Burn Rate and Runaway

Burn Rate and Runaway

Why Are You Hearing So Much About Burn Rate and Runway Right Now?
Runway and burn rate are always essential metrics. It’s critical to be on top of these measurements during challenging times like the ones we live in now. So here’s how to look ahead at your runway, calculate burn rate, and critical considerations for leaders and startup founders right now.
Nearly all startup founders will have sleepless nights. But you bet that most of these sleepless nights come back to one common problem – running out of cash. So cash flow management could be responsible for a significant part of business failures.

Two terms are featured in more news articles and posts today: burn rate and runway. So why do burn rate and runway matter to all the companies?

All know that a plane must run a certain amount of tarmac before it takes off. So likewise, a business owner must calculate how many months of business activity can afford without intake.

Those operating expenses are quantified as your burn rate: how much cash you spend on average in a given period (e.g., per month). Assuming your income stays the same, increasing your burn rate (i.e., consuming more every month) shortens your runway. Conversely, decreasing your burn rate lengthens your runway.

Runway and burn rate are essential metrics when the economy is good. But it’s even more critical to be on top of these measurements under challenging times.

Of course, more robust financials means more cards you hold in conversations with investors. Alternatively, suppose fundraising isn’t an option. In that case, you need to know that the cash you have on hand can see you through until the storm has passed and the economic climate changes again.

Here’s how to look ahead at your runway, calculate burn rate, and critical considerations for leaders right now.

How to calculate runway and burn rate
To calculate how much longer your cash will last (i.e., your runway), you need to know how much money you’re spending every month (your burn rate).

There are different types of burn rates to consider. Depending on your circumstances, you’ll either want to use gross burn rate, which only factors in expenses, or net burn rate, which factors in your income and expenses.

Suppose you’re an early-stage startup with no revenue. Using your gross burn rate as the default metric could be more meaningful. Instead, track the net burn rate if you have a fairly predictable cash inflow.

To make more sense calculate the gross burn rate and simply add up all your monthly expenses.
To calculate the net burn rate, choose a specific time frame, subtract your end cash balance from your starting cash balance, and divide by the number of months. Let’s look at a simple burn rate example.

Starting cash balance from January 1, 2022: € 1.000.000

End cash balance from October 31, 2022: € 400,000

(€ 1.000.000 – € 400,000) ÷ 10 months = € 60,000 monthly net burn rate

Once you know your company’s burn rate, you can calculate how many more months your cash will last if you continue to spend money at the same rate.

For example:

If your burn rate is € 60,000 and you have €400,000 in cash:

€ 400,000 ÷ € 60,000 = your runway is 6* months
*A/N: I know that mathematically it’s six months and 20 days, but let’s keep it safe.

Why runway matters
It’s essential to know your cash flow position. You need to know how much you’re spending every month and how long you can sustain those expenses with your current revenue and taking into account forecasted revenue growth.

Your calculations might change depending on whether you’ve sought external funding. Many startups backed by venture capital (VC) have higher expenses than revenue. They need VC fundraising to grow and develop their product. They are not typically concerned with building a long runway.

Bootstrapped businesses rely on their profits to cover their expenses. They aim for positive cash flow annually, and have to monitor their burn rate to ensure a long runway.

Instead, startups expect high burn rates in their early stages when investing heavily in hiring, research, development, and marketing. Many VC-backed startups have a strong negative cash flow. If you plan on a high cash burn rate, bringing in more money is the only way to build your runway. These startups boost their cash reserves through fundraising.

When the economy is good, investors are more willing to take calculated risks on new companies, including those with shorter runways. But in lean times, when investors spend less overall, they’re more interested in the startups with underlying solid financials. Runway is one measure of this sustainability and resilience.

Investors might see runways between 12 to 18 months as reasonably solid in more bullish economic environments. (In this context, it’s not unusual for startups actively fundraising to have runways under six months.) However, the dynamics can shift in a less bullish economic environment.

Given that fundraising will be more challenging over the next couple of years, some top investors now recommend that startups build out a runway of 12 to 18 months. Some are even pushing for 24 months.

In other words, startups should make sure they have enough current cash – or expectations of future cash generation – to cover their expenses for one or two years, given the uncertain fundraising environment that could still lie ahead.

That aim is undoubtedly ambitious for many companies, but unfortunately, no one knows how long the predicted recession will last.

So even though the downturn might not last three years, raising funds can take many months, even in good times. Startups with higher burn rates may face additional funding challenges in a bearish economic climate. For some companies, this might mean difficult choices in the months ahead, such as cuts for optimizing for a longer runway or spending in pursuit of growth.

Runway shrinkers
The runway is calculated assuming your burn rate is at least somewhat predictable. However, the burn rate can shoot up unexpectedly, and revenue can dip just as suddenly, both of which shorten your runway. Scenarios that might cause either of these include:

More competitors: Your relatively quiet market has been invaded by competitors. Your marketing budget increases faster as you compete to be heard over the noise, raising your monthly burn rate.

Big churns: Your most significant account hasn’t renewed its contract: suddenly, your runway calculation has lost a considerable chunk on the income side.

Legal costs: Unexpected legal or administrative issues drain financial resources, increasing your burn rate.