How to model “cash runway” for your startup.
Even before getting any funding, VCs always ask “how long will this money you are raising last?” After funding, the question is still the same but phrased as “So, when is our cash out date?” They are absolutely right to make this ”running out of runway” a top concern at a young startup.
Running low on cash makes you do stupid things, like…
- Turns every decision into a tactical “expense” decision instead of a strategic “growth” decision
- Makes you fire people you shouldn’t (sometimes a good thing, but, often, a myopic forced knee-jerk)
- Gives the existing investors and new investors low-ball the next round of funding because you really need the money
- Eventually kills the company
In other words, running out of cash = death. And playing chess with death is a game that takes caution and planning.
Here’s a simple way of modeling “runway left” that lets you think about the problem using nothing but one simple variable — how many people are working for me? The assumptions being made in this model is that you are generating no revenue (safe assumption for a lot of early stage startups), that your expenses are fairly predictable (you can add exceptional expenses into the model) and that you have raised some cash, started spending it, and have an idea of what the monthly burn has been for the last few months. The rest, you can extrapolate.
So, let’s say you are a small company that raised some money, got yourself to a headcount of 10 full time employees, and have $1.5M cash still in the bank. (You probably did a $2, $2.5M round if you started with just a couple of founders).
Calculate like this:
1. What is the average cash burn every month? Get this from your financials, try to ignore the extraordinary items (Beta Launch, quick jet trip to the Caymans, etc.) [Let’s say it’s $150K/month]
2. How many people do you have, full-time, on staff. This is the most important independent variable over which you have full control. Unfortunately, sometimes people have to be cut, and, fortunately, sometimes people need to be hired. In the days of open source software, cloud computing, Scrum, etc. your expenses will be almost entirely determined by how many people you have to pay every month. People are expensive. [Let’s assume there are 10 full time employees]
3. Divide the burn by the people and get the average burn per person. [$150K/10 = $15K/employee/month]
4. So, assuming no revenues (if revenues come in, you can add it to the cash balance before the next board meeting), you currently have $1.5M/$150K = 10 months of runway. If you added two more people, your monthly expenses would be $180K and you would have 8.3 months of runway.
5. Compromise with your investors on what the “danger” signals should be coming from the “months of cash in the bank” number. I always started fundraising when that number dropped to 9 months and below. If it got to 4 months, your fundraising should be in full swing and you should start freaking out if you don’t see any term sheets on the horizon. Below 4 months is danger territory and you should be starting to negotiate with the existing investors and sending clear danger messages.
6. Create a matrix that shows your headcount on one axis and months on the next. Each cell contains how much cash is in the bank. Something like this:
Explanation: The left-most column is the decisions you’ll be making — how many people will you be hiring or cutting. The next column shows the resultant headcount after you make that decision. The “Hire: 0” row means you’re keeping things stead and not changing headcount.
The colored numbers represent months of cash left in the bank (again, remember, no revenues assumed) in the month indicated in the column header.
The colors depend on your definitions of “OK, danger, panic” as discussed below. Here, GREEN: 9+months is OK, YELLOW: 9-4 and you should be fundraising (start at 9 months left), RED: 4 and below, you’re in trouble. GREY: 1 or zero, you’re out of cash and, basically dead.
I try to use this matrix on a single slide in the board deck to answer the question: “How are we doing on cash?” which will always get asked.
The company above, for example, should start looking for cash immediately if it hires two people next month. If it cuts two people, that can wait until January 2011.
The model, of course, can get more complicated. When you hire and cut affects the runway positions. Revenues coming in change the cash balance. New rounds of financing dramatically alter the whole thing.
Here’s a link to an Excel spreadsheet with where you can do some tweaking: HeadCountMath.xlsx
The lessons from this exercise:
1. People are your biggest expense (I am talking about software companies, the only thing I know). Headcount affects cash burn more than office spaces and lunches by far.
2. Remember that employee expenses are not just salaries — benefits, computers, software, soft drinks, etc. all add up and are roughly proportional to the number of people you have on staff. Therefore, taking your burn and dividing by the number of people gives you a good approximation of the loaded cost of taking on new employees.
As CEO, you should be able to get a call in the middle of the night from one of your investors and answer the following without even thinking about it:
1. How much cash do I have?
2. When will we have to get more money?
3. What would cutting two people do to the above answer?
4. What would hiring three more engineers you’re dreaming about do to that answer?
Another interesting thing that comes from seeing this visually and knowing things in terms of dates is that you can start timing company announcements, events, customer wins, etc. on the basis of when you need to raise cash according to the chart.
Don’t know what the rest of you think, but I’m both a quantitative guy and an Edward Tufte fan. I like analytics that manifest themselves VISUALLY.