A company's runway is the amount of time they have until their funds run out and they are unable to continue operating. Companies should have sufficient runway to achieve a set of milestones that generates an inflection point for the business, reflecting an increase in valuation and the odds of a successful round of fundraising.
Given that growth rate and revenue directly drive valuations, the most risk averse approach in managing a startup’s runway is going to focus on leveraging your funds to drive growth. Funds in a startup are like the fuel that propels rockets into space. Companies are by default standing still, and burning fuel over an extended runway will have startups losing momentum before hitting escape velocity.
Capital efficiency is an essential concept to understand relating to how to effectively propel your companies forward. Utilizing the money you have available to be efficient with driving revenue will be a consideration for future investment and motivate spending towards goals effectively.
When evaluating the decision to spend on a new opportunity, assess if your company is spending as little money as possible to drive as much revenue as possible in making that decision. Being capital efficient in those decisions means making as many low cost, high revenue ones as possible relative to the revenues generated. What you want to maximize in managing your spending is revenue and growth, not conservation of funds.
Spending as companies are not yet ready to sell when the timeline for generating revenue is less clear in the shorter term can still prepare for catching up to higher efficiencies later. Doing things that don’t scale at early stages and driving on milestones motivated towards driving high growth rates and high recurring revenue will be money efficiently spent.
Aversion to spending will stall and kill businesses, so startups should spend efficiently towards accelerating their growth.
In general, we recommend each OCV company to create a rough operating budget for ~18 months runway at the start. We believe this is a reasonable time estimate to meet key milestones that Seed round investors would be looking for in their investment evaluation. Of course, market conditions and company-specific needs may increase or decrease this estimate. The key is to plan for and allocate resources ($) to meet milestones that will (1) demonstrate sufficient traction to secure new funding from investors and (2) increase the valuation of the business.
- Milestones to be reached prior to the next round of financing
- What resources / teams are required to reach these milestones?
- Aim to grow the company 20% every two weeks. Company Goal Setting and Growth
- Burn rate
- At your current operating level
- How much faster would you be able to grow if you increase the burn rate?
- A long runway doesn’t make a company sustainable - startups need to focus on growing fast
- After a fundraising round, aim for 18-24 months of runway. Fundraising should take place with 6 months of runway remaining (with less than this investors will view unfavorably)
- Macro environments
- Funding availability
- Talent pool availability
- Global economic outlook (impacts customer purchase decisions / contract size and terms / sales cycle)
There are limited funds companies have available. OCV will help provide input into decision making around how to leverage this effectively and help inform on considerations above. An effective founder needs to cultivate a sense of scrappiness, assess tradeoffs, and drive on overarching goals regardless of obstacles.
The Oscillating Growth Model
After closing a round, invest in the company and people (investors expect fast growth!). As runway shortens (about 1/2 way), reduce the speed of investment so new team members have a chance to ramp up and increase productivity. By the time you’re ready for the next fund raise, the company would have demonstrated high efficiency. More efficient companies will more likely to raise new capital. Once you close the next round, cash is in the bank, you can hire fast again.
Typical revenue target for a Seed stage company will likely remain at $1M ARR. The bar for secondary metrics around the quality of the business (i.e. gross margin / sales efficiency, etc.) as an alternative to recurring revenue will likely increase in a constrained funding environment.
The Rule of 40 is a popular metric used in the SaaS industry to evaluate the overall health and growth potential of a company. It helps assess the balance between revenue growth and profitability.
The Rule of 40 states that the sum of a company's revenue growth rate and profit margin should be equal to or greater than 40%. In other words:
Revenue Growth Rate + Profit Margin ≥ 40%
A company with a high growth rate but negative or low profit margin may struggle to sustain its operations in the long run and should account for this in balancing rapid growth with healthy profit margins.
By focusing on both revenue growth and profitability, the Rule of 40 encourages companies to find a balance between investing in growth and achieving profitability. It serves as a guideline for evaluating the overall financial performance and sustainability of a SaaS company.