Startup Funding Masterclass: Part One
As a startup founder, you often get asked what your startup runway looks like. It's a super common question. And yet most of us end up balancing our time and money on an Excel sheet.
This post is Part One in a new Masterclass series on Startup Funding. Funding is the fuel that every business runs on. Knowing the ins and outs of funding is therefore essential if you want to your startup to be successful. We searched for a compact-yet-comprehensive guide on startup funding and found it nowhere, so we decided to build one ourselves. This is that essential guide.
– Jeroen Corthout, Co-Founder Salesflare, an easy-to-use sales CRM for small B2B companies
This article aims to explain not just what 'startup runway' really means. We'll also show you how it's calculated, how much runway you need and how to lower your cash burn.
1. What is a startup runway?
A startup runway is similar to how an actual runway allows airplanes to take off and land. It refers to how long your company can survive in the market if the income and expenses remain constant. If a startup doesn’t have enough runway, they risk going out of business before they understand the market they’re looking to serve. Imagine having just developed a great product but being left without the cash required to sell it. Every entrepreneur's worst nightmare.
Let's look at a business without any revenue. They're spending (or burning) about $10,000 every month. With $100,000 in the bank, they have a 10-month runway.
Within these ten months, the startup would need to not just take their products to market, but also maintain a cash reserve that is higher than their burn.
CBInsights states that running out of runway is the second most likely reason for startups to fail. Hence the reason that most startups raise money is usually to increase their runway until the business starts to generate revenue.
2. How is startup runway calculated?
1. Define your startup's gross revenue
If you're not closing deals yet, proceed directly to the next section on documenting your expenses. If you are closing deals: record the value of each deal in an Excel sheet and add them all up to know your gross revenue. Be conservative! Focus only on the deals that have already been paid or are very likely to get paid.
2. Document your startup's expenses
Start documenting every little expense you make running your startup. From the teams you hire to the operational costs like office space, internet, food bills, phone bills and more: include them all in your expenses.
3. Calculate your net cash burn
Burn rate refers to the rate at which a startup would spend from its cash pool in a loss scenario. It’s calculated by subtracting the operational expenses from the revenue generated by the startup on a monthly basis. If you're pre-revenue, then your cash burn is equal to your expenditure.
Net Cash Burn = Revenue - Expenditure
4. Determine your startup runway
Divide the cash you have in your bank by the net cash burn calculated above to know how long your startup runway is.
What about upcoming costs that you will need to scale?
While startup runway mostly refers to a constant scenario, go ahead and be conservative: include these expenses in your runway. Either subtract expenses from your runway or include monthly expenses in your expenditure in step 3. If you have no idea what you might need, try leveraging your network: find companies with similar business models or technologies. Usually, their expenses will provide a good approximation of yours.
What about those incoming revenues?
Again: be conservative and leave these out for now. They have their place in your business plan but not in your runway.
3. How much startup runway should you raise?
While every startup has different goals and therefore different runways, the CB Insights report shares some estimates for the median time lapse between funding rounds for tech companies.
- 12 months for Seed to Series A
- 15 months for Series A to Series B
Experienced venture capitalists like Fred Wilson recommend planning a startup runway of about 18 months between rounds. This time span is meant to give you a cushion period to implement your plans even in situations that will make growth more difficult, i.e. so-called 'headwinds'.
Another study published by Radicle Labs, however, states that the average period listed may be too short. Taking into account the growth of startups at different stages, it suggests that founders should plan for at least 18-21 months of runway, going as high as almost 35 months to play it safe.
The reason is simple: things don’t usually go as planned.
4. What are the mistakes to avoid?
You should look to raise more than you think you'll need, without giving up too much equity or creating unattainable valuation expectations.
If you raise just enough or far more than your runway, it indicates that you weren’t aggressive enough with your plans, or gave up too much equity, respectively. And if you raise too little for the period, there’s the risk of running out of money before you make enough progress to raise the next round.
Remember to take into account existing operational costs and what you might need as you’re scaling.
Look for ways to keep your burn to a minimum and then simply avoid the following mistakes while raising money for your runway:
1. Raising too little
You might feel like you’re being really realistic, but raising too little is a big no-no. The penny-wise approach might actually result in you having to raise money more regularly.
Considering how long each fundraising round, you'll be wasting a lot of time trying to raise funds instead of focusing on building and growing your startup. What’s even worse is that every time you have to go out to raise more, your risk of failure increases. Perhaps you'll be going through a slow period just when you would need to raise again? It's always better to raise while you're hot.
2. Raising just enough
There’s a fine line between raising too little and just enough for your startup runway. Let's say you go with the time frame suggested by industry experts, i.e., about 18 months or less and raise runway for exactly that period.
Now, in this scenario, assume you’re going to end up taking up to 10 months to build a product that caters to your target market needs. Then you'll take about two months to raise funds, which will then take a few more months to show up in your account. This leaves you with barely a month or two to grow your product.
Considering just how many companies are out there trying to target the same market as you, that’s way too little to even start getting attention.
