Startups have been red hot in recent years. We have seen a wave of popular startups go public over the past two years, and in a recent livestream I interviewed Jocelin, a former Instagram tech lead, and Wen, a former Facebook PM, about giving up high-paying Silicon Valley jobs to return to Taiwan and start companies. I have also heard from many friends who joined startups. Recently I had the chance to learn how to evaluate a startup, so I organized what I learned here for anyone who wants to understand it too.

How Do You Evaluate the Stock or Options a Startup Offers You?

With a public company, the share price and the number of shares outstanding are easy to look up. But when you get an offer from a startup, it might say 10,000 shares. At that point, you need to ask for the total diluted shares outstanding, so you can figure out what percentage of the company your grant represents. Also, VCs usually hold preferred stock, and terms such as its liquidation preference affect what common stock is actually worth, so that needs to be factored into the calculation too.

Sometimes a company is unwilling to share this information. You can offer to sign an NDA with the recruiter in exchange for the financial data. If the recruiter does not know the details, ask them to find out and get back to you.

On the official side, startups generally need a 409A valuation to set the strike price of their stock options. Early on, a company might do this once a year. At later stages, it may be updated every six months, every quarter, or even every month. From the 409A, you can learn the fair market value of its common stock per share, and how the company assesses its future growth.

What Are a Startup’s Possible Exits?

A startup generally ends in one of three ways: an IPO, an acquisition, or shutting down. Every company will tell you its goal is to go public, but in most cases, the second or third outcome is more common. If an acquisition is the likely path, think ahead about which kind of company might acquire it. Does that type of company regularly make big acquisitions of promising startup teams? In recent years, the Bay Area has had many autonomous driving startups, but there are only about 20 automakers worldwide with the scale to produce cars themselves. When one automaker buys an autonomous driving startup, that is one fewer potential buyer for all the remaining ones, and their chances of an exit drop a little more.

How Do You Read a Startup’s Valuation?

Look at its funding history and whether well-known VCs have invested. If a VC has a strong track record in the startup’s industry, that is a big plus. Every VC and every partner has their own area of expertise. For this, I recommend The Midas List, which is updated annually and has categories by field and region.

Also, if a VC led one round and then participated in the next, or even led multiple rounds, it means the VC is extremely bullish on the startup, which is a very good signal. A recent example I saw is the red-hot Clubhouse. Andreessen Horowitz led both its Series A and Series B rounds. The partner behind the investment was Andrew Chen, who previously worked on rider growth at Uber and specializes in growth hacking. Of course, every VC has its own investment criteria. The well-known YC (Y Combinator), for example, focuses on the seed stage. Some VCs only do early stage, others only late stage, so there is a lot to learn from looking at which VCs show up at each funding stage.

What Makes a Startup Succeed?

From many stories I have heard, a company’s success depends on a good executive team, board members, and investors. The product and the idea may keep changing until the company finds product-market fit, but a strong lineup helps the company find its winning direction better and faster through trial and error. Engineers interviewing at a startup will look into its tech stack, but the business model actually matters far more than the tech stack in deciding whether a company can succeed.

How Do Startups Compare?

You can compare startups using the growth rate, churn rate, and retention rate of similar companies. The burn rate, how much cash the company burns each month or quarter, also tells you whether its growth is sustainable. After all, maintaining high growth is expensive.

Should You Join a Startup?

When I first switched into software engineering, I also started at a startup. Startups have their advantages: they move fast, the work you own can be more varied, and you can grow quickly along with the company and gain great experience. Everyone weighs this differently. From what I have seen, many people who leave big companies for startups value broadening their horizons and getting unique growth experiences, such as founding a team, developing a product from zero to one, or special learning opportunities. These matter far more to them than making money in the short term. After all, money will come if you’re successful and if the company is successful.

How would you evaluate a startup opportunity? Feel free to share and discuss in the comments.

This post was originally published on my former blog, 「半路出家軟體工程師在矽谷」, on March 11, 2021. The blog is now offline, and the text is preserved via the Wayback Machine. It has been lightly edited for this site.