Everybody loves to boast big milestones. Hey, I discovered a big problem. I built a minimum viable product. I achieved product-market fit. I got a fat check. I became a unicorn.
We know: giving that same love to a mundane financial concept like "startup runway" is hard. Still, you should take a break from the popular cousin valuation and give good ol' runway a chance 🌹.
Why? Because this can make or break your startup.
VCs know this and we're dead sure they will ask about your runway. We want you to give investors the best answer possible. Yeah, because we love you.
So here's ✨Latitud's guide on startup runway ✨. Let's understand:
In business, runway means how much time your company has until it spends all the money in the bank. That amount of time depends on how fast your burn through the cash, or your cash burn rate.
Just like an airplane needs enough runway to land safely, so does a startup. The only difference is that a startup's runway is made with cash.
We all know the startup journey isn't a smooth flight, especially in Latin America. The trip of customer discovery, product development, and finally product-market fit is one of blood, sweat, and tears. You need to pass through the reddest reds to arrive at the bluest blues. So your cash runway better be padded, and your cash burn better be under control.
Cash runway and cash burn will show you respectively how much you're burning and how fast you'll be toast. Together, they form a heavy metal band known as 🔥 the ticking clock to hell 🔥.
Cash runway and cash burn are both veeery important metrics, especially for early-stage startups.
Unlike mature companies, most early-stage startups don't have predictable revenues and costs. They're probably relying on founders’ and angels' money.
It's crucial to constantly keep up with how fast you're burning through that cash. Why? Because that will also show you how much time you have left to break even.
Is there something more important in your startup than the deadline to rise or die? Yeah, we thought not. And CB Insights agrees with us: running out of cash is the main reason why startups die.
When to use this runway calculation? Here's the usual way to calculate runway, taking last month’s cash burn. This cash runway calculation assumes you have stability in expenses and revenues. Are you an early-stage startup with any seasonality in revenues and expenses, and just had a really good or a really bad month? Jot this formula down for later.
How to calculate runway like this? The traditional cash runway formula is:
Traditional runway = Current cash balance/Monthly net burn
Cash balance: what you have in the bank. It includes that pre-Seed check you got from family, friends, and f̶o̶o̶l̶s̶ fortunate ones.
Net burn: also known as Revenue minus Operating Expenses. If Operating Expenses surpass Revenue, you'll find a negative number. And that's your net burn. When you don't consider Revenue in your calculations, you have your gross burn.
What's an example of a traditional cash runway calculation? Your startup has $100k in cash reserves. It spends $30k considering all expenses in a month but only brings $10k in revenue in that same time period. That means your net burn rate is $20k a month.
And with that, you have a runway of 4 months. By the end of August, you're toast.
In Google Sheets, you could see it with these formulas:
When to use this runway calculation? This takes into consideration what you gained and lost during the past months. Of course, the more months, the better, so you have more historical data. This calculation allows for some fluctuation but it's still easy to math out.
How to calculate runway like this? The historical runway formula is:
Historical runway = Current cash balance/Average net burn
In Google Sheets or Excel, you can calculate the average net burn through the function AVERAGE, taking into consideration any period you want. Then, get your current total cash and divide it by that average net burn.
Still, pay close attention: averages can be dangerous. For example, if you've been through a fast hiring phase in the past six months, your payroll now probably won't reflect the average of previous times.
What's an example of a historical cash runway calculation? Let's take our previous example, but consider that your startup hired two salespeople, one in February and the other in March. Each one of them costs an additional $3000 but brings $5000 in revenue. So our average net burn is actually less than what we saw back in April.
Still, your startup's cash has been depleting month after month. By taking the average of what your startup burned through the quarter and the cash balance by the time the quarter ended, it only has 2 more months left to live. Just like before, you'd still be toast by the end of August.
When to use this runway calculation? You might have noticed a pattern. Be it one month or one quarter, we're looking at the past. But our dear startup has nailed something: it's hiring people that bring in more than they cost. If it continues that way, and/or if the startup receives an investment, it can boost the cash balance.
But which amount of cash does the business need to survive until revenue surpasses expenses?
That's when you need a predicted runway calculation. A predicted cash runway calculation is the choice of ever-changing startups.
How to calculate runway like this? The predicted cash runway formula is:
Predicted runway = Current cash balance/Predicted net burn
What's an example of a predicted cash runway calculation? By the end of June, you realized what you had nailed. You're pretty confident that you can hire people for the same salary and they'll sell just as much as the previous employees.
So what would happen if you decided to onboard one salesperson per month? And what about two salespeople per month?
