How founders should think about runway: A guide from Sequoia Capital
Pricing your product based on costs & Spotify’s DIBB framework.
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How founders should think about runway: A guide from Sequoia Capital.
Don’t price your product based on costs. Why?
Spotify’s DIBB framework features for better decision-making.
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📜 DEEP DIVE
How founders should think about runway: A guide from Sequoia Capital.
Founders often view runway as just a number or equation, but VCs expect them to think beyond that. Sequoia Capital shared a framework on how founders should approach the runway. In this write-up, we will discuss...
Runway Reality
What is your runway right now? How should you calculate it?
How should you think about how much runway you need?
How do you extend your runway if you need more?
Let’s deep dive into this….
The basics: What is a runway?
It’s your cash balance divided by your monthly burn.
If you have $10M in cash and $0.5M in burn, you have 20 months of runway
But it gets a little more nuanced than that. The cleanest way to look at your cash balance is net cash, which is the cash you have on your balance sheet minus any debt you’ve drawn.
If you have $10M in cash but you’ve drawn $5M in venture debt, you really have $5M of net cash and you should use that number to think about your runway.
But why? The reason is that debt is borrowed money. It’s not yours. You owe it to a creditor. Similar to how you make personal budget decisions based on your assets minus whatever debt you owe, you should think about your company’s cash position the same way.
The TLDR is that having a line is a helpful lifeline when you’re facing a cash crunch, but drawing it comes at a cost. It makes it harder to raise your next round. It comes with covenants which means debt holders can own more and more of your company. It can be a negative signal, and it can generate a lot of overhangs.
That said, one of our recommendations, if you are tight on cash, is to secure a venture debt line and just not to consider it part of your runway. Ideally, you don’t draw on it unless absolutely necessary, with eyes wide open to the tradeoffs
Monthly burn—this is different from your net income.
Net income is an accounting concept. Burn is cash in minus cash out.
It takes into account things that aren’t in your monthly P&L: for example, if you have to buy inventory upfront, or if you have capex outlays upfront, or for a subscription company if you collect upfront on yearly contracts—all of these things impact your cash burn. It’s critical to have a very tight grip on what your cash burn is. There may be ways to reduce the gap between EBIT and free cash flow—maybe that means paying your suppliers a little later or collecting revenue earlier.
If you have a lumpy business, meaning you have to provide cash upfront to build out capital expenditures or you’re purchasing inventory, it’s existentially important to have a very detailed understanding of your expected cash outlays. If you’re not careful in managing and forecasting these outlier expenses, then your runway can turn out to be 3 months when you thought it was 15.
One more thing: Runway is not static.
Just because you have 8 years of runway doesn’t mean you can forget about it and assume you’re fine. As your revenue and expense base change, your runway can change very quickly. You want to stay focused on the burn number. You should be calculating your runway every single month and watching that number religiously.
A Mental Framework For Founders - Runway and Milestone
If you are reading this newsletter, previously I have mentioned “You are raising fund not to increase your runway, but to achieve your milestone”
As a founder, how should you look at this graph? Suppose you and your CFO put your heads together, and your best guess for how cash changes over time looks something like this chart.
This is your cash-out point. 12 months before that, it’s time to think about raising again.
Runway doesn’t come in a vacuum. It’s intimately tied to meeting valuation milestones.
Imagine you’re driving your car on the freeway and running out of gas. What matters is not how many gallons of gas you have in your car, but whether it’s going to last you until you reach the next gas station. Think about what your goal is for your next fundraising. Maybe it’s an up round. Maybe it’s a flat round. Maybe it’s a down round. Maybe it’s to reach a cash flow positive.
Whatever your goal is, which is a conversation between the leadership team and the board, there is some valuation milestone attached to achieving that goal. Figure out what metrics or “fundamentals” get you to your goal. Maybe it’s ARR. Maybe it’s Gross Profit. This is the green line on this chart.
The rough mental framework is that well before you run out of cash, you need to make sure you have the fundamentals in order to meet your next valuation milestone.
