“Is my equity going to be worthless?”
The unfortunate truth for many people who join a startup is yes.
Unlike investors with a portfolio of bets, employees can only get equity in one company at a time, so it’s important to move on if you believe the company you work at is a sinking ship.
The good news? While it’s hard to pick the next unicorn with absolute certainty, it’s surprisingly simple to determine whether your startup is one of the ‘bad ones’ (meaning it’s in the bottom 50th percentile or so of startups). We’ve done the number-crunching to identify those crucial failure signals.
A few things to keep in mind
- Underwriting startups is both a quantitative and qualitative exercise. Combine all of the metrics you can find with qualitative signals (personal intuition, references, etc.) before making any decision.
- Many of these insights do not apply if your startup is a slow-growth, profitable business (especially one that doesn’t need much VC funding).
- This is backward-looking data. The startup climate will be different in the future than it was in the past. And just like with any type of investing, you shouldn’t blindly follow historical data to predict future success. Put older data into context and make your own evaluation.
4 questions to determine if your startup is on the wrong track
We looked at the following:
- Down round
- Time between funding rounds
- Headcount growth
The four data points above are the most publicly-available, easily-benchmarkable metrics to figure out where your startup stands. In future pieces, we’ll explore other important metrics like revenue and retention that can vary widely based on the company’s business model, industry, and stage.
We looked at whether a company had an event (like a layoff or down round) between 2014-2020, then looked at how it impacted their odds of success in 2023.
We split up startups into two categories: success and non-success.
We took companies' valuations as of September 2023 and divided it by their last known valuation before September 2020. We categorized those above 2X valuation growth as success and those below 2X as non-success.
We acknowledge this isn’t perfect—we’ll inevitably catch some great companies in the non-success category and some future flops in the success category—but it’s a good place to start given the lack of clear “success” and “failure” signals in private markets.
Did your startup have layoffs?
Out of the metrics we were able to look at, layoffs were the strongest indicator of whether or not a startup was more likely to be unsuccessful. We defined layoff as the company dropping 20% in headcount across any 3 month period from 2014 to 2020.
|Startups without Layoffs||Startups with Layoffs|
In other words, startups with layoffs between 2014 and 2020 were 36% more likely to be unsuccessful.
What it means: Layoffs are much more common in the downturn since 2022. Great companies do go through periods where they need to trim headcount and then ultimately succeed; however, we looked at cases where companies cut >20% of their headcount. Layoffs of that magnitude are one of the most negative signals for your startup’s success.
Did your startup raise a down round?
For the unfamiliar, a “down round” is the term for when a startup raises a new round of funding at a lower valuation than their previous round.
|Startups without a down round||Startups with a down round|
Startups that raised a down round were 28% more likely to be unsuccessful.
What it means: The nuances matter. For example, in August 2023, Ramp raised a down round from top investors. Ramp is generally considered a successful startup and is rated highly on Prospect. If your startup raised a down round simply because of unfortunate market timing, it may not be a bad sign. If your startup raised a down round because it hasn’t been able to materially grow or make investors more confident in the company’s potential, that’s a strong signal for non-success.
Did your startup take more than 3 years between funding rounds?
We looked at the data for startups who had significant gaps between their funding rounds.
|Startups with <3 years between rounds||Startups with >3 years between rounds|
Startups with more than 3 years between funding rounds were 23% more likely to be unsuccessful.
What this means: Not every company that takes time between fundraising rounds is going to fail. For example, Mercury—which says they are profitable, something most startups never achieve—has not raised in 3 years, likely because they do not need the money.
There are also differences by stage here. Growth stage startups should be scaling a business that is working and often need new capital to do so. Early stage startups are trying to find product-market fit and may not raise as often.
If your startup hasn’t raised in a while, investigate and figure out why.
How fast is your startup’s headcount growing?
Headcount is a valuable way to tell how quickly your startup is growing. Even startups known for being incredibly intentional about their hires, like Linear, have impressive headcount growth.
Below, we’ve grouped headcount growth percentage by percentile.
|Headcount growth % over the past 6 months||Headcount growth % over the past 1 year||Headcount growth % over the past 2 years|
These numbers are time-sensitive, and it’s worth checking on new benchmarks if you’re reading this piece years in the future (we’re writing it as of 2023).
What it means: Looking at headcount growth can help you avoid companies whose growth has stalled. Convoy, the trucking startup once worth $3.8B that recently shut down, did multiple rounds of layoffs in June and October of 2022. Neither round was more than 20% of the company so it would not have been flagged by our layoff metric above; however, Convoy’s 6 month headcount growth turned negative as early as May 2022 and has been lower than the 25th percentile since July 2022.
While headcount growth isn’t the only metric you should use, and there are examples of irresponsible headcount growth, it’s a strong signal.
Other things to consider before leaving
You now have a better idea of where your startup stands. Here are a few more things to think about as you weigh your options:
- How do the startup’s internal metrics look? We didn’t cover internal metrics here because they’re significantly more complex to analyze. We’ll cover them in future pieces. But if you are confident in the leadership team’s plan and the company’s metrics, that should hold more weight than what we’ve discussed here.
- Are there non-financial benefits of working at the startup? If you’re learning a lot, loving the work, or working alongside great people, you may not want to leave just because of some unfavorable metrics. That’s totally fine.
- What will the effect on your resume be if you quit? If you’ve been at the startup for just a year or two, it’s a valid concern to think that leaving might create a blemish on your resume. Our take is that resume concerns usually aren’t good enough to justify staying on a sinking ship.
- Do you have other offers in hand? Quitting is no use if you don’t have a better place to go. If you want to be sure, get offers in hand before leaving. If you’re exceptionally confident in your hireability, this isn’t necessary—though still may be a good idea.
The bottom line
Picking the next $10B startup feels like playing the lottery (though it’s a lot easier with Prospect).
Determining if your startup isn’t likely to give you a return on your equity, though, is easier. With the data above you should be able to educate yourself, one way or another, about where your startup stands. And of course, once you’ve crunched the numbers, the rest is up to you.