Startup Runway

in Startups, Venture Capital

Runway Questions: why is 18-24 months the “ideal” runway when raising venture capital?

Runway is literally just how many months you have left before your company runs out of money.  As an entrepreneur, you may think you want as much runway as possible, and in one sense, that’s totally true. But as an investor, you don’t want your money to be deployed too slowly because investors are fighting three things: inflation, risk exposure, and opportunity cost.

When I talk to founders who are raising VC for the first time, they’re focused on how long their runway is and how long they can make their seed round last. They’re proud to show how their operating plans can deploy the capital over a 48 month period of time. Sure, from a survival perspective, that’s good, but every VC who hears that is silently cringing and getting ready to pass on the investment. Why?

Venture Capital is a business model. Velocity is part of that business model, and entrepreneurs raising capital need to understand a VC’s perspective. Fundamentally, your company is a financial instrument. VC’s can opine all day about value and passion and drive, and those things DO matter, but from their perspective, those are just boxes to be checked as part of analyzing risk of the investment.

Think of it this way. I have $500k I can invest, and I have two options.

Option 1: Startup A (Fast) with an 18-24 month runway and 10M shares outstanding.
Startup A takes your $500kat a $5M valuation.  Companies generally raise a series A after 12-18 months, and let’s say their series A is $5M on a $20M pre (So $25M post).  So in eighteen months, the book value of your $500k investment is now $1.8M dollars. That’s a 122.68% CAGR.

Let’s say you invested that $500kM on January 1, 2010 (as shown above). After eighteen months, the resulting $1.8M is worth $1.72M in 2012 terms thanks to inflation.

Option 2: Startup B (Slow) with a 48 month runway and 10M shares outstanding.
Startup B takes your $500k at a $5M valuation.  And they raise the same series A as above in forty eight months.  So in 48 months, the book value of your $500k investment is now $1.8M dollars too. That’s a 37.74% CAGR after forth eight months. Four years. Damn.

Let’s say you invested that $500kM on January 1, 2010 (as shown above). After forty eight months, the resulting $1.8M is worth $1.66M in 2014 terms thanks to inflation. That’s already a loss compared to Startup A.

Here’s what the seed & Series A look like.

seed & A

So now let’s look at these investments in terms of “average” time between financing rounds from here on out and we’ll go through Series B and Series C.

The median time between rounds tends to be 15 months

Median time to IPO tends to be 8 years.

time between rounds

Option 1: Startup A (Fast)
If Startup A Raises a Series B fifteen months after their Series A, and then a Series C fifteen months after that, that’s a total of 48 months to Series C. The initial $500k is now worth $42,857,143 in book value, and the investment is much more de-risked, and a series B or C investor may have already bought them out pre IPO so chances of liquidity are higher.

After forty-eight months, the resulting $42.8M is worth $$39.5M in 2014 terms thanks to inflation.

Option 1: Startup B (Slow)
Let’s assume Startup B raises their Series B & C at “average” speeds. That means they’re hitting the same timeframe/value as Startup A in seventy-eight months.

After seventy-eight months, the resulting $42.8M is worth $37.2M in 2014 terms thanks to inflation. That’s a loss of $2.3M dollars. Startup A obviously makes more sense assuming the same outcomes and the overall risk exposure is significantly less.

Here’s the math:

Series ABC

As an investor, fundamentally, the faster deployment time lowers your exposure to risk and inflation. Consider, that the longer time between rounds, the “less likely” you are to raise if you’re not profitable. Not to mention, the sooner you get larger investors in, the faster you lower your risk. By taking your time on your seed, you’re throwing away investor’s money.

So what should you do as a founder?
I suggest building a 24 month budget, and refine and sell it as a 16-18 month budget. You’ll need 3-4 months to complete your series A, and you don’t want to be raising down to the wire.  So, does this mean that you should plan to spend all of the money you raised in your seed? Definitely not. If it takes you three years to raise a series A, good job. You’re default alive, which is better than 50% of companies who fail to raise Series A’s at all.