These two lines are intertwined (Previous image). There’s a delicate balance in your scenario analysis between investing in growth and burning cash in order to make sure that you are leaving enough runway to meet the next milestone. It’s important to hope for the best but plan for the worst as you are plotting out how to make the math work.
Raising your next round on pure story is not enough anymore.
That worked when the capital was plenty, but investors are now going to care about your metrics, and more importantly your financials. So it’s important to make sure that you are focused on getting that valuation milestone to the right place.
Now, you’ve done the exercise of figuring out your runway versus your metrics and valuation fundamentals. There are three possible scenarios for your runway situation:
Bucket 1: <12 months of runway, when it is existential to focus on your runway
Bucket 2: 12 months of the runway but not enough to raise a flat round based on rational metrics: Here it’s critically important to focus on the runway.
Bucket 3: Enough runway to raise a flat round, up round or reach cash flow positive: Stay the course and continuously optimize.
Some founders are in Bucket 1. A few are in Bucket 3. But many are in Bucket 2. If we can emphasize one point in this writeup it’s this: many founders may think they’re in Bucket 3 but are actually in Bucket 2.
The financials that you have to reach to cover your next round have changed. The bar has been raised. Many of us are 3-4 years away from reaching our last valuation, with less than that amount of cash. In that case, it’s critically important to focus on managing the runway, even if you have years of runway remaining.
So - how to extend your runway?
If you take us at our word that all probably need more runway than thought, the question is: How do you get it?
Like many things in business, it’s very easy to say and it’s very hard to do.
The first step in getting very tactical is to understand your current state.
This means looking deeply into your P&L. If you’re talking about runway, that means you’re losing money every month. So you have to figure out where the net loss comes from. Once you’ve identified the specific places in your P&L causing your burn, you can start thinking about which dollars yield efficient growth and which are not as helpful
To understand which parts of your P&L need to be addressed, begin with the big picture and break it down into parts. Starting with net loss, you can break that into two parts: gross margin and opex.
Then break each of those down into component parts: ○ What are all the drivers of your gross margin? What is the cost of sales, etc? ○ What are all the drivers of compensation opex and non-compensation opex? How much of the opex is dedicated to computer hardware, hosting and subscriptions, etc? ● Keep breaking it down until you have a detailed view of the components that contribute to total net loss.
Once you’ve identified the important contributions to your burn, you can plot them in terms of their burn impact on the y-axis. Then there’s the ease of execution:
how easy is it to address and how big an impact does it have? Unfortunately, you’re not likely to find many items that are high-impact and easy to execute. Changes that extend your runway a lot will almost certainly be difficult. This plot is important because it will set your roadmap for the actions you take to extend your runway
Once you understand the levers available to impact the runway, you can use them to set a goal. Your goal should be oriented around how long it’s going to take for you to reach a rational milestone. Let’s say your goal is a flat round. Given the market conditions, for many of us that’s going to take us three years.
To unpack why that is:
Say you hypothetically raised your last round at a billion dollars, and you have five to 10 million of ARR.
if you want to raise your next round at a billion dollars, you might need 75 to 100 million of ARR, which might mean you need to grow about 10 to 15X.
It takes time to do that. It very well might take three or four years
If it takes three years, recommend you have four years of runway. The reason: as mentioned earlier, you want to raise 12 months before running out of money. Generally, investors view it as a bad sign to have a very short runway, so you want to avoid being in this situation when raising a round. So the time you need to hit your goal plus 12 months is the ideal runway that would suggest.
One recommendation: When you decide how long it will take to reach your goal, be very realistic. Use public comps and ask the toughest board member. Ask her what it will take to reach a flat round based on rational milestones, and then add 12 months.
So now you’ve taken the steps to understand where you are, and you’ve broken down your P&L to understand where the money goes. You’ve plotted your options in terms of ease-to-execute versus burn impact. And you’ve set a goal based on rational milestones.
