Running Out Of Money Isn’t A Milestone

Nearly all startups use the same methodology to figure out when to raise their next round of capital. The founder projects the planned burn rate and estimates the day they will run out of cash. Then they subtract a margin for fundraising approximately four months from the date the company’s bank account will be empty, and declare the difference the fundraising-process start date.

While logical, this method is highly flawed. It’s predicated on the idea that running out of money is the key milestone upon which to base a fundraising. However, running out of money isn’t a milestone — it’s exactly the opposite.

Milestones should be accretive to the value of your business; they typically come from key proof points that validate important hypotheses. Milestones can be based on the product or technology (a great prototype); customer validation (a key contract); legal (overcoming a regulatory hurdle); or financial (meaningful revenue growth).

Running out of cash is the opposite of a milestone — it’s the ultimate moment of vulnerability. Running out of money is Game Over. Some investors will try to take advantage of that moment of vulnerability with very tough terms, but that worries me less than the true implication of being vulnerable. Vulnerable companies are simply unappealing to investors, and often cannot attract capital on any terms.

Investors are motivated to write checks when they feel like your company presents a great opportunity to return multiples on capital. Investors believe in the opportunity because of the narrative of the company and the evidence that the company amasses validating that narrative. Companies rarely look less likely to return to investors than when they are about to run out of money.

The cash crisis undermines the narrative. Even if other milestones in the business are positive and appear equal, it is much easier to attract capital as a company with eight months of cash than the same company with two months of remaining cash. As the company runs low on cash, it starts to smell funny to investors, who start to ask themselves questions like how did the company get into this situation? And if this is such a great opportunity, why didn’t anyone else want to write a check?

So what’s an early stage founder to do about the cash vulnerability predicament? First, I’d suggest leaving more room for error. Ideally, don’t raise 12 months of capital out of the gate, expecting to go back out raising in eight months when down to four months of cash. Instead, raise 18 months of capital and start raising again when down to nine months of capital in the bank.

When debating this with founders, I often hear two arguments for waiting until almost out of capital to raise the next round. First is that the company’s progress is so significant month after month that its valuation will be meaningfully better by waiting as late as possible to raise. We’ve been lucky enough to experience this situation several times when revenue doubled by waiting three more months and the growth resulted in a much more successful fundraising.

This is a fair reason to wait, but the founder must be very confident that the evidence will make a fundraise easy. Resist the temptation to believe that by burning cash to the brink, the company will have so much progress the valuation will appreciate despite the burden of the impending lack of cash. It rarely works out that way.

The other explanation I hear is that the milestones of the company aren’t particularly strong and the founder needs as much time as possible to prove as much as they can. In other words, had the company tried to raise with 6-9 months of capital still on the books, it would have little to show to prospective investors.

Further, they argue that even with 4-6 months of cash remaining, the company won’t have compelling milestones to share with investors. The company needs to show the progress that comes from burning until almost out of cash to have the best chance of convincing new investors to write a check.

This is usually faulty logic. Companies in this situation rarely successfully pull off the Hail Mary pass with seconds left on the clock. Instead, they face diminishing returns, while further damaging the outlook of the company by being on the edge of running out of cash.

No one wants to write checks for this type of company. If the founder had been out looking for an extension with 6-9 months of cash, it could have still raised capital with the halo of promise. In this stage, the company looks more dead than alive, and the halo has faded.

In this situation, I suggest founders consider early seed extensions. If the company is progressing extremely well, this is completely unnecessary and the company should start raising Series A early. However, without major leaps forward, it is much easier to top up a seed round when a company still has 6-9 months of capital than with modestly more business progress but 60 days of cash left and waning inside commitment.

Some people in the startup world believe that good companies succeed and bad companies fail. While rare companies find incredible success right out of the gate, I don’t agree with this view. Some companies become good companies over time because they find ways to finance their way through lots of challenges. Other companies, with great promise, become bad companies because they don’t plan their financing well and they lose the opportunity to live up to their potential.

Let your bold vision and capable execution, not your bank account, determine what your company will become.