In the first scenario, you wouldn’t have enough cash in hand and would see a negative cash balance in November. In the second one, you would be deciding to bet more and earlier on a winning formula. Well, look at that: it made revenue equal expenses sooner. You're 👏 not 👏 burning 👏 cash 👏 anymore! 👏
This example considers only one variable: the number of salespeople, given fixed salaries and sales. But you should consider every projected revenue and cost when calculating your predicted net burn. And redo the math constantly, because things change.
Also, add some buffer there for less revenue and more cost than expected. That's what we'll talk about right now.
Determining how much runway your startup actually needs depends on how long it will take for you to turn a profit. Or, if you're in the venture capital track, how long it will take for you to reach the milestone needed to raise your next round of funding.
First, look at your business model. A startup that's developing a health product that needs regulatory approval will probably need more runway than a software as a service with a quick sales cycle, that can get more clients in days.
Then, look at your startup's potential revenues and costs. Yes, we know you're an optimist at heart. But we also recommend you project pessimistic and realistic scenarios.
Let's again take your startup as an example. What if the new hires sell less than the previous ones? And what if they don't sell at all during the first month? Be conservative in your projections so that your lack of runway doesn't catch you off guard.
'kay, but what about the numbers?
Let's talk about historical averages. Almost a decade ago, CB Insights estimated the median time lapse between the most known funding rounds. It was 12 months between Seed and Series A, and 15 months between Series A and B. Another study, this one made by Radicle Labs, pointed out a median from 15 to 19 months of runway.
But we're not in Silicon Valley. It’s also not 2021 anymore. We think it's more interesting to talk about runway for the current difficult market moment and consider the always difficult Latin American startup life.
That's why Ana Martins, Brian Requarth, and Julio Vasconcellos talked about runway for early-stage LatAm startups in the Latitud Podcast. Atlantico's investors and Latitud's co-founder recommend you have at least 24 months of runway. If you wanna be overly conservative, Julio recommends you shoot for 36 months.
You have all the formulas and what's the desired runway now. All you have to do is get your calculator game on!
You already did, and realized you might get charged with arson because your endeavor is almost getting burned to a crisp? 🔥
You're a startup, so act like one and do more with less.
But how? Let's check out three ways to manage and extend your startup's runway:
Do everything in your hands to decrease your expenses. That will lower your burn rate, making your cash reserves last longer.
If you see the business possibly getting in a difficult situation, look not only at trimming your startup's fat. You might have to look at the meat and even the bones to guarantee your company's survival.
For example, laying off people to add a few months of runway can hurt more than help your business. If payroll is where the bulk of the cost is but revenue doesn't catch up, it may be time for a full review of your company structure.
Look at the list below and ask yourself, what's really, really, reeeeally essential?
- Physical office spaces. Could they be reduced or completely eliminated?
- Company expenses. Are all the offered benefits really used and valued?
- Customer acquisition costs. What's the cost of every marketing and sales strategy? Do they actually generate a return on this investment, or do they need to be abandoned?
- Headcount in every department of your startup. This is the hardest measure, so leave it as a last resource. What's the individual ROI of every employee? Can this ROI be improved via short-term training? Or is it better to reduce the team, giving that employee a good severance package and help with finding a new opportunity?
We know: as a startup founder, you always have your eyes on getting new customers.
But here's a pop quiz: which of your marketing and sales strategies actually turn you a profit?
If you wanna extend your runway, double your efforts on profitable channels and profitable customers.
And how to know that? Do a customer acquisition cost and lifetime value analysis for every marketing and sales initiative.
Yes, this one's a little trickier than just reducing expenses. Measuring and discovering the best marketing and sales strategies from a profit perspective, comparing their costs and revenues in full, takes a while.
If you need to keep hiring or increasing other costs to generate more revenue, then your revenue is not that scalable. In that case, it's better to give up some revenue now that you still have the cash to figure out ways of scalable growth. And that means you'll probably see slower customer growth in the short-term, by cutting the initiatives that were not as sustainable.
Still, all that work will pay off. By guaranteeing a good return on investment in your marketing and sales efforts, you're getting closer and closer to not depending on external funding. This gives you more control of your business: you only raise capital when you actually have a good deal in your hands.
Since we're talking about fundraising… Yes, it’s possible to raise external investment with the goal to extend your runway.
But there's a catch: you must be prepared for the current moment, with smaller checks and more conservative valuations. That's why we always tell you to cultivate your relationship with investors and not knock on their doors only when you actually need the money.
Still, here we are.
So, how to navigate these murky waters?
A good option is talking to your current angels and VCs about a round extension. This extension can appear in the form of a flat round, keeping the valuation of the previous round. Or it can be a simple agreement for future equity (SAFE), giving investors the right to claim their equity in a (we hope) brighter future.
If you prefer interest over founder equity dilution, another option is searching for credit instruments.
But there's another catch here. Most credit requires assets and years of financial records with positive cash flow as guarantees. Two things few startups have.
