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Founders of small businesses often (mistakenly) believe that their employees share the same passion and risk tolerance that they do. (Dmitriy Shironosov/Getty Images/iStockphoto)
Founders of small businesses often (mistakenly) believe that their employees share the same passion and risk tolerance that they do. (Dmitriy Shironosov/Getty Images/iStockphoto)

Funding

How far can you go? Know your 'cash runway' Add to ...

Most entrepreneurs spend a lot of time on runways, but not always at the airport. Rather, they’re balancing cash runways, which, loosely defined, are the amount of time or money with which they can operate in the red. For example, if a firm that’s not generating revenue is burning $20,000 a month and has $100,000 in the bank, it has a “runway” of five months.

While the concept is straightforward, the reality is more complicated. Entrepreneurs must understand their personal cash runways, as well as those of their employees and the company as a whole. Knowing the length of those runways, and how to navigate them, is crucial to predicting and troubleshooting the inevitable ups and downs of starting a business.

Company cash

The most common reason for a startup to hit the end of its cash runway – when cheques start to bounce – is poor cash-flow management. Founders who successfully make it out of the “valley of death” between launch and profitability do so because they keenly predict their financial needs from the start and raise cash accordingly – typically going after twice as much as they need and knowing it will take twice as long for that to materialize.

Team cash

Founders often (mistakenly) believe that their employees share the same passion and risk tolerance that they do. And, as such, they are willing and able to deal with rocky cash flow accordingly. Unfortunately, employees often don’t have the same incentives as owners (read: equity). The excitement of toiling for a startup can come to a crashing halt when employees feel that their next pay cheque may be in jeopardy. Keeping the team onboard via equity options and other non-cash compensation is a smart way to smooth out times of low-cash turbulence and to get employees more invested in the company’s long-term success.

Founder cash

If the cheques have bounced and the employees have cleared out, founders may find themselves in the same position they were in when the company started. This is where they encounter the founder-cash runway: how long the owners (or any significant equity holder) personally can operate in the red in hopes of better times. This generally requires a lot of convincing of creditors, counsellors and spouses. The key to managing a personal cash runway is to treat it as a real barrier. Don’t extend the time period another six months or another $50,000. That’s a recipe for disaster, personally and professionally.

These descriptions are simplified but underscore the importance of striking the right balance between fundraising, non-cash employee compensation and maintaining a realistic personal war chest – a must for any successful enterprise.

Sam Hogg manages early stage venture capital investments for NextEnergy, a Detroit-based research lab in the advanced energy sector.

Copyright © 2012 Entrepreneur Media Inc., All rights reserved

 

 

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