The layoffs in the tech industry keep coming, with no signs of slowing down soon. In a time when companies often do multiple rounds of layoffs, sometimes more than once in a calendar year, the onus is squarely on job seekers to piece together as much information as possible when deciding whether to join a new company.
The bleak reality is that many tech startups are running out of money. The broader economic environment makes raising new funds incredibly challenging, especially after several hot years where valuations ballooned to gigantic sums. Investors are putting pressure on these investments to live up to their promises.
The prevailing sentiment for job seekers in tech has been to find a company whose mission and founders one aligns with. If the financials of the business don’t add up, however, especially in the current climate, the former doesn’t matter — that company might be out of business before it can fundraise.
In the current rocky job market, job seekers need to get strategic with their questions and get a clearer picture of how a business is set up for the future before signing on.
3 Things to Evaluate Before Taking a Job With a Startup
- The company’s valuation and challenges/opportunities.
- Burn rate and runway.
- Churn rate.
The Company’s Valuation and Challenges/Opportunities
For businesses that have previously raised venture capital, you need to understand the round’s valuation and how the company is currently valued. Digging into the data source that was used for the current valuation, such as a 409A, investors, or something else, is essential. Valuations for startups are not typically straightforward, with a variety of methods commonly used to assign a valuation. That’s why you need to understand how the company has arrived at the number. This information may illuminate significant discrepancies and how the company has held up.
Let’s look at a hypothetical example. Suppose a company most recently raised a round of venture capital one year ago, and investors valued the company at $100 million. Flash forward to today, and the company is currently valued at $80 million. Now there’s suddenly a $20 million dip in the value— this is the place to dig.
You might discover that the company was initially valued at $100 million using what’s called a “market multiple,” which is commonly used by VCs as a way to figure out a valuation for a business. Essentially, investors look at the acquisition prices for similar businesses in a sector as a baseline for what the company might be worth. This number is typically based on a multiple of the business’s current sales. For example, if a smart watch company is acquired for six times its annual sales, then six is the market multiple.
Now, back to our company that dropped $20 million in its valuation. Perhaps at the time of the last valuation a year ago, companies in its space were being valued at eight to 10X. Now, though, due to the economic climate, similar companies are only seeing market multiples of five to seven. This might lead us to believe that the company is now struggling to deliver on its projections to investors.
When comparing two companies that you might join, this data can offer a look at what the business might be up against as well the pressures and challenges that may lay ahead. Maybe you’d feel more comfortable joining a company that isn’t fighting a bloated valuation.
Understanding how the business plans to increase its valuation is critical. Answers that reveal ways the business is looking to increase revenue like new partnerships, features, or areas of focus are good leading indicators. For many companies, cutting down on spending, minimizing burn rate, and increasing runway are also advantageous.
Burn Rate and Runway
Burn rate refers to how much money a company spends each month. Generally, this includes everything from employee salaries to technology spending and any other expenses. A technology startup’s burn rate often exceeds the amount of money it brings into the business each month. An increasing number of companies are bootstrapped (i.e., not taking on outside funding) or are operating at profitability, which means they’re bringing in more money than they’re spending. If a company tells you they’re profitable or on the path to be so soon, this can be a strong indicator of a healthy business!
Let’s look at another hypothetical example for burn rate. Company ABC spends $100K a month in total on everything (salaries, software, health insurance, marketing programs, etc.). Every month, they average $30K in sales. Thus, Company ABC spending $70K more than they make. This $70K is the burn. You may also hear burn rate expressed as a multiple, like 1.2X, which means the company is “burning” $1.20 for every dollar they’re making. Defining a good burn rate depends on the phase of growth a company is in.
Along similar lines, the term runway refers to the number of months a business has until it runs out of cash. Historically, many sources consider 12 to 18 months a good runway, though there appears to be a shift in the market such that that length may no longer be enough. Similar to burn rate, what defines “good” in regards to runway directly relates to what stage of growth the company is currently in. As a job candidate, you should try to understand how much runway a company has, how soon they need to raise their next round of capital (if any), and how that process might be going if it’s currently in motion.
Churn Rate
Churn occurs when a customer stops paying for a business’s services. Churn rate refers to the number of customers who stop paying for a business’s services over a set period. This metric is fundamental in today’s economic climate because it indicates how well a product or service performs. Does a business have high churn? Something is amiss. Understanding what a reasonable churn rate is varies from industry to industry, but as close to zero is ideal. Take some time to research and find industry publications that report on the companies in businesses
Doing Your Homework
Although no foolproof way exists to ensure the company you join is going to remain successful, job seekers can take measures to better protect themselves. Understanding the financial health of a business is the first step. Another may be negotiating terms in advance in the event of layoffs and termination of employment. For example, if you’re moving from one company to another, you may want to consider negotiating an employment contract that lays out exactly what compensation and benefits you would receive should the company decide to layoff or eliminate your role to best protect yourself.
