Don’t Crash On The Runway
It’s INTRO to Finance time. I’m Jason, and on behalf of the entire Indie.vc team, we want to thank you for all your encouraging emails from week to week.
We love hearing how much you enjoy ItF! We never imagined that entrepreneurs, investors, and operators would enjoy reading about finance this much. Thank you for all the encouragement and questions. Please keep them coming.
Our topic this week is:
"How should I time my debt financing conversations?"
You’ve probably heard the phrase "timing is everything”. In finance, that can undoubtedly be true. Starting the conversation too late can leave you scrambling for runway with limited options.
The best time to raise money is when you don't need to raise money. Without the pressure to urgently get a deal done, you can take your time to structure the right deal with the right long-term partner. And, because you aren't urgently in need of cash, your business doesn't look distressed. You don't have to worry about someone taking advantage of your desperation for money. You have the leverage to look elsewhere if terms and timelines aren't what you expect.
This doesn't mean you have to make a hobby out of continually talking with financiers. If you’re profitable or flush with cash, start the process a few months before you want to have the money available. If you’re still burning cash, be aware of when you might run out of capital. Start the process early enough to avoid undue pressure.
Know Your Runway
The easiest way to gauge how much time you have left before running out of cash is to calculate your runway.
To calculate your runway, you need to know a few financial numbers. It's pretty simple, but because not every company is linear or consistent in their financials, we’ll use an average. See the formula below:
Months of cash = Cash / Average monthly net loss for the last three months
Example:
Cash: $500k
July Net Income: -$25k
June Net Income: $50k
May Net Income: -$100k
$500k in cash / -$25k average monthly loss (Average of July, June, and May Net Income)
= 20 months of cash
Taking a couple months' average net income allows you to account for the ups and downs of a growing business. Now that you know how much time you have, you can start timing your fundraise accordingly.
A fundraise becomes challenging when the company has less than three months of cash. Having this little cash can leave the financier with limited ability to help you out. The ultimate goal is to get their money back, and unless you’re on the cusp of turning a profit, it may not be clear how the business will be able to return capital.
Start Early
Non-dilutive financing can take anywhere from a few days to a few months to finalize. Beyond finding the right partner, you still have to get through diligence and legal to receive the funding. If you’re looking to raise more than $100k in debt, start talking to debt providers when you have a minimum of five or six months of runway. If you’re borrowing less than $100k, begin with at least four months of runway.
These are the minimum amounts to optimize success in the conversations. It doesn’t mean you should wait this long. If you’re profitable or recently closed a round of equity funding but want to pad the balance sheet with additional non-dilutive funding, financiers would love to talk with you. You don't have to worry about a high-pressure situation.
If you find yourself in the opposite situation with too few months of runway, your best bet is to look at non-debt financings. Factoring or Saas Subscription financing can be helpful if they fit your business (read: in your INTRO profile), because they rely less on your business standing and more on who your customers are.
If you’re unable to bring in cash, equity funding, or non-dilutive financing, you’ll have to increase your runway the old fashioned way – decreasing the amount of money you’re losing each month.
Like we said in another issue, it’s better to understand your options and start building relationships earlier rather than later. Or, as Mark Suster put it, financiers look to fund lines, not dots:
If you’re just getting started and want to find all of the appropriate funding options for your business, start building lines out of those dots by creating an INTRO profile today.
Thursday mornings are better with a healthy dose of finance. Subscribe to INTRO to Finance to receive a new issue every week.
