Your next funding round is always your most important funding round. How much do you need? How much of a funding runway do you need it? What is a funding runway? Who can you get to invest in your business? Is your offer attractive enough? The crucial points depend on where you are at presently, where you intend to go, and how you plan to get there. On that score, I like Ike – and what he had to say about planning!
Plans are useless, but planning is indispensable.
– Dwight D. Eisenhower
Money Makes the World Spin… Faster
Money isn’t everything, but it is arguably the number one resource that can help a business scale up faster and easier. 7 Super Go-to-Market Strategy Plans defines how you can convert other resources like time, technical know-how, and industry expertise, in different stages of your ramp in order to “Go Big.” Not every business founder is looking to start the next Amazon or Uber, but if you are – it’s a decision you need to make early. There are different paths that you can take in the beginning, but if you intend to “Go Big,” all paths eventually lead to raising funds.
Strategy has a lot to do with how you get there. Bezos started Amazon with a $300k loan from his parents, then secured $1 million in seed money, and only needed one $8 million Round A before its IPO. Uber went through 22 rounds before its IPO: 14 for Facebook and 15 for Airbnb.
My aim is to help you follow in their footsteps with the fundamentals you should include in your funding plan.
What is Your Burn Rate?
Burn rate is your financial overhead to maintain operations before generating a positive cash flow. It is a measurement of your negative cash flow from any seed or VC money you’ve acquired. There are two figures to watch:
Gross Burn Rate: If your startup averages paying $40k on salaries per month, $10k for an office, and another $10k for utilities, software licenses, etc., you’d have a gross burn rate of $60,000.
Net Burn Rate: Using the example above, but factoring in that you are generating $30k in revenues per month, you’d have a net burn rate of $30k.
What is Your Funding Runway?
Your funding runway is simply how long you can maintain operations before becoming profitable or needing your next cash infusion – your Series A, B, C, etc. Let’s say you have $300k banked. Using the above examples, your gross burn rate only supports a 5-month runway; but if you were generating $30k monthly, you’d have a 10-month runway.
Insufficient Funds – The #2 Reason for Startup Failures
Absolutely invaluable to this discussion are two articles by Sebastian Quintero: Dissecting startup failure rates by stage and its companion piece, How much runway should you target between funding rounds?
Though his data set is from 1990 – 2010, it encompasses over 35,000 startups of which “6,856 eventually achieved an IPO or acquisition” – 19.2%. For present purposes, I think the key point of his findings are that 79.4% of startups receiving seed money failed to close their Round A. Of these, 97% also failed to be acquired. Thereafter, between each funding round, the failure and acquisition rate fluctuates. Generally speaking, the further a startup is able to go, the more likely it is that it will go further, or be acquired in the process.
Sebastian also refers to a CBI Insights report that is also useful to reference. They report the Top Five causes for startup failure as:
- No market need: 43% – one of the first questions to ask with an MVP.
- Ran out of cash: 29% – what we are discussing here.
- Not the right team: 23% – also part of the present discussion.
- Outcompeted: 19% – another element of the MVP discovery process.
- Pricing and Cost Issues: 18% – in part, another MVP issue.
How Much of a Funding Runway Do You Need?
General market consensus says that you should plan on 12-18 months between funding rounds, many leaning toward 15-18 months, plus plenty of cushion. Miguel Socias of Carta provides additional guidance suggesting that, “CEOs should plan to raise at least two years worth of runway in order to maximize the probability of getting funded.” Both infer that industry and location can impact the calculation.
So, a startup generating no revenue, using our earlier gross burn-rate as an example, should plan to raise at least $1 to $1.5 million for their Series A. Some Series A’s have raised up to $20 million.
What’s a Seed Round, Series A, B, C, etc.?
Series A, B, C, D, and E Funding: How it Works provides a full explanation of the different funding rounds (as one would expect). In summary, they represent different stages in a company’s growth corresponding to its valuation and how much funding it is seeking.
Typical Funding Rounds
|Seed||Variable||$50k to $2 million||Idea|
|Series A||~$15 million||$10 million||Proof of Concept|
|Series B||~$50 million||$20 million||Build|
|Series C||~$100 million||$50 million and up||Scale|
Continuing with our example, if you succeeded in raising $1.5 million of seed money, your goal is to achieve a valuation in the ballpark of $10-20 million within two years. This is doable if you keep your burn rate at $60k per month. But, if your operational expenses in the process increase to $90k per month without generating $30k in revenue, you’ll shorten your funding runway by 7-8 months. $1.5 million divided by $90k = 16.6 months.
Trying to grow without spending more money is a challenge. Simple enough.
The real trick though is that while you are in the process of securing your Seed Round, you should also be laying the foundation and doing the groundwork to getting your Series A. The 18-24 months typically involved may well be the average, but you are not tied to it. Having an attorney and financial services specialist as a core member of your team is a good start for your long-term planning.
Many startups, try using their seed money to develop their MVP which can run $50-200k, or more, by itself. Doing this chews through their initial capital like nothing else. It can be viable if you’ve been fortunate enough to have generous investors wanting to seriously accelerate your launch. Normally, actual development of your MVP is best left until you’ve secured Round A Funding.
Extending Your Funding Runway
The two primary options to extend your funding runway include reducing your operating costs or increasing your monthly revenue. Many experts advise cutting costs. If you were frugal from the beginning, you may not have a lot of fat to trim. Another problem with cutting operational costs is that it can have a negative impact on your partners, employees and customers.
