7 steps to improve cash conservation and extend runway
Several early-stage investors have urged their portfolio companies to prepare for potential economic downturn. For start-ups this means being prepared to survive without additional funding for longer than previously planned. Some of the well-known examples include Sequoia Capital’s presentation deck Adapting to Endure [1], and YCombinator memo urging its portfolio companies to Plan for the Worst [2]. Both memos recommend start-ups to revise their business plans and prioritise efforts to conserve cash and extend runway. In simple terms, this means finding ways to cut spending, to generate more with less resources, and to find alternative sources of funds.
If you're one of the start-ups looking to conserve cash and extend your runway, I have summarised below 7 steps on how to approach it systematically. Steps 1 through 3 go over essential preparatory processes, and steps 4 through 7 explore some practical options where you might find some additional funds. This post is written from the context of a tech start-up, but you may find this useful also in a more mature business setting.
1. Define your cash conservation goals and reconsider your Plan A
Before starting to implement any changes, establish what do you want and need to achieve. How far would you need to stretch your runway and what are the milestones you need to reach meanwhile? Reconsider what is your Plan A and “business as usual”. While you may have previously relied on raising additional equity financing every 6-18 months, then this may no longer be “business as usual”.
It’s possible you would like to keep your overall revenue and business targets at similar levels as previously however, reaching these in a longer timeframe and no longer relying on any new equity funding in the next 12-18 months. It may also be that your priority will become to find an accelerated path to cash-flow positive state with currently available funds – or to a Default Alive as opposed to Default Dead state as coined by Paul Graham [3].
It’s hard to overemphasise prioritisation in this situation - any targets you set need to be clearly time-bound and you need to clearly know which ones you’ll drop when needed. Start by reflecting on your most recent business plan and categorise all the initiatives you had into “nice-to-have wish-list” vs. “must-win battle-grounds”. You want to focus your efforts on must-win battles for now and leave nice-to-haves to the future when things are looking brighter again.
If you have not already, take the discussion to your board and advisers. They should be able to provide you additional insight into the changing economic climate and how it could affect your business, your industry, and the available financing options to you.
Remember, your new Plan A will not be a static blueprint of success – you will need to continuously evolve your plan as you go along. Set yourself clear cut-off dates and milestones so you know when you need to forget about your Plan A and switch to Plan B or really shake things up (yes, that may mean to pivot!). I like how Reid Hoffman conceptualises this idea into ABZ planning [4].
If it’s clear you need to make some changes, get the rest of your team on board as early as possible. You need your team on your side for coming up with creative solutions, and for implementing the necessary changes. Whenever you’re trying to push through significant changes, it’s worthwhile to understand the principles of change management [5].
2.?Understand where your business truly stands today
To understand how much you need to improve, and to identify potential improvement opportunities, make sure you truly understand where your business stands today. For this, take a deep dive into the fundamental unit economics of your business. You should go beyond the total level “blended” metrics (such as total LTV / CAC ratios [6], revenue growth %, total no of monthly active users, average spend per customer). Especially in times of cash constraints, you want to shift your focus towards more cash-based, and more specific metrics.
Understand your true customer profitability - the gross profit each of your customers generates
While the definition of a Gross Profit seems obvious per textbooks, there is a lot of discretion in how to calculate it. Key here is to remain first and foremost honest to yourself – Gross Profit should include Revenue less All the Costs for generating that Revenue. In addition to the more obvious direct product or service expenses, consider adding the following often overlooked items as part of your Cost of Revenue:
Prioritise cash-flow based metrics
Firstly, make sure you’re adjusting your key metrics with gross profit (as above) – e.g. LTV should reflect the Lifetime Value (that is lifetime profit) and not simply the Lifetime Revenue of the customer. Secondly, prioritise cash-based metrics where possible – e.g. consider CAC payback period instead of LTV / CAC ratio. Thirdly, and perhaps most importantly, make sure the cash burn rate and cash runway measures are on top of your KPI reporting list.
Don't be fooled by blended total level metrics
Even though your total level of LTV / CAC ratio seems healthy 4-5x, there may be a significant difference between how your paid customers vs organic growth customers perform. Make sure you divide the metrics per customer cohort, per customer group (paid vs unpaid channels), or per individual customer to dig out the truth.
3. Keep a close eye on where your business is heading
Now that you know how far you need to travel and have a hypothesis on the right path forward, you need to keep a close eye on the progress and whether your plan is working out… well… “as planned”. For this, you really need to keep your forecasts rolling!
