While most industries suffered from the devastating economic repercussions of Covid-19, others saw tremendous growth. One such sector was the Technology industry.
During this two-year period, Tech soared to a new level of success, which led to a complete funding frenzy among investors, especially VCs. The economy finally witnessed the perfect conditions for a thriving Tech startup ecosystem to flourish, with higher valuations and greater investments being poured into young startups, most noticeably at the seed funding stage.
According to Pitchbook, “More Tech startups crossed the $1 billion valuation threshold than in the previous five years combined.” The combination of a booming economy and a growing Tech industry created the perfect recipe for young companies to secure funding for growth.
Unfortunately, as we’ve seen time and time again, what goes up, must also come down. Now in the midst of a war in Ukraine, the ongoing effects of covid, and blows to the economy, experts are seeing a likely economic crisis looming in our near future.
Topics covered in this article:
- How to approach an economic downturn
- Extending your cash runway
- Planning for success: How to prepare for takeoff
Approaching an economic downturn
Because of the recent mixed public company earnings and the strong possibility of an incoming economic recession, tech startup valuations are declining, and rapidly. In fact, Joyce Mackenzie Liu, CFO, and founder of Pegafund, reported that Tech startup valuations have plummeted by 30-50% over the past year, with the bulk of this decline occurring over the past two months.
Joyce also states:
“While current financial health remains similar, public Cloud companies are now trading on current revenue multiples of 9.7x and 7.5x for top and median quartile businesses, respectively, with investors placing a premium on companies that have a balanced mix of revenue growth, margins, and capital efficiency. (This is in contrast to the emphasis on forwarding 12-month revenue which we experienced in recent years.)”
Investors are now proceeding with caution as the economy continues to adjust. Because of high inflation, market volatility is trending upward, leading experts to believe that the IPO market will remain closed until further notice.
What does this mean for tech startups?
So what does all of this mean for founders in the startup ecosystem? It means it is time to adapt, hunker down, and ride this wave until we can see the light at the end of the tunnel. One of the best ways startups can go about this is to extend their financial runway.
According to CB Insights, one of the most common reasons startups fail is because they run out of runway. To avoid this, you must learn how to reduce your cash burn and extend your runway as quickly as possible. Our FP&A Ops team has put together this comprehensive guide to help your organization brace for the bumpy journey ahead. In this article, we will be covering everything you need to know on how to control costs and extend a company’s cash runway during times of uncertainty.
How to extend your cash runway: Advice from our experts
The future is inevitable. Instead of being reactive on the sidelines and watching the market unfold, take a more hands-on approach by adopting these simple principles below.
The 7 ways founders can extend their cash runway include:
- Calculate your Net Cash Burn Rate
- Be cautious of your timeline
- Reduce expenses
- Raise prices
- Prioritize scenario planning
- Reforecast for success
- Improve the efficiency of your tech stack
Below, we will be exploring each of these points in depth so your team can start implementing these practices as soon as possible.
1. Calculate your Net Cash Burn Rate
The net burn rate is a critical metric that showcases the rate at which a company uses up its cash reserve in a loss-generating scenario. This number can be calculated by subtracting the operational expenses from the revenue generated. Typically, a company that is pre-revenue has a cash burn rate that is equal to its operational expenses. Startups that are looking to stretch their funding further must control and slow down their month-over-month net cash burn in order to stay afloat until their next funding round.
Many startups will often calculate burn multiples, which illustrates how much a startup is burning in order to generate each dollar of ARR. As a rule of thumb, the lower the burn multiple, the more efficient a company is growing.
For companies that are considered a venture-stage startups, consider following these multiples:
- Under 1x → Amazing
- 1-1.5x → Great
- 1.5-2x → Good
- 2-3x → Suspect
- Over 3x → Bad
2. Be cautious of your timeline
If a runway is too short, a plane will never be able to take off. The same concept goes for startups. But how long is a startup expected to survive during these difficult times? According to CB Insights, a startup should have a runway of 18 to 24 months. Anything less, and a company puts itself at risk of going under.
CB Insights conducted a study to analyze the average runway time for startups at different stages. The findings can be seen in the graph below:
3. Reduce expenses
If you are currently looking to extend your startup runway, cash conservation should be your number one priority. Reducing operating expenses is one of the easiest ways to stretch your cash reserve further.