Pricing and cost issues, as well as running out of money, are tied to your ability to sufficiently monetize your app. I firmly believe most startup founders, even many enterprises, do not consider all of their monetization options. This is a HUGE discussion in its own right… actually closer to 6-7 huge discussions. The following posts cover different monetization issues in reasonable depth:
- Everyone likes “free” – so How Free Apps Make Money is important for the majority (90%) of mobile apps.
- All of the primary monetization models – 13 Mobile App Monetization Methods is your checklist.
- The inverse of On-Demand, One-Stop Shops expand your verticals by working with other closely related, non-competing businesses in your region.
- With Big Data and the Data Economy the information you are able to collect could be worth more than the actual products or services you offer; and if nothing else could put some frosting on the cake.
- The Business Case for 10,000% Design ROI shows how many little improvements over time can radically increase conversion rates and how that applies at scale.
- More care must be taken with Virtual Currencies for Mobile Apps but if you do it right, and take care of your legal obligations, they can be a cash cow.
- Cashing in with Mobile Wallets and Loyalty Programs – More than faster checkout and more convenient payment options, it’s hard to imagine a retail chain surviving the next decade without one.
The Pareto Principle is Your Friend
I would add that a quick study of the Pareto Principle, also known as the 80/20 Rule, can be invaluable. Over the past 20 years, I’ve seen that it holds true for just about any sample group of sufficient size. It asserts that 80% of your revenue will come from 20% of your users. It goes further to say that 64% (80% of the 80% of revenue) will derive from just 4-5% (20% of 20%) users — and ultimately that roughly half of your revenue may come from just 1% of your customers. These are your super-users, or whales – they love you. It makes sense then to provide special options (even if just vanity items) to optimize revenue from this very important user segment.
Avoid Reducing Staff
Their first advice is often the worse – cut costs by reducing staff. This works for disruptive influences, slackers and potentially when you need stronger skill sets. These personnel are likely on your short-list to let go whether you’re facing a financial crunch or not. Otherwise, letting go of productive team members is worse than going to a loan shark for 50-100% interest rate loans. You need to factor opportunity cost, time to find and onboard a replacement, continuity of knowledge, the impact of turnover begetting turnover, and finally disruption to team spirit.
Startups are intense. You need to depend on your team to give their all for the business through thick and thin. You have many other options available before firing people.
Creative Options to Extend Your Funding Runway
While it gets off to a slow start, check out 101 Ways To Fund Your Business (That Aren’t Conventional Loans). Some are obvious, and others are non-starters. It’s a sort of checklist to exhaust all of your options – best applied before you hit a financial crunch. On the very low “I need some bootstraps so I can bootstrap” end of the spectrum are business grants from Idea Cafe. That’s a possible $1,000 that could finance the creatives to start a Kickstarter Campaign.
One of the first things I would recommend is spending 2-3 days to see if there are any government programs that could help you. This starts with the Small Business Administration, Service Corps of Retired Executives, the outdated but still valuable Economic Development Directory and supremely awesome Federal Labs Consortium for Businesses.
Another source of prospective investors whom you may not run into locally – can be found through SelectUSA. This is a US government-wide program led by the Department of Commerce. In 2018, SelectUSA facilitated $20.8 billion in foreign direct investment (FDI). This comes from foreign companies investing in US companies doing business in the United States.
Scraping the Barrel of Creative Options
I wouldn’t even call it this, but let’s say you suddenly realize or are forced to burn through more of your funds than you’ve planned – “Whoa, we’ve only got enough funds and projected revenues to get us through 4 of the next 8… or 12 months, what do we do?” Well, first – that’s not the time to start laying people off. You are in business to make money, so tackle the deficit head on by increasing your revenue one way or the other.
Revisit your Go-to-Market Strategy and list of Monetization Options. If you have enough money to get you through 4 months, or even 2 months, consider a crowdfunding campaign. What can you reasonably provide and fulfill to your backers to help you get through the Valley of Death?
Have a newsletter with a sizeable readership? Take stock of what you can offer and easily fulfill. Come up with useful or meaningful vanity products. Grinding Gears Games independently crowdsourcing Path of Exile’s initial development raising over $1.2 million with the help of $12,500 founder’s packs. AirBnb derived some of their funding from selling customized cereal – Cap’n McCain and Obama O’s. If you have an actual product a few months away from release, jump into pre-order sales.
The Difference between Startups from 2010 and 2020
As discussed in Why Startups Fail – A Matter of Process?, there is today an increasing focus on Minimum Viable Products (MVP, and variants of it). Understanding Your MVP will bring you up to speed if you are unfamiliar with the term.
Fail fast and frequently is practically a motto in the startup world. The real test is being able to also fail painlessly – to find a product-market fit practically before any significant investment:
“If a product/market fit is not found early on, there’s no great loss but still much gained in the form of customer feedback. This can be used for reevaluating the project, or to conclude it is not viable before taking on a major financial commitment. If there is a fit, it means there is money coming in which can reduce subsequent funding requirements. When you already have paying customers, it’s easier to attract funding.”
Relative to startup failure rates, an MVP should help you answer whether people need or want your idea, like it better than the competition, spend money on it, and how much. Competition is continuous, so you should be applying continuous product development (CPD) after you’ve launched.
If you follow the advice in this article and keep your eye on the prize, we are confident that you will succeed in getting the funds you need to “go big” or simply sustain your business at its current scale for the long haul. Happy funding!