Forecasting can serve several purposes, but in the context of cash conservation and runway management, the primary two would be: 1) to have an up-to-date view on whether you can still make it to your destination with the remaining runway, and 2) to continuously learn and adjust your plan along the way.
Establish a well-working forecasting process
To evaluate if you have a well-working forecasting process ask yourself the following questions:
To improve the timeliness of your forecast, make sure you receive your historic actual financials and reports reliably on time. The “monthly close” process that makes sure the financial receive does not only depend on the accounting and controlling teams but can often be delayed due to important input information or approvals pending from the operative teams. Assign someone from your internal teams specifically to improve the reporting timeline, even if you rely purely on external providers to take care of the accounting.
You will never have a “100% accurate” forecast, and this is expected - your effort was wasted only if you don’t debrief on what went wrong and why. Forecast is essentially your hypothesis on how your business develops given the operational inputs you provide – make sure you continuously test and learn from it. Incorporate the learnings to your next iteration of forecast – over time you want to see that you’re getting better at predicting the relationship between your operational inputs and the actual results.
Expand your forecast to include total change in cash
You should be able to have full transparency on where the money is going beyond the operating results – including any investment, interest, loan, and tax payments.
Keep your forecast rolling for at least the 12 periods ahead
The frequency and the level of detail (quarters, months, vs weeks), will depend on how much runway you have left:
Play through best case and worst-case scenarios
This will not only allow you to better understand which are the most sensitive assumptions in your forecast, but more practically what is your margin of error in reaching your goals. It should also help signal when it’s time to reconsider your plan A and turn to Plan Z (as mentioned in step 1).
4. Increase your revenues - create and capture more value from your customers
It should not come as a surprise, but it’s always worth repeating – it is cheaper to retain a customer than to acquire a new one. At times where you need to conserve cash, it is even more important that you can retain all your value-adding existing customers, and maximise the value captured from these customers.
Get close(r) to your existing customers.
Make sure you are proactively reaching out and showing genuine interest in what they have to say, and proactively educating them about the problems in your product domain, and how your product solves them. Tight feedback loop can help you identify potential customers at risk-of-churn early, as well as help develop ideas for additional customer problems to solve.
Deliver more value to your customers
This may mean offering complementary managed services, new services with the existing core product features, relevant referral programs, complementary product partnerships, or any other similar measures that you can deliver with your existing competences. These may not necessarily be something you want do focus on in the long term, but these may be essential to get you over the current period.
Capture more value from the customers
There may be portions of the service that your customers really value but you have not yet specifically charged for. Common examples of such value-adding “free” services include e.g. managed onboarding, and managed support services (that go beyond technical support and troubleshooting).
Consider raising prices
Raising prices to your existing clients may be a good idea, even if you haven’t found ways to deliver more value through the steps above. It is likely you have experimented with different pricing models primarily in the customer acquisition phase of the customer journey. Consider taking closer look at the prices you offer to your long-term customers - the perceived value for your product may be significantly higher now as the customer has incorporate your tool into their processes and, hence they may also be willing to pay more for it.
Establish minimum spend requirements
Minimum spend requirements or alternatively maximum volume and capacity limits can help turn your unprofitable customers profitable, or for the very least help weed the unprofitable customers out from your customer base. You really cannot afford to lose money on serving your customers. You should find guidance on the required limits through the insights developed in step 2.
5. Cut your spending – re-consider what is discretionary
Re-consider the definition of discretionary spend. Travel has long been considered discretionary, but the pandemic thought us that also an office space can be optional. Your team can be a great source of creativity in helping you identify similar saving opportunities. Discretionary spend should naturally be your first consideration to cut.
领英推荐
Take a full stock of recurring expenses
Evaluate closely all your recurring expenses such as different tools and subscriptions your teams are incurring and how much are you paying for them.
Make smaller bets more often
When money is tight, you may not be able to afford to go all-in on the new market, or new product you were planning to launch. You want to gather positive signals from smaller scale experiments and increase your commitment on the new development ideas gradually. What is small vs large will naturally depend on your overall scale, but I would recommend not to spend more than 5-10% of your runway on any individual (yet to be proven) bet.
Postpone (non-crucial) hires
If you can think of a way to meet your end goals without the planned hire, it is likely a non-crucial at this moment. The emphasis on this one really goes to non-crucial – times when your competitors are looking to cut their staff, it may be a good opportunity to find great talent that you did not have access to before.
