A company's runway is the amount of time they have until its funds run out. OCV companies are funded with sufficient runway to achieve initial traction and reach an inflection point for fundraising. Faster growth leads to a higher valuation and increases your odds of successfully fundraising.
The #1 mistake founders make is thinking you can extend your runway to success. This leads founders to aim for maintaining a long runway instead of gaining traction as quickly as possible. Preserving your runway seems efficient, but it’s the opposite. Funds in a startup are like the fuel that propels rockets into space. Companies need speed to raise their next round. Using cash to increase the speed of growth is the way to go, even if it shortens your runway. Keith Rabois (Khosla Ventures) explains further,
“If you think about lift in a plane context, a company is only valuable if you achieve lift. Runway is a tactic for achieving lift, and you may need to extend the runway so that you have more time to get lift. But unless you’re actually achieving lift with that extra time, it doesn’t help you.”
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Capital efficiency measures how effectively a startup uses its invested capital to generate growth. It measures how much value you can create from each dollar spent. Prioritize achieving "lift" (meaningful traction) rather than simply extending runway for arbitrary time periods like two years. When fundraising, identify the most critical inflection point you need to reach and structure your financing specifically to achieve that milestone. It's acceptable to let runway drop very low if the company is approaching real traction, as VC’s will readily invest in companies showing clear momentum, regardless of how much cash remains.
Optimize for doing the most with the money you have and growing as fast as possible. If increased spending on one activity has a high probability of generating a lot of usage and/or revenue, take the risk. Measure the speed and potential payoff of actions and go after activies with the quickest payoff. Aversion to spending will stall and kill businesses, so startups should spend efficiently to accelerate their growth.
When evaluating a spending decision 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 means finding many low-cost, high-revenue activities but it doesn’t mean “don’t spend any money.” Maximize spending on activities that directly drive revenue and growth. Don’t maximize for conservation of funds.
In general, we recommend creating a rough operating budget for ~18 months of runway at the start. This is a reasonable time estimate to meet key milestones that Seed round investors would be looking for in their investment evaluation. 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.
Runway Considerations
After closing a round, invest in the company and people (investors expect fast growth!). As the 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 will have demonstrated high efficiency. More efficient companies are 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.