So let’s say hypothetically you need to cut your burn from $3 million a month to $2 million. We don’t want to sugarcoat this: It’s going to be hard. Of course, a people-related cut is the hardest decision any leader makes. Beyond this, you may face many challenging and nuanced decisions:
If you’re a global company, you might need to reevaluate certain markets.
If you’re a company that’s relied on a marketing or sales investment in order to grow, you might have to reevaluate your strategy.
You might have to increase pricing. This is scary, especially if you don’t have time to fully test the value proposition.
The big thing to remember is this: If you take the steps necessary to extend your runway in line with rational milestones, confident you and your whole company will be better on the other side.
So Overall :
You likely need more runway than you think.
Ultimately, your next round will be based on your metrics, which is going to be reflected in your financials.
Be real about what bucket you’re in. Think most companies are in Bucket 2, which is more than 12 months of cash, but need to make some changes.
You have what you need to win. You can execute and we’re here to help you do that
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📄 QUICK WIN
Don’t price your product based on costs. Why?
Founders often struggle with pricing their products correctly early on. Many make the mistake of setting prices based on their costs, especially in non-software startups. While this might seem logical, it’s not the best approach. Here’s why you should consider “unreasonable” pricing instead:
The Problem with Cost-Based Pricing
It doesn’t account for the value you’re providing to customers.
It can limit your growth potential and ability to invest in improving your product.
It may attract price-sensitive customers who aren’t your ideal target market.
The Benefits of “Unreasonable” Pricing
Identifying Your Ideal Customer Profile (ICP)
High initial prices help you quickly identify customers who feel the pain point most acutely.
These customers are willing to pay more for a solution, even if it’s not perfect yet.
Validating Market Demand
If people are willing to pay a premium, it confirms there’s a strong need for your product.
This validation can save weeks of experiments and help you focus on the right target audience.
Accelerating Product Development
Higher initial revenue allows you to invest more in improving your product faster.
You can build specifically for your ICP, ensuring product-market fit.
Real-World Example
I see a lot of founders launch a website, with:
A logo that was just an emoji
An onboarding flow using Typeform
A database in Airtable
Also, set the initial price on the higher end. Despite this - they have seen good outcomes of getting a few people onboard 5-6, why? They felt the pain point so strongly that they wanted it solved at all costs.
The Inverse Relationship
There’s an inverse relationship between how painful a problem is and how “perfect” the product needs to be:
More painful problem = less perfect product + higher willingness to pay
Less painful problem = needs to be perfect + price sensitivity
When to Launch
Once your product is 70-80% ready for your ICP, they will likely convert. If not, it may indicate that the problem isn’t worth investing more time into, as the product will be hard to grow.
Long-Term Strategy
While starting with “unreasonable” pricing can be beneficial, it’s important to note that this approach isn’t permanent. As you grow and expand your market, you may need to adjust your pricing strategy. However, the initial high pricing helps validate the market, identify your ICP, and provide capital leverage for faster growth.
Remember, don’t let perfect be the enemy of good. If you’re solving a truly painful problem, your early adopters will be willing to pay a premium for an imperfect solution.
Even in one of the previous writeups, we have shared 5 frameworks that can help you to find the best pricing strategy for your startup.
Spotify’s DIBB framework features for better decision-making.
Spotify created the DIBB Framework to help align its entire organization around a consistent decision-making process. It helps founders derive insights from their data and identify the right calculated risks to take.
There are four parts to it:
Data → Gather and analyze accurate data that are relevant to the problem you’re solving
Insight → Look for patterns, trends, and insights in the data to inform decision-making
Belief → Create a hypothesis based on your insights and gain conviction
Bet → Test your beliefs with action and define expected outcomes
What I like about this is that it feels very similar to what founders naturally do: collect data points/trends, identify an opportunity, gain a conviction, and then take a shot at it.
Not all of your bets will work out, but that’s ok — you shouldn’t expect them all to. The important thing is that each bet is focused on driving your startup’s North Star goals.
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