In a recent Investor call, the CEO calmly said: “We only have two months of track left.”
The fact that we were on Zoom couldn’t hide the reactions from investors: some faces turned decidedly pale. As an angel investor, I have faced variations on this scenario, some more significant than others. Fortunately, it doesn’t happen often.
Just as airplanes need a runway of a minimum length to take off and land safely, startups must have enough cash to achieve product fit-to-market. I’m using “hint” as a metaphor to describe how much cash a business has at its disposal to operate before it runs out of money.
The size and weight of an aircraft dictate the length of runway it needs. Similarly, the amount of cash a startup needs varies depending on what it’s doing. A life sciences company seeking FDA approvals typically needs more than a SaaS startup.
It’s critical to pinpoint as precisely as possible the runway you’ll need, adding contingency funds for unexpected challenges. Otherwise, if your business runs out of cash, you risk a “bargain” price for the business. Or worse yet, your business could be forced to cease operations.
Here are five ideas to consider and remember when you’re thinking about the catwalk.
Use this simple equation: Divide cash on hand by monthly expenses, then add compensation as income.
How much track do you need?
Seed stage and Series A companies should plan to have at least 12 to 18 months of runway. Put as much of your available cash specifically into product development or revenue growth so you have more time to ramp up and make meaningful progress. Having a positive cash flow will benefit your next round of financing or increase the self-sufficiency of your business.
It is important to be capital efficient and use funds only to increase revenue, increase product development, or both.
If your business earns a dollar for every dollar spent on growth or product development, you have a capital efficiency ratio of 1:1. Aiming for capital efficiency encourages you to make better business decisions about where to adjust expenses before increasing investments.
A life sciences company I invested in had contracts with several organizations for specialized chemistry needed for product development. Instead of pursuing large contracts with each of these organizations, the company awarded them smaller contracts and, based on performance, awarded a larger contract to the company that delivered the most value.
To calculate the amount of runway your business requires, you need to determine your burn rate: the amount of cash needed to run your business, offset by revenue. Specifically, estimate monthly costs: Think about salaries, overhead, capital needs, marketing, research and development costs, and other expenses, along with income.