Pro tip: Make sure you raise enough for a buffer period in case things don’t go as planned, which is not uncommon in startups.
3. Raising too much
When it comes to your startup, you understandably might want to give yourself enough time to test the waters. Thinking like this might then tempt you to raise funds for a longer period to take care of the project expenses.
Doing so does take some stress off your shoulders but you risk wasting too much time to achieve every milestone on your product road map. You may even release too late in the market and miss an opportunity to test the waters or grow.
But that's not all: raising too much also puts you in a tough spot with investors.
It might put the expectations of your current investors too high if you raise a lot at a high valuation, setting you up for the well-known trap of failure versus expectations: in the next round you will need to have delivered on your previous’ round valuation or you won’t be trusted with another round.
On the other hand, giving up too much equity to raise more startup runway makes your startup less interesting for investors in the upcoming rounds.
In the, frankly, likely case that you do end up misjudging your startup runway, the only way to not crash and burn is to try and prolong it. That can be done by paying attention to what you’re spending the most money on and starting to reduce your monthly burn.
5. How to reduce your cash burn and prolong your startup runway?
It's important to continually monitor the growth of your startup plus your cash burn at every stage and to also improve your operations in order to optimize your startup runway.
1. Monitor your cash flow consistently
A common metric that startup founders measure to track performance is the profit their business is making. But while that gives you an idea of how much money you’re making on an accounting basis, it’s far more important to understand what your cash balance looks like by monitoring your cash flows. It's not for nothing that “cash is king”.
Cash flow refers to the total amount of money that’s being transferred in and out of your company’s bank account. It therefore tells you how much your cash reserve grows and shrinks in a certain period.
Fast Pay shares a simple formula to calculate your cash flow:
Cash Flow = Income - Expenditure
Your income should include sales, investments, bank loans, grants and other types of funding. The expenditure should take into account team salaries, operational costs, tax and VAT, repayment of loans and similar expenses.
2. Reduce your expenses
While you monitor your cash flow, identify where you can reduce your expenses to prolong your startup runway.
Here are a few things you can do:
- Opt for shared office spaces - Save on the operational costs of a leased office and work from co-working spaces.
- Don’t hire teams prematurely - Instead of bringing in full-time resources, consider outsourcing certain tasks.
- Automate more of your work - Don’t spend time and resources trying to accomplish tasks manually. Automate processes like invoicing to shift focus towards growing your business.
- Spend on what actually works - Be it in marketing or sales, don’t spread yourself too thin and restrict your budgets to things that have proven effective before.
- Create a culture of frugality - Advocate the lean startup thought process more actively and motivate your teams to try and make the most out of restricted budgets.
- Hold regular cost reviews - Review major expenses and renegotiate. Include your team and make it a culture building activity. Keep in mind the 80/20 rule and focus on big wins so you don’t get sidetracked.
3. Take charge of your receivables
Receivables refer to your startup's outstanding invoices. It's the money owed to you by your clients. The time frame you allow your customers to settle these invoices has a direct impact on the burn for that period.
Let’s say you allow invoices to be paid within a 90-days period. In this scenario, you need to be able to fund your startup’s operations for the duration of that period without jeopardizing expenses for the coming month.
To manage your receivables well, start by clearly defining your payment terms. Make sure all your customers know when their payments are due plus the charges on late payments. Don’t put yourself in a position where you’re drowning in debt just to try and please your customers.
Pro tip: While your margin matters, cash in the bank is even more important. Consider discounts to incentivize clients to pay up front.
4. Create an emergency fund
Just like the first aid kit in your home, an emergency fund is for times when your startup hits an unforeseen low. This could be because your expenses suddenly shoot up while you’re still months away from raising the next round of funding. Or it could be because you’re suddenly required to add unaccounted-for resources -like a specialized consultant- to your road map to grow faster.
The startup world is unpredictable and that’s precisely why you need to create an emergency fund for your business. This refers to the amount you set aside and won’t even think about using until there's absolutely no other choice.
Experts suggest keeping emergency funds that will allow you to subsist for anywhere between three months to a year. They should let you keep current expenses going and still leave some room for additional ones.
5. Make technology work for you
A lot of us use Excel sheets to plan our finances. But when you start a business, it becomes hard to keep track of your cash flow. Doing it all manually means risking human error and the inability to keep your sheets updated at all times.
This is exactly why you need to start using smart tools like Runway, Wave, QuickBooks and others to keep track of finances during your runway. Removing this admin load from your shoulders will give you peace of mind and more time to focus on actually growing your startup.
6. Taking off from your startup runway
The idea of securing your startup runway is to give you just enough time to fly to the next level of growth with your company.
So make sure that when you’re planning to launch your startup, you’re backing every move with concrete market data and calculating the cost you will have to incur for it, so that you have enough room (but not too much!) to successfully execute that take-off maneuver.
Ready for take-off? Share with us some of the tips you have followed to successfully calculate your startup runway! Also, don’t forget to tune in next week for Part Two in our Startup Funding Masterclass: Types Of Startup Funding!
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