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Understanding Startups

By Neil Patrick

All startups are not the same. In this post, we’ll take a look at how to decide what sort of startup you are dealing with. This is key to accurately assessing the risk and rewards you are potentially signing up for.

What Is a Startup Anyway?

In everyday parlance, a startup can be any business in the early days of its existence. But this definition obscures understanding which startups are a good choice to join and which are not.

The U.S. Small Business Administration describes a startup as a "business that is typically technology oriented and has high growth potential."

Paul Graham states that "a startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of 'exit.' The only essential thing is growth. Everything else we associate with startups follows from growth."

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Graham adds that an entrepreneur starting a startup is committing to solve a harder type of problem than ordinary businesses do. "You're committing to search for one of the rare ideas that generates rapid growth.”

Straight away, we can see that not every startup:

  • is necessarily a tech business.
  • requires venture capital funding.
  • is being set-up with a view to an exit or sale to deliver wealth to its founders.

The common factor is growth potential.

Which means that if you cannot easily see this potential for the business, then not only is it unlikely to succeed, your involvement is unlikely to be sustained or well-rewarded.

Stages of a Startup

So if you are approached about working for a startup, the first critical thing to establish is exactly what stage of development the startup is at.

This graphic shows the six key stages:

Startup Development Phases

The earlier the stage of the startup, the greater chance you have to negotiate some equity if you join. This reflects the risk you are taking.

The rewards can be great for early joiners, but only when the business achieves growth and profits and a successful exit. Many entrepreneurs aim for this to happen within about 5 years of launch.

But, unless you are already connected with entrepreneurial people, the chances are that you will not be approached to work at a startup in phases "Concepting" (the -1 phase, in the chart above) and "Ideating" (the -2 phase). The earliest stage for hiring is most likely to be the "Committing" stage (phase 0) when the business is taking on people to enable the realization of its vision and goals.

The risk of failure reduces as each milestone, above, is passed. So the security increases.

The essential thing to determine when considering joining a startup is which stage it is at. The earlier you join, the higher the potential rewards, but the higher the risk. And vice versa, the later you join.


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Capitalization

Apart from developing their product or service, most startups are obliged to commit a significant amount of their efforts to the hunt for funding.

Again, understanding the level of capital to hand and likely to be obtained, must be a factor in your evaluation of the attractiveness of joining the business.

There are different stages of investment.

First: the seed round.

The first round is called the seed round. This is when the startup is still in the very early phase of development when the product or service is still in the prototype phase.

At this stage, founders and/or angel investors will be the ones participating. A startup with only seed funding secured cannot usually last for long without trading in some way. Nor can they commit to paying salaries because the revenue streams are not yet sufficient to bear this cost.

This is an awkward and tense stage for many startups. They need people to turn their product or service into cash flow. And they need it fast. If you can help make this happen, then you are in a strong negotiating position to secure not just a job, but also an equity share.

Second, the Series A round.

The next round is called Series A. At this point, the company is already trading and making revenues even though these may be small.

In Series A rounds, venture capital firms will be participating alongside angel investors. A business at this stage is in many ways the best balance between risk and reward for potential employees. The business will have secured enough confidence from investment professionals to warrant a higher degree of confidence from employees.

Following, Series B, C, and D.

The next rounds are Series B, C, and D. These three rounds are the ones leading towards the IPO (initial public offering or ‘flotation’). Venture capital firms and private equity firms will be participating. At this stage, there is relatively little risk in joining a startup. Certainly no-more than joining a large and well-established corporation.

Crowd-Funding

This is a new buzzword. It has grabbed headlines as there have been some very successful and high profile businesses which have secured millions of dollars of capital for business startups by using crowd-funding or peer to peer lending.

However, if a startup says it will raise its seed capital by crowd-funding, you should exercise great caution.

This means that the business cannot access any funds apart from the owner’s personal capital and lines of credit, until a successful crowd-funding campaign has been completed. And when it comes to crowd-funding, we find that success has little to do with business merit and potential, but everything to do with the nature of the business.

In essence, the simple fact this reveals is that crowd-funding is where what I’ll call cyber-geeks (and hardly anyone else) invest some of their money to help products and services they want become reality. This is another reason why it is often called "peer to peer" lending.

I recently examined the 100 most successful crowd-funding campaigns. And some very interesting patterns emerged from the analysis.

What this showed was that every single one of the top 100 were from just four business sectors:

  1. Computer games
  2. "Niche" movies (mostly it seems involving zombies)
  3. Software and tech gadgets
  4. Heritage organizations and charitable ventures.

So, if the startup you are considering joining is in one of these four sectors, then crowd-funding has a realistic prospect of raising capital. If it isn’t, then you should seek a lot of reassurances as to why crowd-funding is going to succeed for your potential startup employer.

Bottom Line

Ask questions and do research to understand what phase a startup is in before you decide to join it. Evaluate the risks and rewards in line with the stage and capitalization and your sense of how popular the product or service will be.

In the next post, we’ll take a look at how to evaluate a startup before you decide to join.

More Information About Startups


About the author...

Neil Patrick is a veteran of start-ups, having been a founding director of three start-ups to date including the largest venture capital backed start-up ever in the UK. He’s also a visiting lecturer on the MBA courses at Cardiff University Business School specializing in Entrepreneurship, Corporate Strategy and Marketing. He is a mentor for business start-ups at the Innovation Centre for Enterprise (ICE) in South Wales. He is also the Editor of a popular careers blog, 40pluscareerguru. You can follow him on LinkedIn at linkedin.com/in/neilrpatrick, on Twitter at @NewCareerGuru, and also on Google+.


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