Yeah, we’re all taking a toll in 2022. Our revenues have shrunk, runways are slimmer, and VCs are less likely to invest. The downturn hasn’t been labeled as a “recession” yet, but after Covid, a new new-normal is here. And a change in our playbooks is due.
As the saying goes: “The pessimist complains about the wind, the optimist expects it to change, and a realist adjusts the sails.” So, from one sailor to another, here’s a quick guide on how to navigate these rough waters.
We’ll focus on the fundamentals of managing a startup’s financial position: calculating your Burn Rate and Runway.
This metric reflects the amount of cash your business burns through (aka, spends) in a month. You’ll need this information to calculate your cash Runway and determine whether your costs-to-income ratio is too low, or whether you can afford to invest more in growth efforts like marketing and advertising.
This is a simple exercise that, as a first step, requires you have your numbers in order. In particular, your startup’s historical expenses.
The formula for Burn Rate is pretty straightforward 👇:
So, go back in time and define a representative month to start with, when your operations could be fashioned as “ordinary”. Then take the starting balance, that is, the amount of cash in hand at that month, and subtract the current amount. And then split the result by the number of months that have gone by.
For instance, if you started this year with $100.000 in the bank and by the end of October there are $90.000 left, your Burn Rate is $1.000 per month
The important thing here is that you go back as far as you consider necessary and take as many months as you can, to soothe the noise from extraordinary movements.
Runway is the question any investor asks when they say “How long can you keep this up?” Expressed in months, Runway shows how much time your company has until it runs out of cash.
To calculate, you’ll need to know your current monthly revenue and current monthly expenses. Then divide the remaining cash by your monthly burn and TA-DA! You have it.
Taking the example above, let’s say you’ll generate $30.000 in sales this month and spend $20.000 on salaries, tools, rent, etc. If you divide the remaining $10.000 over your Burn Rate of $1.000, you’ll get a resulting Runway of 10 months.
Now, your situation probably doesn’t look like the example above. Unfortunately, new sales will be harder since all companies are cutting back costs, and some of your current clients are more likely to churn. So you’ll need to adjust future expenses.
VCs are currently reporting that they expect a 15-20 month Runway to consider investing in a startup, and you’ll need to start fundraising at least 4-6 months before you run out of capital.
After raising funds, investors expect you spend at least a year just building the product, instead of worrying about bankruptcy. So your Runway is currently lower than 12 months you need to consider doing 3 things simultaneously:
As FDR put it, “A smooth sea never made a skilled sailor”. So you are in luck: you we given the chance to prove yourself a trustworthy steward of investors’ money.
Planning for possible situations will help you avoid being caught off-guard during this storm. And a critical aspect of planning is having the right information. So take a spreadsheet (yeah, it’s that simple) and chart your future cash flow for the next 18 months.
No matter how the economy affects your original plans, you will be in a good position to make smart moves and get ahead of other startups competing for Venture Capital.
I leave you to it. Fair winds and following seas, dear founder 🙌!
The Lazo Team 💜.