Every startup founder loves to prompt for questions from investors and potential key team members about their vision, and the huge opportunity that can be had with their disruptive technology. However, if you are on the other side of the table, there are some other key questions that you need to ask, which will tell you more about the real success prospects for this business.
Enthusiastic startup founders may try to deflect or minimize these questions in true media-training style, so you need to be patient, calm and persistent to get the whole story. From my perspective as an investor, I recommend that every founder needs to know the answers to these questions, be open and honest in answering them thoughtfully, and without making excuses:
1. What is the current runway and burn rate? These terms quantify how fast money is being spent, and how long the business can survive before another round of investments is required. Early stage burn rates over $50K per month, or a runway of less than 6 months may indicate an inefficient or desperate startup. Think twice before you jump in.
2. How complex is the capitalization table? The allocation of shares among the founders, and the number and size of outside investments, will speak volumes about the health, stability and management of the business. Most founders like to talk about their many months or years of sweat-equity, but cash invested is a stronger commitment.
3. When did this effort really start, including pivots? If the company has been around for more than a couple of years, and still has no product or revenue flow, there better be a good explanation. One more key employee or one more investor will probably not turn the situation around. History gaps and founder turnover may indicate a long road ahead.
4. Does everyone on the team have a clear role and mutual respect? You will not get this answer directly from the founder, so ask to talk to other key team members to make sure everyone carries their weight, and communicates effectively. Some conflict and differing perspective is healthy, but too many titles or close relatives should be suspect.
5. Any outside advisors or board members available for discussion? Every startup should have at least a couple of outside advisors who are not major investors or family members, anxious to talk to new investors and key new hires. These should be people with complementary skills to the founders as well as industry expertise or connections.
6. Is there a real customer willing to give a testimonial? Do not be sidetracked by potential customers in the middle of a free trial or friends of the founder. If it is too early for customers, make sure you understand exactly when the product ships, how detailed is the rollout and promotion plan and how many times these plans have changed.
7. Are any lawsuits and challenges to intellectual property pending? Before you invest your life savings, or bet your career on this startup, you need to know how much of a barrier to entry the brand and patents are projected to be. If you have questions or concerns, now is the time to seek legal advice, not after the fact.
8.How much and when can I reasonably expect a payback? Since 9-out-of-10 startups fail completely, serious investors look for a return up to 10 times on their investment within 5 years. Look for examples of similar companies and revenue multiples achieved from acquirers. Calculate employee stock option values and vesting times, as well as salary.
These questions are the key ones in every due diligence effort, always done by accredited investors, but almost never done by key employees and new partners. Ironically, startup investors are normally in less personal jeopardy than early startup employees. Smart investors know that many startup investments will fail, while employees always plan on million dollar payouts.
In any case, in addition to the grand vision and the chance to change the world, I recommend that it is worth your while to calmly and assertively get some good answers to some hard questions from a passionate startup founder before you sign your life away.