So you need to search for credit instruments aimed at startups. Convertible notes, revenue-based financing, startup credit cards, and venture debt are some examples.
Here's a checklist of the mistakes you might be making on your journey to a healthy runway. If you check any of these boxes, time for some self-reflection.
Here are some terms you need to know if you wanna master your startup's runway. But to be a founder ready for investment, be sure to check out our full glossary for venture-backed startups!
The income statement starts with how much money you made from gross sales/gross revenues. With each line you go down in the income statement, more expenses are taken from your sales.
At the end of the statement, you reach the net income (also known as net earnings or net profit/loss). You use it when you need to analyze the profitability of your startup.
A cash flow statement starts where the income statement ends: at the net income of your company. The net income must go through some adjustments, such as capex (money spent on things like equipment and properties) and debt repayment, to get to the last line of the statement: free cash flow.
The cash flow statement summarizes the movement of cash and cash equivalents. That's basically the variation in the amount of money in your bank account, or how much you've earned or burned at the end of the period analyzed in the statement, such as a month or a quarter.
Your cash flow can be positive or negative. You can use your cash flow statement to check your startup's runway.
The contribution margin answers a simple yet fundamental question: when your revenue is big enough, will you actually have a healthy business? Will there be money left even after all you need to pay?
You can answer that with a simple calculation:
Contribution margin = net revenues - (variable costs + variable expenses)
Net revenue or net sales sit right between your gross revenue/sales and your net income. It means your sales minus adjustments like refunds and discounts. Some examples of variable costs and expenses are raw materials, shipping, marketing expenses, and credit card fees.
The cash balance is the amount of money you have at your disposal. To take this value, you take the cash balance of the previous month and add this month’s cash flow.
Btw, about cash flows: they are divided into cash inflows and cash outflows. By cash inflows, we can understand the income coming from sales, investments, and loans. Cash outflows are everything that leaves your startup, like money spent on things like salaries, supplies, and loans.
You calculate your cash balance by using this formula:
Cash balance = beginning cash balance + cash inflows – cash outflows
The balance sheet is the statement that people know the most. On your left, you have your assets, also known as the stuff that you own. On your right, you have both your liabilities and your equity: stuff you have to pay, and what's left for the shareholders. The sides must be equal. Which means that total assets = total liabilities + total equity.
You can use the balance sheet to assess the health of your business. Some concepts that we see inside the balance sheet are cash position, total debt, and operating working capital.
Cash burn shows how much the company spends in a certain period (e.g. a month or a quarter). That's the amount of money your startup loses, draining your cash reserves and shortening your runway.
The gross cash burn rate is equal to the operating expenses of the company in a determined period, like salaries, rent, equipment, software licenses, and others.
To calculate your net burn, you have to subtract these expenses from the revenue that was generated in that same period. If your operating expenses are bigger than your revenue, ta-da, you're burning money.
Burn multiple is how much cash you have to burn to grow. The less cash you burn, the better, of course. And this is how you calculate it:
Burn multiple = net burn / net new annual recurring revenue
You already know our friend net burn. Now, net new annual recurring revenue (NNARR) is the yearly value of new accounts added to your business + new upgrades in value you had in existing accounts - value lost in reduced or closed accounts. Whew.
But what even is a good burn multiple? If you're adding more value than burning it, hey, you're doing amazing. Now, if you're getting further and further away from that, we have a problem.
Check out Felipe Mansano's summary for burn multiple, or how much did you burn to grow. See where your startup stands according to our financial friend. (You know what you did last summer.)
Customer Acquisition Cost (CAC) is how much you need to find a potential customer and convert them into a real one. And that's how you find it in a certain period:
CAC = Total marketing and sales expenses / New customers acquired
Everything that is marketing or sales-related should be in this equation: salaries, commissions, tools, ads... When you add up all these expenses in a certain period of time and divide the total by the number of customers acquired in that same period, you have your CAC. That plays a very important role in understanding profitability and efficiency.
LTV or Lifetime Value refers to how much value a customer brings to your company while they stay a customer. A high LTV likely means you have good retention rates and clients keep generating revenue for the company.
A very important point here is that you should calculate your LTV not based only on revenue. You should consider your variable costs and expenses, and therefore calculate the LTV based on the contribution margin. So here's the deal:
LTV = Monthly or annual contribution margin per client / Monthly or annual churn
LTV:CAC is a ratio that seeks to understand the long-term profitability of your company, and helps answer an important question: are you spending more on finding customers than you are earning from those customers in the long run?
If your answer is yes, then you have work to do. A good rule of thumb is to have an LTV:CAC ratio of 3 or above.
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Venture capital: everything you need to know as a startup founder in Latin America
Startup incorporation: the complete guide for you to start with the right corporate structure