On a recent appeal from investors, the CEO calmly said, “We only have two months of runway left.”
The fact that we were on Zoom couldn’t hide investor reactions – a few faces turned decidedly pale. As an angel investor, I’ve been faced with variations on this scenario, some more consequential than others. Fortunately, this does not happen often.
Just as airplanes need a minimum runway length to take off and land safely, startups need enough cash to scale in the product market. I use “trail” as a metaphor to describe the amount of money a business has to operate before it runs out of money.
The size and weight of an aircraft determines the length of runway it needs. Likewise, the amount of cash trail a startup needs varies depending on what it does. A life sciences company seeking FDA approvals typically needs more than a SaaS startup.
It is essential to determine as precisely as possible the track you will need, adding contingency funds for unexpected challenges. Otherwise, if your business runs out of cash, you risk a “sell-off” price for the business. Or worse, your business could be forced out of business.
Here are five ideas to consider and remember when thinking about the track.
Use this simple equation: divide available cash by monthly expenses, then add offsets such as income.
How much track do you need?
Seed stage and Series A stage companies should plan to have at least 12-18 months of trail. Set aside as much money as possible specifically for product development or revenue growth so you have more time to accelerate and make meaningful progress. Having positive cash flow will benefit your next round of funding or empower your business.
It is important to be capital efficient and use funds only to increase revenue, increase product development or both.
If your company earns a 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 adjust spending before increasing investments.
A life science company I invested in had contracts with several organizations for the specialty chemistry needed for product development. Rather than 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 provided the most value.
To calculate how much lead your business needs, you need to determine your consumption rate: the amount of money needed to run your business, offset by revenue. Specifically, calculate monthly costs: think about salaries, overhead, capital requirements, marketing, R&D costs, and other expenses, as well as revenue.