Desk Notes: Planning your cash burn in a bear market

We are all aware of the state of global markets. Things have changed. When we started EVP, businesses pitching for capital used to present forecasts that showed raising an amount of capital and gliding through to break even and profitability.

About 4 years ago something bizarre happened. Startups quite literally started presenting forecasts pursuant to which they planned to go broke. Until the start of this year, it was commonplace to build a forecast which in essence relied on raising more capital, absent which, the business would run out of money. So hot were the capital markets that startups would assume they could raise money to survive even absent any investor commitment. In a country in which insolvent trading is a criminal offense, this is truly bizarre. Fortunately, that seems to have come to an end. As Y Combinator aptly put it:

For those of you who have started your company within the last 5 years, question what you believe to be the normal fundraising environment. Your fundraising experience was most likely not normal and future raises will be much more difficult.

EVP has a portfolio of 40 software businesses. We lead all initial investments and we take board seats with every business we work with. This gives us somewhat of a front row seat to these conversations that are currently taking a disproportionate amount of headspace. In the case of Mark, it’s not uncommon to see snippets from Excel models floating in and out of dreams at night.

Below we share some insights from common discussions we have with our portfolio of early stage software businesses.

[This article is targeted at revenue generating, (initially) loss-making startups taking on venture capital to accelerate growth]

Getting Deliberate on Cash Trajectory

If you’re a revenue generating software startup thinking of raising capital, ask an investor for advice and you’ll typically be told to raise enough to last the business 18-24 months.

In our experience, this advice misses important nuance on what your business looks like as cash approaches zero and the shape of that cash depletion over the 18-24 months. We typically see 3 approaches to cash. Let’s call the first two ‘pre-2022’. The third aligns better with our recommendation and the fourth sets out how we suggest you forecast today (for those that want to shortcut the read).

We include a cash waterfall in all monthly board packs. If you don’t do this, start. In essence, it shows your initial cash position, cash injection and then expected monthly burn and runway. By splitting out the change in cash each month, you can carefully scrutinise your cash burn each month. Below is a screenshot of an actual cash flow waterfall from one of our portfolio company’s board packs.

The graphs following this are illustrative of different shapes this cash waterfall may take with the initial images providing warnings and final images containing suggested actions.

1. The straight line to zero mistake 🤓 - “I raised $5m and my investor told me to make it last 18 months. That means I should burn $280k per month!”

[There are sometimes good reason you nose dive. You may have capital committed or debt waiting or you may have to hit certain numbers for a reason. We are focussing on forecasting in a bear market.]

2. The nose dive mistake💥 - “If things are working, I’m going to double down. My investor told me we’re not here to preserve cash and a good business will always be able to raise. WAGMI!”

Why this approach is great:

• You give yourself the flexibility to push spend as hard as possible if the results are coming through.
• If you’re assured of your capital future, you don’t need to pull back on growth for capital raise purposes. You can make investments for the future unencumbered by the need to turn a profit.

Why this approach is not so great:

• It’s incredibly high risk. If you have an “unexpected miss” on revenue late in the game, you can find yourself unable to meet payroll.
• You’re not giving yourself time to see the benefits from the investments that come late in the funding cycle.
• If the funding landscape changes close to your cash low point, you have very little time to pull on the handbrake and shift to profitability.
• Any new investors will have significant leverage in funding discussions.

3. The Soft landing 👩‍✈️ “I want to invest but I want a soft landing as I approach my cash low point.”

Why this approach is great:

• You make your investments early with meaningful time to prove benefits
• You’ve got flexibility as you approach cash low point - you can go profitable if you decide funding markets aren’t great and you’ve got leverage with investors if you do decide to raise.
• You have time to course correct if your investments don’t take off

Why this approach is not so great:

• You’re potentially forgoing growth opportunities as you near your cash low point

So now back to reality…

In the current market, we’re encouraging our portfolio companies to adopt the soft landing approach to optimise for efficiency and flexibility in the lead up to and funding discussions. In truth, this is what we have always advised.