A few ways to reduce expenses as a startup might include:
- Slow down hiring: Bringing on a new team member can be expensive. If you have been rapidly growing your team, slow down and only prioritize the most critical positions that need to be filled. If you find yourself with only three to six months of runway left, you may be forced to lay off employees. While no founder wants to have to make this decision, headcount is often the biggest expense for a company and can be the difference between life, or death for a struggling startup.
- Rethink your office space: Do you currently pay a lease for an office space or coworking space? If you want to cut down on operating costs, consider downgrading to a smaller office space or adopting a fully remote working policy.
- Prioritize spending: What tactics have previously brought success to your organization? Whether it's focusing on sales or marketing initiatives or doubling down on product development, invest in outlets that have a proven track record for supporting growth. From there, cut or reduce spending on all other areas that do not positively impact your bottom line.
- Cut ad spend: It’s common for startups to pour money into ad spend. Companies will set MRR objectives and adjust their ad spend accordingly to help them reach their targets. While ad spend may help bring in leads and ultimately close deals, this investment often comes at a high cost. As companies continue to scale, their advertising budgets must also increase to keep up with this increasing MRR target. Startups in danger of going under should cut ad spend and focus on growing their revenue more sustainably. While a company's growth rate will take a hit, this is one of the immediate ways for startups to cut costs and stay afloat.
4. Raise prices
Often, startups under-price their products and services to start acquiring customers and generating revenue. However, once you start growing your customer base, gaining visibility on the market, and having a clearer positioning, you need to make sure that your pricing is more aligned with the value you deliver.
If you are a founder struggling to break even, consider raising your prices to increase revenue. Start by increasing your pricing plan for new customers, and if needed, adjust your prices slightly for existing clients as well. This requires a high level of tact, as the last thing you want is for them to churn. As long as your product or service offering is robust, they are very likely to see the value and keep using it.
5. Prioritize scenario planning
Scenario planning is the process of making assumptions about the future and predicting how your business will be affected. By preparing for what could happen, you will better be able to react and respond to forthcoming obstacles. This process gives organizations the power to go from reactive to proactive in their strategic planning initiatives. In today’s market conditions, the only way a company will be able to stay alive is if they are able to adapt at a moment’s notice.
Right now, companies should be focusing on three main scenarios. These include:
- Sustainable growth
By creating strategic financial plans around these three scenarios, organizations will better be able to adapt as an economic dip unfolds.
6. Reforecast for success
Reforecasting allows organizations to course-correct as needed. By taking a more strategic approach to financial forecasting, leadership can identify challenges, seek out opportunities, and create a clear roadmap moving forward.
Reforecasting also paints a clearer picture for senior management of which scenario the company is falling into. By analyzing these insights, companies can improve their agility and make faster decisions while planning for the future.
When implementing a financial reforecasting plan, startups should be focusing on these key KPIs and metrics:
- Customer acquisition cost
- Cash conversion cycle
- Net revenue retention
- Revenue expansion
- Cash runway
- Net burn
These metrics will allow senior management to take a pulse on an organization’s overall health and track organizational performance.
7. Improve the efficiency of your tech stack
With the market being so unpredictable, it can be hard for companies to plan for the long term. Most finance teams use an Excel spreadsheet to manage their financial data, however, this manual process can be tedious, prone to human error, and difficult to build for multiple scenarios.
In order to save your finance team valuable time for more strategic analysis initiatives, automate these processes by implementing a strategic finance solution, also referred to as FP&A software. While your team may want to cut costs, it's still essential that you are prioritizing the right tech platforms to support growth. Not only does an FP&A software help improve data quality, but it also allows finance teams to stay agile and make the right decisions for the next 18 to 24 months… and longer!
Planning for success: How to prepare for takeoff
We can all agree - the future is uncertain. Unfortunately, no matter how much we plan, no one knows what will happen in the coming year. What we can do, however, is stay prepared, tactical, and agile for what has yet to come.
If you’re prepping your company for takeoff, now is the perfect time to buckle up and strategize. By following these tactics above, you’ll be able to navigate the storm with a healthy runway and set your company up for a future of growth and success - even if a bit of turbulence might come your way.