A little bit of background
Investment cycles, like every other economic cycle, go through crests and troughs. Investment into Indian start-ups is down by about 79% in the first 5 months of 2023, clearly indicating the harshness of the ongoing funding winter. Large scale lay- offs, pay cuts and other drastic cost reduction measures are commonplace among start-ups. The situation in these boardrooms cannot be vastly different from that of a war room.
Speaking of wars, an asset of unparalleled importance is a runway. This strip of concrete is capable of winning wars and offers a distinct strategic advantage. For generals and strategists, awareness of their runways can prove to be the difference between victory and defeat.
What is a cash runway?
Meandering back to the world of finance, cash runway is an estimate of how long the business can operate before exhausting its cash reserves and requiring an external infusion of cash. Dividing a company’s cash reserves by its net cash outflow (referred to as burn) every month will show us the runway that it has, in months.
Historical or Projected?
A balanced approach in which the historical trends are adjusted for forecasted events is likely to give a judicious estimate of the runway available.
Why should it be tracked?
Running out of cash is the second most common cause of failure among start-ups and the first step in addressing any problem is knowing when there is one.
The cash runway metric assumes special significance if the company is at an early stage where it relies heavily on external funding to conduct its activities or if its business operations are severely hampered / altogether halted by exceptional events. These events may be internal or external.
Cognizance of the runway available allows a company to approach fundraising proactively. The company can set milestones that need to be achieved to unlock a desired valuation with a reasonable idea of the time it has to get there. Thus, it can analyze situations and balance its growth spends while leaving an adequate runway to meet contingencies.
It can help flag the adverse impact of business decisions. These can then be investigated to understand cause and effect to avoid future occurrences.
Shoring up investor confidence is a key consideration for all companies and the knowledge that the company is conscious of its runway and factors this metric in while making core decisions will go a long way. When investors talk about concepts like runway extensions (covered in the subsequent sections), there is an implicit assumption that this metric is being carefully looked at by the leadership team.
What is your runway telling you?
In a recent advisory to its founders, Sequoia described a bucketed approach to evaluating runways and deriving action items based on them.
We can bucket runway numbers into three major categories:
1/ Runway is less than 12 months: Here, focusing on your runway is the top priority and can be the difference between survival and oblivion.
2/ Runway is more than 12 months: This is a rather dangerous zone. It is like a one goal lead in football- looks comfortable but can quickly disappear with a drop in focus. Thus, it calls for a strict vigil on the runway number.
3/ Runway is sufficient to get to the next round: This is an area of relative comfort, yet the process of cost and overall business model refinement is key to ensuring the organization stays in this zone.
It was also observed that there is a tendency among firms to bucket themselves in the third zone while in reality they may be closer to the second. Consciously avoiding bias while identifying with a certain zone becomes crucial.
Is there an ideal runway number?
The simple answer is that there isn’t an ideal runway number.
While there are reports suggesting that companies typically have a period of 18-24 months between funding rounds, this is subject to multiple factors and should not be used as benchmark without accounting for those factors.
Runway extensions
Runway extensions are common in today’s environment where external uncertainties fueled by macro- economic factors, geo -political risks are compounded by the internal challenges faced by growing organizations still working on fundamental aspects of their business model.
Internal optimization
While there are some off the shelf ideas that a company can consider:
1/ Identify areas with significant burn and evaluate the gestation period
Despite certain verticals or projects having extraordinary long-term potential, it would be prudent to consider temporarily halting them in order to conserve cash reserves and extend the runway. Once subsequent funding is secured or routine operations are generating sufficient cash, the company can resume these fund intense projects.
2/ Work on credit terms given to customers
A sale made may not immediately translate into cash inflow due to generous credit terms. On the other hand, these terms may enable larger volumes. It is key to work out a balance between the factors to retain customers and realize revenues earlier.
3/ Raising fresh funds at less-than-ideal valuations
Raising a bridge round or a round at a valuation below what is considered ideal or in extreme cases, even below the last round may allow for some breathing room. Recently, Pharmeasy, an Indian online healthtech startup raised funds at a 90% lower valuation (as compared to its previous round) to meet debt obligations.
If viable, debt can be an option to raise funds to avoid equity dilution in case of overly deflated valuations.
A more appropriate alternative would be to understand the approach to the extension exercise:
1/ Get Granular
Before getting to the decision-making aspect, it is imperative to understand the nuances of the P/L. A deep dive into each item of expense to gauge its causes and effects will help in making informed calls.
2/ Derive action items and set quantifiable targets
Post analysis, armed with an idea of what is essential and what is not, a list of actionable items needs to be derived. This translates the top-level ideas into execution level items that will ultimately lead to goals.
At this stage, a simple two by two matrix based on ease of execution and impact plotted on two axes can provide a framework for simplifying the process.
The outcome of this step must be a clear and achievable target. “A runway extension by X months” leaves little room for ambiguity in the minds of the execution team, allowing them to focus on action items.
External impact
Formulating a plan to extend the runway without taking into account the effect of macro-economic factors will seldom be successful.
Consideration of factors like:
1/ Sensitivity of the industry to geo- political risks and dependence on the global economy,
2/ Change in industry trends in terms of technology, consumer perception and others,
3/ Investor sentiment in case the company is approaching a fund raise
will ensure that internal optimization efforts are in sync with the external environment and give a more realistic view of the task at hand. The organization can then simulate scenarios to target the best case while being prepared to survive the worst.
Common pitfalls in the way it’s arrived at and used
1/ An over-emphasis on this metric may lead to hesitancy in making high growth decisions which could hamper long term trajectory of the company.
2/ Runway analysis is sometimes treated as a one -time exercise and this could have disastrous consequences as this a constantly changing metric based on the way the business grows and functions. There must be conscious and continued efforts to understand the effects of business operations on the runway.
Listen closely
Any metric looked at in isolation is unhelpful at best and harmful at worst. Cash runway is no exception.
The prerequisite to tracking a metric is to view it in the context of achieving specific goals. This could range from planning for the next round of fundraising to validating key strategic decisions.
Utilizing your cash runway to preempt dire situations and steer through a period of limited funding is the ideal use case.
