On a recent investor call, the CEO calmly said, “We only have two months of runway left.”
The fact that we were on Zoom couldn’t hide the investors’ reactions — a few faces turned decidedly pale. As an angel investor, I’ve faced variations of this scenario, some more consequential than others. Fortunately, it doesn’t happen often.
Just as airplanes need a runway to be of a minimum length to safely take off and land, startups must have sufficient cash to reach product-market fit. I’m using “runway” as a metaphor to describe how much cash a company has at its disposal to operate before it runs out of money.
A plane’s size and weight dictates how long a runway it requires. Likewise, the amount of cash runway a startup needs varies by what it is doing. A life science company that is looking for FDA approvals usually needs more than a SaaS startup.
It’s critical to determine as accurately as possible the runway you’ll require, adding in contingency funds for unexpected challenges. Otherwise, if your company runs low on cash, you risk a “fire sale” price for the business. Or worse, your company could be forced to cease operations.
Here are five ideas to consider and remember when you’re thinking about runway.
Use this simple equation: Divide available cash by monthly expenses, then add offsets such as revenue.
How much runway do you need?
Seed-stage and Series A-stage companies should plan to have at least 12 to 18 months of runway. Put as much cash on hand as possible specifically toward product development or growing revenues so you have more time to ramp up and make significant progress. Being cash-flow positive will benefit your next round of funding or boost your company’s self-reliance.
It’s important to be capital efficient and only use funds to either expand revenue, increase product development or both.
If your company earns one dollar for every dollar spent on growth or product development, it has a capital efficiency ratio of 1:1. Aiming for capital efficiency encourages you to make better business decisions about where to tweak expenses before increasing investments.
A life science company I invested in had contracts with several organizations for specialized chemistry required for product development. Rather than pursue large contracts with each of these organizations, the company gave them smaller contracts, and based on performance, it awarded a larger contract to the firm that delivered the most value.
To calculate how much runway your company requires, you should determine your burn rate: the amount of cash needed to run your business, offset by revenues. Specifically, calculate monthly costs: Think salaries, overhead, capital needs, marketing, R&D costs and other expenses, along with revenues.
To arrive at your runway, use this simple equation: Divide available cash by monthly expenses, then add offsets such as revenue. The result will tell you how many months you can operate before running out of money.
If a company has $1,000,000 in cash, and a burn rate of $100,000 a month, with $200,000 in expected revenues, it will have 12 months of runway.
Having 12-18 months of runway between funding rounds gives you time to implement your plans. It’s a careful balance of keeping burn rate at a minimum while investing in key areas.
Things rarely go as planned
Projections are useful, but you can’t account for unexpected problems or opportunities.
Every month, run reality checks for potential challenges or opportunities that could decrease or increase your runway. Check if revenues are coming in, costs have increased on key supplies, or if a project is running as planned or needs extra investment.
One startup I backed was recently hit with a substantial unexpected rent increase, which immediately truncated its runway. In response, the CEO strategically held off targeted expenses until he secured the next funding round.
Another company I invested in had a fire that delayed their production schedule and caused expected revenues to decline. It quickly raised more funds, moving up the ask for the next round sooner than originally planned.
Many of your advisers, board members and investors have been in similar situations as entrepreneurs, so be sure to tap them for advice. Never hesitate to ask questions when you don’t have answers.
Fundraising is rarely quick
Fundraising can take much longer than you’d prefer. Investors and investment groups have their own timetables, which often involve many filters that include initial scouting, selection for presentation, deep dives and then due diligence. This sequence can take up to three to five months to complete, and an investor may decide not to fund the company at any point.
Another company I invested in has raised funds thrice. The first round took five months to secure, the second four months and the third round only three months. As the company was increasingly de-risked with each round, subsequent rounds took less time to complete. Still, it took three to five months for each round, which made planning for this longer funding time horizon essential.
As you factor how long your fundraising cycle will be, keep in mind national and religious holidays, and typical vacation periods. Investors may be taking time off during these times, so build these possible quiet periods into your runway calculations.
Transparency isn’t optional
I invested in a predictive analytics company that delivered only good news for investors each quarter. The CEO decided against transparency; he kept investors in the dark about serious problems the company had encountered rather than seek help. He could have made advisers and investors aware of the challenges and they would have helped with the solution.
Specifically, the CEO withheld the important fact that product development would take longer than he had previously committed to, and failed to let investors know sales had fallen short of the planned-for traction. These issues directly impacted future runway, as sales would help offset the burn rate. When investors finally saw the real numbers, the company had only two weeks of runway left.
On the other hand, a beverage company I invested in pivoted to an e-commerce model at the beginning of the pandemic — sales had been in free fall at its brick and mortar retail locations. The CEO kept all investors aware of the challenges and opportunities along the way, and made the advisers and investors partners in achieving the successful pivot. The rapid switch from street retail to online-only slashed expenses and helped secure additional funding from existing investors.
While it’s not easy to convey less than stellar news about your company to investors and other stakeholders, it’s absolutely critical to be transparent. Investors conduct diligence and will discover the truth. If you are not being truthful, you risk severely damaging your reputation, and funding prospects will dim because investors talk.
Never assume that funding is a done deal
Remember this: Fundraising isn’t complete until documents are signed and funds are deposited and available.
Verbal commitments are a terrific first step. After this, investors will examine and accept investment agreements, lay out the terms and transfer money to your company’s bank account.
Much of the time, you’ll be working with many investment groups, each with multiple levels of diligence. Don’t assume one investment group or investor will come through 100%. To offset the inevitable disappointment of not receiving funds that were promised, raise a bit more capital than you think you’ll need to cover unexpected expenses. This will help lower the risk of raising more funds to keep sufficient runway.
Many things make up your company’s runway, and you’ll have to constantly juggle focus on money, time with product development, sales, how fast you’re burning through cash and fundraising.
Always know where your company is, and frequently communicate your financial runway to your investors, employees and other stakeholders. You owe it to them and to yourself. It’ll give you peace of mind, and you’ll be better able to lead.