It’s a difficult and confusing time to be an entrepreneur. People are relying on you. Investors may be pressuring you or showering you with advice (solicited or not). You’re reading expert opinions and finding that many of them disagree.
We’re all yearning for a crystal ball. What should we expect in the year ahead? A U-shaped recession. A V-shaped recession. Or even a W-shaped recession. No one knows with any certainty what’s to come.
In a U-shaped recession, startups that survive will likely have slowed their burn rates and invested in ideas with some near-term ROI. For a V-shaped recession, it's wise to focus on accelerating product roadmaps in ways that favor faster growth when conditions become more favorable. A W-shaped recession's volatility, on the other hand, can make it difficult to make any big decisions.
No matter the future, you need to know how to calculate your runway and how to make sure you have enough cash to be prepared for ups or downs.
What is cash runway?
Your startup's runway is the amount of time in a given period the business can operate before you run out of cash. Knowing how much cash runway your startup has is important for making critical business decisions, like acquiring more funding or making changes to your cost structure so you can grow under your own steam.
In any economic environment, running out of cash is the number one reason startups fail.
So, it's important to know how to calculate your startup’s runway. You also need the tools to assess whether you have enough cash runway.
Be a success and not a statistic. We explain how to manage your startup's runway below.
How to calculate runway
How much runway should a startup have?
How to extend your startup's runway
How to calculate your startup’s runway
For most companies, runways are dynamic. If your cash flow shrinks but expenses don’t, your runway gets shorter. Increasing cash — by raising funds, for example — extends your startup’s runway.
The cash runway formula is simple:
Runway = current cash ÷ burn rate
What you need for this calculation: a period’s worth of expenses and income. This should include the total cash expenses, revenue, cost of goods sold (COGS), and the time period in months. The longer the time period, the more accurate your runway calculation will be.
Step 1: Calculate your burn rate
Your startup's burn rate is critical for calculating your runway. There are two types of burn rates: Gross and net burn. Gross burn measures your cash expenses in a given period. Net burn is the rate that we are using to calculate the runway.
Gross burn = total cash expenses
Net Burn = (starting cash - ending cash) ÷ number of months in the given period
Example:
Let’s say you want to calculate your SaaS startup’s runway over a 6-month period. You have starting cash of $1,700,000 and an ending balance of $1,250,000. Taking these cash numbers into account, you can now calculate your net cash burn rate:
($1,700,000 - $1,250,000) ÷ 6 = $75,000
Net burn for your SaaS startup = $75,000
Step 2: Calculate runway using current cash and net burn
To finish our calculation using the previous example, you now take your ending balance, which is your current cash balance, and divide it by the burn rate you just calculated.
$1,250,000 / $75,000 = 16.66 months
Your SaaS startup’s runway = 16 months
How much runway should a SaaS startup have?
SaaS startups, in particular, burn a lot of cash to grow fast. Not only does it cost more to acquire a single customer, but also it typically takes several months to recoup those acquisition costs. There are numerous advantages to the SaaS business model, but rapid growth will inevitably strain your free cash flow.
Growth at any cost is no longer the name of the game. Most SaaS businesses have taken aggressive steps to manage their cash burn — that opens the door to opportunity for startups that have the runway and growth capital to keep moving the business forward.
So, how much runway do yo need?
It’s recommended that growing SaaS businesses have 18 - 24 months of runway.
In the previous example, our SaaS startup has a little over 16 months of runway — just under the recommended minimum of 18 months. They’re not in a bad position; but extending their runway to 24 months ensures the business can both absorb stresses and capitalize on opportunities over the next 2 years. And it's always better to raise money when you have money.
Three advantages of a longer runway
The longer your startup's runway, the longer you can operate your business without needing to raise additional capital, which gives you the flexibility to postpone fundraising until the deal climate improves.
Generally, you’ll be able to access more favorable funding terms and interest rates when you don’t need capital.
Rather than spending time and resources raising capital in a pinch, you can focus your energy on value-adding activities for your business, such as accelerating product development and investing in capturing more of your total addressable market (TAM).
How to extend your startup's runway
Deal climate can make a huge difference in valuation. For instance, during the Great Recession, deal valuations fell by 27.3%. Right now, investors have leverage to request more favorable terms from startups. Startups that are able to extend their runway with debt in the near term may be prudent to wait for the right opportunity to secure their next round of equity funding.
Consider these 3 strategies for extending your SaaS startup's runway:
1. Extend cash runway by cutting costs
Expenses play a key role in your cash burn rate. Therefore, cutting expenses while maintaining cash inflow will extend the runway for your business.
Travel, event, and entertainment expenses, which can make up a substantial portion of operating budgets at startups, can be an easy place to start making cuts. Many choose to go straight to cutting back marketing spend, though, that's not always the best strategy.
Personnel costs are usually the largest portion of expenses for most startups. That can lead to difficult decisions that shouldn’t be made in haste. It’s important to reflect on the impact of personnel decisions on teams, especially small ones.
For some, a hiring freeze might be enough. Other entrepreneurs find ways to avoid layoffs. For instance, companies may consider temporary across-the-board pay cuts in combination with a reduced work week.
Startups have a unique opportunity, right now, though. With big tech giants laying off thousands of employees, there's a lot of talent available to earlier-stage startups that's usually impossible to get. If you're in a position to make a few key hires, you're very likely to come out ahead in the long run!
2. Turn recurring revenue into extra runway
Equity funding or working with a bank may be top of mind for companies in need of a longer runway. A lesser known, but increasingly popular option for tech businesses who need extra runway is revenue-based financing.
If you're not familiar with RBF, it's the top alternative to dilutive financing thanks to startup-friendly deal terms. In exchange for financing, companies agree to share a percentage of future revenue. Payments vary with your company’s monthly revenue, making RBF a flexible way to pay down debt in a time when customer payments may fluctuate more than usual.
RELATED: What is Revenue-Based Financing and How Does It Work?
A provider of optimized IT management services, iOPEX turned to Lighter Capital to finance the company through a period of rapid growth without having to raise capital from a VC. More recently, the company tapped additional support from Lighter.
iOPEX CFO Archana Srinivasan explains why:
“In uncertain times, it is prudent for all companies and any startup to focus on their cash position and preserve runway. Surviving a downturn and being able to grow again when it turns around is going to be the new measure of success. We initially turned to Lighter Capital as a way to tap funding without diluting equity. When COVID-19 hit, Lighter proved to be a true partner. The speed and dexterity that the Lighter team brings has been amazing.”
3. Gain intelligence from business analytics to make your cash go further
Understanding your startup's runway — and your entire financial picture — can help you effectively navigate tough times, too. Lighter Capital clients benefit from our new data analytics platform, Lighter Analytics, that gives startups a view into cash runway, customer churn, and other key metrics that are critical for understanding the health of the business.
We built it for two reasons:
It helps companies present their financial performance in a standardized format to investors.
We also wanted to give companies access to cohort analysis that helps them understand how their company compares to others with a similar business model, size, and industry. The goal is to make it easier to get cohort insights on all key metrics.
This has benefits for both founders and investors:
Entrepreneurs get a new perspective on how investors view their data.
Looking ahead, investors will be able to use the platform to manage the performance of their portfolio and find smarter investment opportunities.
The platform is an ideal tool for startups in need of a deeper look at their runways and other key performance metrics. Subscribe to our e-newsletter for updates on Lighter Analytics.
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