The runway is one of the key indicators for the entrepreneur to plan the growth of their startup: it allows them to know how long the company can continue operating with the available liquidity. To improve its runway, the company can reduce costs or increase its cash flow through new rounds of financing or growth loans, such as those offered by BBVA Spark.
Planning is essential for an entrepreneur’s business to get off the ground. Beyond offering an attractive product or service, it is essential to have healthy accounts so as not to run out of money before becoming a viable business. The runway is a key indicator. In essence, this metric provides an insight into how long the startup can continue to operate with the cash or liquidity available to the startup.
How is a company’s runway calculated?
To calculate the runway (the time a company has before running out of cash), another related concept must be taken into account: the cash burn rate. The cash burn rate is how much money the startup spends (“burns”) and is generally calculated on a monthly basis.
To put it simply, a company can be compared to a car driving along a road. There are a few litres of petrol in its tank (euros in cash). The petrol used over a period of time would be the cash burn rate. Meanwhile, the runway would be equivalent to the number of kilometres it can travel on that petrol (months in the case of the company).
The formulas for calculating both metrics are as follows:
The runway is a metric that is commonly used in the early stages of a startup, when the company goes through the so-called “valley of death”. This concept refers to the period of time from when a startup gets its initial funding until it starts making money.
To better understand these concepts, a practical example is given.
- Opening cash balance. This is the cash the startup is counting on at the beginning of the month.
e.g. 200,000 in cash at the beginning of the month.
- Closing cash balance. The cash balance after income has been added and expenses have been deducted (i.e., payments to suppliers, workers, rent, etc.). As discussed above, early-stage startups might not have made any money.
a) e. g. If a startup has had expenses of 20,000 euros for the month in total and hasn’t made any money, its final cash balance for that month is 180,000 euros.
Cash burn rate = (200,000 – 180,000)/1= 20,000. That is, 20,000 euros per month.
b) If a startup has had expenses of 50,000 euros for the month in total and has made 20,000 euros, its final cash balance for that month is 170,000 euros.
Cash burn rate = (200,000 – 170,000)/1 = 30,000. That is, 30,000 euros per month.
e.g. a) ‘Runway’= 200,000/20,000 = 10
e.g. b) ‘Runway’= 200,000/30,000 = 6.7
Therefore, company a) can ‘spend’ 10 times its cash burn rate (20,000 euros) until the cash runs out. The company will therefore have a 10-month runway. In other words, the company can be in operation for 10 months until its cash is zero if it does not make money or raise new funds.
Meanwhile, company b) could only be in operation for 6.7 months.
What is the runway for?
One of the challenges that a startup must face is obtaining the financial backing necessary to develop its business plan. Therefore, the calculation of the runway is key for entrepreneurs: it allows them to know if they need to raise more funds to move forward with the project. At ‘TechCrunch’ they recommend that, in general terms, startups in the seed stage or series A plan their ‘runway’ for at least 12 to 18 months.
In addition to being useful for entrepreneurs, this metric is also useful for investors when deciding whether to participate in a new round of financing. For example, if they perceive that the company ‘burns’ or spends a lot of money and will only be able to survive on the funds for a few months, they may be more cautious about contributing capital to the project.
How can the runway be improved?
It is important to plan how the company spends its resources in order to maximise available liquidity and have optimal cash control. To improve its runway, several avenues can be pursued:
- Increase liquidity. In the event that the startup seeks to increase its runway by increasing its cash flow mainly through fund raising, it can resort to different sources of financing. The most common are:
- Founders. The creators of the company invest an amount of money in it to launch the project.
- Friends, family and fools. This is the name given to early investors of a startup.
- Debt. When companies are at a higher growth stage, they can also access debt instruments. BBVA Spark provides specialised financing solutions to support high-growth companies, such as venture debt (a financing model that allows entrepreneurs to obtain financing without reducing their equity) and growth loans (enabling high-growth companies to initiate new scaling processes).
- Venture capital funds. Another option for raising capital is to resort to venture capital funds and present the project to them so that they can participate in financing rounds. The size of these rounds increases as the startup grows.
- Reduce expenses. In order to do this, it will be necessary to analyse whether there are any budget items that can be cut or reduced without affecting the company’s development. For example, it is possible to look for more economical alternatives to reduce office or warehouse rental costs.
- Renegotiate payment terms. A final way to improve its runway is to renegotiate invoice payment terms with suppliers.
The runway is essential for startups, especially when they are at an early stage of growth. Running out of cash is the main reason why early-stage technology companies fail, so managing the runway is essential to their survival and to their continued progress towards profitability.
