you to grow your skills. Taking a lower-than-market salary offset by equity is really a gamble. Even companies with strong financial positioning today could be wiped out by 1 major event (pandemic, anyone?)

Unless your field is financial analysis, I think trying to determine the valuation of a startup is not the best approach. What you should concern yourself with is whether or not you feel the company has a good chance of overall success (and job security). There will also be some questions the employer may refuse to answer without an NDA (non-disclosure agreement) in place.

Look into the leaders of the company. Do they have track records of launching or running successful businesses? To your point about resume and job tenure, do they have a history of starting up companies all over the place and then selling them off? I would judge the company and the potential job more by the management and their track record than the current valuation, which could change drastically with each new contract or investor.

Speaking of investors, what's their current funding status? This article on Investopedia has a good summary of the funding phases. If they're in or through Series A, then they should already have a track record and have convinced investors that they're a better long-term bet.

What about other employees? Does the company have any you could speak with to find out about what it's like working there? (Provided they don't yet have a presence on sites like Glassdoor.)

Will there be room for career growth? Do they have good medical benefits? What about vacation time? Retirement contributions?

BobbyScon
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It would of course be ideal to do as thorough a financial due diligence as you would and could if you were making a substantial cash investment (angel investor, VC, etc.) However, for understandable reasons, the founder(s) may not be keen to show you all the financial (and strategic) information they would show a VC or angel syndicate.

If the overall tone of your comp discussion as a prospective employee is "here is your salary [decent but maybe not as great as somewhere else] and in addition here's equity/options as a reward/incentive when we're successful", then say thank you, and join if you're OK with them being worth zero, full stop.

If you're being asked to take a significantly lower salary in return for upside, and you're important enough to matter, it should be totally legitimate to:

  1. Ask for scenarios. "Given the salary, it's important I understand the upside part a bit better. Can you give me some approximate numbers how much [...] could mean and under what circumstances?" Judge by gut feel of reasonableness and concreteness.

  2. Ask what is available. "Can you share any of the material you've given to prospective investors? I recognize there are pieces that are pretty confidential, of course." Be reasonable but not unrealistically demanding.

I would be approaching this mentally less like "financial due diligence" and "audit/verification" --- accept the details and the math at face value. If those are wrong, you have bigger problems! Think of it more like trying to understand what it will take for this venture to be successful, and whether you are appropriately excited and keen to participate in the team challenge to achieve it vs thinking it's a lost cause!

Houska
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A large portion of compensation from startups is in the form of equity or stock options (often at the cost of lower salary).

This is simply wrong, or, incredibly out of date.

20, maybe 15 years ago, it was a cliché that you could trick programmers in to working for free/little, because you were going to "give!" "them!" "options!"

Nobody is that stupid anymore, it's a thing of the past.

Let's assume that this is for a person who is not a startup valuation expert

It's not possible to be an "expert" at startup valuations...

It would be like saying "I'm am 'expert' at predicting if the sun will rise tomorrow."

All but a handful of actually-starting startups simply fail.

What questions should I be asking

This is very simply answered, there's only one question: how much cash on hand do you have, right now in the bank, to burn?.

  • if it's less than USD100,000 it's a joke, it's like someone saying "I'm going to write a screen play and be famous in Hollywood!" It's nonsensical.

  • if it's 100-500k they have enough money to hire a few people for 3, maybe 6 months. So you have to make a judgement from there if they will either (A) get much more capital within 2-5 months or (B) astonishingly, for the first time in the universe, the product will be throwing off (say) at least 10 thousand a week in clear profit, with 2-4 months.

If you are talking about started-up startups, so they already have (let's say)

  • two or more, actually salaried programmers (ie, programmers who are normally paid employees, with health plans and all the rest - not like "my Uncle is helping me program it")

... then the question will already be answered.

The company will be able to state "Based on our last round of investment, the valuation is _ _"

Fattie
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