Strengthen your cost controls
You need to make sure your saving efforts actually get realised, and cost controls are the way to do that. The level of cost control can range from having one single person having tight control and approving all and any cash paid out (in cases of distress) to simply having clearly documented spending guidelines. In majority of cases, you likely want to be somewhere in the middle - with a cost approval process that at least ensures your teams spend in accordance with the guidelines.
6. Release cash from your operations – optimise your Net Working Capital (NWC)
NWC = short-terms assets – short-term liabilities that your company uses for everyday operations. In tech start-ups I like to think NWC in five buckets:?
To “release cash” from NWC and hence extend your runway, you want to reduce your NWC to the extent possible - that is to reduce your operating assets and to increase your operating liabilities. Over here, cash is really “released” from NWC only if the changes you implement remain in effect over long-term. In a software business you would ideally like to see a negative NWC (that is operating liabilities > operating assets), especially, if you have not yet reached a breakeven point.
Reduce your customer receivables
To reduce your customer driven NWC items, ask yourself the following questions:
Increase your supplier payables
To release cash from supplier related NWC, ask yourself following questions:
Reduce your inventory
If you’re operating in a market-place business or upcycling devices, you are likely already well-versed in operational excellence practices that can help you to reduce your inventory. Regardless, take an extra look at how much inventory are you stocking and whether you would be able to reduce the levels further for the time being.
Increase your personnel liabilities
Employee related liabilities are primarily dictated by regulation and there are limited actions you can take to increase these. I would also recommend leaving available options to increase employee related liabilities as a last resort, as it may require some sacrifice from your employees, such as using legal maximums for your salary processing dates.
Reduce other NWC
Other NWC items include e.g. VAT related receivables and payables. Improving these depend highly on your local tax regime, but there are often overlooked ways. For example, sending out a sales invoice with a date of 1st of July as opposed to 30th of June can extend the payment date of the related VAT to September as opposed to August. Key here is to learn (or know someone who really knows) your local tax regime to identify and benefit from such opportunities.
7. Explore alternative cash resources
If you couldn’t find enough operating levers through the steps above to extend your runway far enough, you need to find additional funds elsewhere. When evaluating the fit of these alternative sources consider the cost (i.e. interest), as well as the payback period of the funds. When you’re looking to extend your runway from month 12 to month 24, taking on an additional loan that you must pay back in 6 months (and cannot refinance or “roll forward”) is likely not helping you much.
Explore the different governmental funds
Regional and local governments often provide refundable loans and non-refundable grants to early-stage companies. You’re likely to find more options available to you if you’re still investing heavily in the research and development of your company, you’re serving and expanding heavily in foreign markets, or your business contributes strongly to the UN Sustainable Development Goals [7].
In addition to above, you may qualify for tax relief programs offered by your government. These programs may allow you to postpone payment of certain taxes for up to a year or two in exchange of relatively affordable interest.
Explore alternative financing solutions of your home bank
Take a discussion with your home bank to explore alternative loan options available to you. There may be additional rolling credit lines or project specific loans your bank is still willing to extend you. These may be subject to additional equity contribution from your existing investors, but it never hurts to ask.
Withdraw additional equity capital rather sooner than later
In most of the cases the advice would be the opposite, but when you know you're heading towards more difficult times, it may be a good idea to withdraw additional equity capital if this is still available to you today. Although your KPIs are likely below of where you wanted to be for your next financing round it may be a good idea to raise the next equity round already now. As you still have some existing cash buffer you are overall in a less desperate position which generally improves your negotiation position in the funding round.
Consider alternative debt solutions
There are some non-traditional debt-solutions available in the market. These can include e.g. loans offered by start-up focused banks that are more accustomed to higher risk, or convertible notes. These solutions come with a higher interest rate than traditional bank loans, but they may be worth consideration if you’re not getting the necessary funds together otherwise. Note, also these alternative debt solutions may require simultaneous additional equity funding from your investors, but it would be much less than what you would be otherwise asking from the investors.
What's next?
Each business is unique in one way or another and there is no single blueprint that would apply to every business the same. This post was primarily intended to provide you some structure on how to think through and find ways to conserve cash and extend your cash runway. Take these steps as guide-posts to help you organise your efforts however, maintain an open mind when searching for and choosing between the options.
In this post I have purposely ignored two topics, namely 1) pivoting your business towards something completely new, and 2) taking on larger restructuring efforts requiring to cut your staff through layoffs. Both would significantly impact your company’s culture and operations, and hence should not be your first considerations. That being said, these may be real options you may need to consider.
Links & references:
Chief Product Officer & Founder
2 年Great read Rene!