Is joining a tech startup like buying a lottery ticket? by Anne Fisher @FortuneMagazine November 14, 2014, 11:48 AM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons Dear Annie: I don’t usually meddle in my kids’ career decisions, but I think my son is about to do something he’ll regret. He’s been working in IT at a Fortune 500 company since he graduated from Stanford three years ago, and he’s been pretty happy there. Now, some friends of his from school are starting a company, and he’s thinking of chucking his job and joining them. About half his compensation would be in equity, and he’s counting on a big payoff if the company goes public. But isn’t that kind of like buying a lottery ticket? It’s a long shot, and you only ever hear about the big winners, who are relatively few and far between. Your thoughts, please? — Skeptical in San Marino Dear Skeptical: No question, joining a startup would be a lot riskier than what your son is doing now, and he surely already knows that. Knowledgeable estimates of startup failure rates range from 75% to 90%, and — depending on how you define failure — some are even higher. One study, for instance, by Shikhar Ghosh at Harvard Business School, looked at more than 2,000 fledgling enterprises that received at least $1 million in venture capital funding from 2004 through 2010. Ghosh found that about 75% failed to return investors’ money, and 95% fell short of specific goals like revenue growth rates or break-even projections. Dire numbers like that don’t mean, of course, that people who want to change jobs should rule out startups — they simply need to ask the right questions up front. Kathy Harris, managing director of New York City tech recruiting firm Harris Allied, thinks job seekers have gotten a kind of gold-rush fever from the gargantuan Alibaba IPO, and the company’s subsequent success. Before making the leap to a startup, she suggests asking these questions: How much funding does the company have? Most brand-new companies are launched with money from friends and family, Harris notes, including the founders’ own savings and even their credit cards. Nothing wrong with that, but you need to know the total dollar amount divided by the “burn rate.” “How long can the firm stay in business with its current cash supply?” How does the firm’s product or service fit into its industry? “Is there a real need for what the company is offering? Look at competitors and ask how the new product or service will fit into its market space,” Harris says. “What are the opportunities to generate revenue, and the triggers that will make this company profitable?” A well-thought-out business plan should address all this in detail. Since this startup’s founders are your son’s friends, he should ask to see it. If there is no written business plan, or if it seems skimpy, it’s a sign that these folks are not ready to run a company. Period. What business experience do the principals bring to the table? Ideally, the management team should have solid experience at running a profitable enterprise, especially “hands-on experience in compliance and regulatory issues and cost containment,” says Harris. If not, how do the founders plan to handle all those mundane but essential matters? Tech expertise and a marketable idea are great, but running a company day-to-day is something else. Make sure all the necessary pieces are in place. What’s the growth plan for the business 3, 6, 9, and 12 months out? “How will the startup grow its customer base? Are there plans to diversify the focus of the business?” Harris asks. The average job seeker interviewing at a startup has to fly blind on these questions, since “most private companies aren’t quick to disclose revenue projections,” she notes. “But interviewees can, and should, still ask about the company’s plans for expansion and growing market share.” Is there an exit strategy? Again, this should be mentioned in the business plan, even if it’s only tentative (which, at this stage, it almost has to be). Have the people starting the firm thought about how investors will eventually be repaid — through acquisition by a bigger outfit, for example, or an IPO? Since so much of your son’s pay will be in equity, it would be smart to find out whether anyone has thought about how he might someday turn it into cash. In weighing the move from a big company to a startup, your son has at least two big advantages. First, his prospective bosses or co-founders are friends, so he can ask tough questions about things that most private companies don’t like to discuss. Second, he’s only three years out of college. The decision to work for a new venture (or not) depends partly on “each person’s stage of life,” Harris notes. “Given startups’ high failure rate, and some potentially lean early years even if the company eventually succeeds, it may just be too risky for someone who has a family, or who wants to buy a house.” Your son isn’t there yet, so why not just recommend he look carefully before he leaps, and wish him luck? If it helps, you could think of this as a continuation of his education. The School of Hard Knocks, if that’s where he’s headed, has been great preparation for plenty of stellar careers. Talkback: Have you ever moved from a large, stable employer to a startup? How did it work out? 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