How much runway does a startup need?
My rule of thumb
I’ve noticed a trend emerging among founders who I meet with as part of my day job. It has become increasingly in vogue for early-stage founders to go to the capital markets and raise funding for 12-18 months of runway, or operations, during primary pre-seed and seed rounds (not bridge rounds or extensions).
When I ask why, the usual answer is minimizing dilution, selling as little equity as possible.
This makes some sense intuitively — founders with the conviction needed to raise money from VCs should believe so strongly in the potential of their startup that they want to hoard as much for themselves as they can.
However, I worry that for many founders this technically correct approach will cause cash flow problems, which have a nasty habit of killing young companies.
Data from Carta backs up my concern. In the overwhelming majority of recent startup vintages, less than 35% of seed rounds got to a Series A in under 2 years.
Capital structures for startups are something VCs ought to have opinions about, so this post explains what I generally advise founders to do instead.1
I write Molding Moonshots in a personal capacity.
If you are building in deep tech and thinking about raising pre-seed, seed, or Series A funding, I’d be more than happy to have a chat on professional terms!
Send me an email and we’ll find a time.
My recommendation
I think founders should generally aim to raise enough capital to fund about 2 years of operations, perhaps a little bit more. Ideally, this time would be divided as follows:
building time — heads-down progress on building the firm for 12-18 months, achieving the milestones investors in the most recent round underwrote
fundraising time — around 6 months to go back to the capital markets and raise the next round
margin time — perhaps 3 months of margin
Here’s a little bit more about what I think should be happening in each period
Building Time
Typically when I talk with founders who are fundraising, one of the things we talk about during the first conversation is what they plan to do with the money.
The goal for early-stage startups is generally a technical achievement or sales objective.
My view, certainly for the startups that I decide to continue the conversation with, is that a good primary use of capital:
is achievable within about 15 months
is going to at least double the value of the startup if it is accomplished on time and on budget
During the building time, founders and their team should execute the plan.
Fundraising Time
During this period, the founder goes out and raises the next round, which ideally values the startup significantly more than the last round based on having accomplished the goal in the last round, and still having incredible growth potential.
Nobody likes fundraising, for a couple reasons.
First, when a founder is trying to raise capital from a VC (or when a VC is trying to raise from its own investors) they aren’t as focused on running the firm.
Second, when somebody goes to the capital markets, it’s typically because they’re in a bet-the-company sort of situation. That’s an incredibly scary position to be in as an entrepreneur, especially for somebody who sees the company as their life’s work.
So everybody who needs money wants to raise it quickly. And it almost always takes longer than the fundraisers want.
A raise of 6 months is not unheard of, and that is generally what I recommend founders budget for in the runway.
There are a number of idiosyncratic factors that may affect how long fundraising takes. One of the most clear in the data is time of year.
Another factor is geography.
Yet another is startup sector. VC as a whole is a cyclical industry, and that means the startups which rely on them are as well. Even within VC, sectors are hot for a time and then not. It’s much more difficult to fundraise if a startup is building in a sector that isn’t hot. Climate, for example, was an incredibly busy sector a few years ago — and now my impression is that it isn’t. And during the 2010s, very few investors were interested in defense startups. VC funds today can’t get enough of them.
Margin Time
Hopefully this runway is not needed, and winds up being cash in the bank when the wire from the next round clears.
However, startups are a high-risk type of business. Founders who successfully raise capital are often fairly good at reducing epistemic risk, or uncertainty due to gaps in knowledge through their work. Investors who don’t trust a particular founder’s judgment will never be able to get comfortable with this, and should just stay away from the founder’s firms.
However, it’s much more difficult to handle aleatory risk, which is uncertainty due to randomness — especially when proving out a new business hypothesis. People who get nervous about aleatory risks should probably stay away from startups and VC as asset classes.
Margin time is mostly meant to handle the inherent aleatory risk, and give the company a few months to deal with an unexpected road bump.
If a startup gets into it, they should probably already be thinking about raising an extension round, an acquisition, or an acquihire.
Why I think my approach is better for everybody
The primary reason I think founders should like my approach better is that raising for more runway can effectively justify a fair and higher valuation (or cap) from VCs.
Most startups that I’ve encountered seem to set the valuation as a function of the amount they have to raise and the dilution they think they can sell to prospective investors.
The VC gets a vote too (they often have a minimum ownership percentage they need to buy) and there’s typically some negotiation, but this is a common starting point.
Cranking up the numerator for a valid reason like more months of operations creates a justifiably higher post-money valuation, which is often attractive to founders and existing investors for a whole host of reasons.
I’m honestly surprised this isn’t more compelling, especially when there are already investors on the cap table.
All the other reasons have to do with the next round of financing that the founders will hopefully go out and raise quickly and painlessly and at a great markup.
First, I think the two year runway vision is far more realistic. I describe myself as optimistic — otherwise I couldn’t be in the business of helping startup founders. At the same time, the engineer in me loves data, and Carta’s data looks compelling to me.
Second, during the period where the startup is focused on building, it is easier to both set and achieve more ambitious objectives with more time.
This is important because in order for everybody to be happy, the next round of financing needs to happen at a significantly higher valuation. The best ways to rationalize this are a technology improvement, or an increase in revenue.
If not enough time passes between rounds, a new VC might only be open to coming in at the last round’s price (a flat round). Founders have a much stronger argument against this when they’ve accomplished a lot since their last round, and that is more likely with more time.
My last point is that heading out to raise money with only a couple months of cash left in the bank places founders in a remarkably weak negotiating position — one which I’m pretty convinced is bad for them, their employees, and their (past or future) investors.
Having minimal runway left at the start of a fundraise makes it much more difficult to negotiate against a VC (especially once a startup has reached the point in due diligence where it’s sharing a financial plan that…includes cash in the bank).
It also makes it much harder for the startup to walk away from a VC it meets and doesn’t want to work with, or who offers terms the startup doesn’t like. If the alternative is shutting down, that becomes an excruciating choice for founders, who do have a fiduciary duty to their existing shareholders.
I believe that by raising enough capital for two years of runway, and starting to raise the next round with enough runway in the bank, this is a totally avoidable startup failure mode.
Every startup is different. What works for one firm may not work for another. Just because I express it as my general point of view does not mean it applies to any specific situation.