5 questions to ask when evaluating start-up financials

A beginner's guide to analyzing start-up financials

Finance is a very popular section of our Business Intensive program.

Early in your career, you may not encounter finance often (unless you work in the function). However, as your career progresses, you need a firm grasp of finance fundamentals in order to: 

1. Pitch new business opportunities internally

2. Pitch start-ups to investors 

3. Evaluate investments personally 

4. Evaluate potential employers

Our goal today is to share a high-level framework for evaluating start-up financials. You can leverage our framework when evaluating start-ups as an investment or as an employee.

These are the 5 high-level finance questions you should be asking to determine a start-up’s health:

Let’s get into each question.

1) What is the company’s revenue relative to benchmarks?

A company’s income statement starts with revenue. Your analysis should too. 

You should understand ballpark revenue expectations depending on a start-up’s stage:

Next, take a closer look at revenue. Across industries and business models, ask:

1A) What’s the revenue type? Recurring revenue is healthier than revenue from one off purchases. After all, by definition, subscriptions are contracted to continue into the future.

1B) What’s the revenue growth rate? If the start-up is on the VC treadmill, they are expected to triple or quadruple revenue each year.

What about companies with no revenue? These could be: 

• Pre-seed start-ups figuring out their product

• Social media companies that haven’t turned on monetization 

• Bio tech and deep tech companies investing into upfront research & development

For pre-revenue companies, aim to understand how key milestones can unlock revenue for the company. A key milestone can be launching a new product feature, reaching a target number of users, securing regulatory approval, etc.

Generally, for pre-revenue companies, you are forecasting future financials based on understanding of an industry and its competitive landscape.

Once you understand revenue, you will want to analyze the company’s burn profile and valuation:

2) What is the company’s burn profile? 

Gross burn rate is the company’s monthly cash outflow for expenses (i.e., salary, rent, marketing, etc). Net burn rate also considers revenue so it’s the company’s monthly cash loss. 

(Fun fact: Employees compromise 70–80% of a typical startup’s costs).

You should ask: 

• What is burn relative to revenue growth? 

• What is the burn relative to historical data? 

• How does the burn multiple compare to benchmarks? 

• What is the start-up’s cash runway? Is it over 12 months? 

Is it bad if the company is losing money right now (i.e., has a negative net income)? Not necessarily. Companies with exponential growth opportunities rarely capitalize on them unless they’re willing to burn through a lot of cash.

You’ll want to understand how exactly the money is being spent and make a judgment call:

• Do you believe these investments will unlock great growth in the future?

• Does the company have enough cash to reach profitability or will it need to raise another round (and at what price)?

3) How rich is the company’s valuation?

You should ask:

• What was the start-up’s valuation in their last round? 

• What revenue multiple does the current valuation imply? 

• What is the revenue multiple compared to the company’s peer set? 

To make a judgment around whether a start-up is over- or under-valued, you’ll need to understand the industry, business model, and growth rates, among other factors. Read industry reports and talk to friends in investing / banking.

Whether a company is overvalued or undervalued relative to its last mark depends on timing. For example, a start-up mark that seemed fair in 2021 might seem grossly overvalued today. Market cycles change everything. 

Pay attention here! The company’s valuation directly impacts the part of your compensation that’s tied to options. You want your entry point into a company to be a price where there is still ample upside potential!

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What else?

Above, we covered items that are on the income statement. It’s important to remember there are 3 financial statements and if you want to understand a company’s financial health, you need to look at all 3. 

The three financial statements are income statement, cash flow statement, and balance sheet.

As you comb through the full financial picture, you want to ask questions around:

• What is the company’s debt level?

• What is the free cash flow?

• Are there significant capital expenditures projected in the next 12 months?

• Are customers paying the company in a timely manner?

We cover all of this and more in-depth in the Business Intensive, a 6-week course that covers 8 core business skills. It’s our version of an alternative to an MBA.

Investors are constantly reviewing startup’s financials: at the point they invest (high levels in the pitch decks; deep dive in the data rooms) and via quarterly reporting (assuming they have information rights). They have multiple shots at bat - as an employee, you have one at a time. Use our framework to know what questions to drill into!