Pulling this all together into something actionable, the below visualisation and bullet points set out our actual recommendations for forecasting at this time and, at most times:

1. Make your bets early - employees take time to ramp and sales cycles can be long. If you don’t make key hires very soon after raising capital, the benefits you could otherwise capture (increased leads / sales, ramped product output etc) will be difficult to see by the time you might need to go back to market to raise capital. Put another way, burn should be highest soon after the raise.
2. Hire in waves - if you hire in waves, you have the opportunity to see the results of each wave. Consider staging hires based on the team you need to achieve specific outcomes. For example, if you want to go from 1 - 10 salespeople and 1-10 developers in a new market, you might hire 3 of each initially then, when they are hitting their stride, go again. If the hires fail, you haven’t gone all in and you can diagnose the issue and build a new plan. Batching hires together in waves over the course of a funding cycle enables you to maintain flexibility to make further hires once you’re confident on the hiring paying off.
3. Go for a soft landing - if your cash burn is low as you head towards cash zero and/or a raise, you will be able to move swiftly to profitability if needed. This gives you leverage in funding discussions and reduces risk if you can’t raise. You never want to head into a fundraise desperate for cash. Don’t assume you can raise money. Assume you can’t raise money and plan to be ‘default alive’.
4. Explore all funding options - the Australia landscape has matured enormously. There are now a plethora of funding options. We have used equity, venture debt, revenue financing, credit cards, bank overdrafts and other types of funding. Looking at all of your options can give you time and help you get to a soft landing.
5. Hitting budget can be a disaster - “Good news everyone! We missed our revenue target but we hit our budget on cash burn!”
   This may seem like a nice consolation prize but in reality it’s about as exciting as winning a Golden Raspberry. This situation essentially means that your business has the same funding requirements as before but without the performance required to impress outside investors and to raise new capital (debt or equity). You’re going to market at the same time but with a sadder looking pitch deck. If your growth is slower, your burn must be lower too leaving some dry powder to deploy when you start to hit your stride.
6. Focus on margin - As you model your soft landing cash waterfall, remember that margin alone is what allows you to have a soft landing. Too often we see founders focus on top line revenue without acknowledging that the business never gets to see some percentage of that revenue (i.e., cost of sales). It is only by driving a larger monthly gross profit that you have more true ‘revenue’ available to pay staff as you close in on a raise that may or may not be successful.
7. The cash buffer needed is different for every business - the cash low point (minimum cash balance at the end of a cash run way) will be different depending on your risk appetite, investor support and critically your business model. A low churn SaaS company probably doesn’t need a large cash buffer as the revenue is able to be reliably predicted. A transactional or seasonal business may need a much larger cash buffer. Traditional thinking is that you should always have 3month of total opex available as a cash buffer. This may be true for a services company but not a high margin low churn SaaS company.
8. Know your exit velocity - overlay your cash burn with other forecasts such as your forecast growth rate, burn multiple and other. As you approach the end of your runway you may be looking at another raise. That’s when you want all your metrics to look first class. If your forecast Rule of 40 looks good at the start of your cash burn and bad at the end, time to reconsider.

A startup is still a business

As a team, we have made hundreds of investments across initial rounds and follow-ons including our pre-fund investments. We are fortunate that we have never lost a business since the first time someone on our team made a VC investment in 1996 (backing a business named Hotelclub which was Leon Kamenev’s first venture prior to Menulog). This isn’t because we are smarter than the other great investors out there, we aren’t, but we don’t think of a startup journey as a “go hard or go home” experiment. Winding up a business is not the alternative to a billion dollar outcome. If you have a viable business model, you can and should be able to grow whilst managing for risk, critically including capital planning. With the startup funding market tightening we’re urging all founders to get deliberate on cash burn both now and after investor confidence returns. It should never have been any other way.

‍