SaaS Founders: How To Optimize Your Runway

Cash flow is one of the primary reasons why most early-stage SaaS companies fail despite showing promise. Simply put: If you’re out of cash, you’re out of business.‍

To maintain the trajectory en route to profitability, there is often a need to obtain more capital. SaaS founders are left with very few options, primarily equity (largely because VCs have realized that the SaaS business model is highly analyzable and therefore generates some of the best returns!) which dilutes their ownership or venture debt, which is restrictive and also eventually leads to some form of dilution. Both of these financing methods are readily available, but as with everything else, have to be timed properly.

It can take years for a SaaS  company to become cash flow positive based on the business model’s cash flow profile (investment in CAC to be realized over time as subscriptions mature),  and the key is availability of capital for growth, i.e. investment in customer acquisition.  You just have to spend money to create market leadership in your segment and invest in customer acquisition. During this period, like any startup you have to be focused on runway, you need to be in business to be successful. With your current spending, how many more months can you operate before you run out of money? By optimizing expenses and leveraging financing tools such as subscription-based financing to bring cash through the door, you can essentially give your company time to grow and acquire more customers.

Calculating your runway

“You can’t run your business and know how long you have unless you know what your actual cash balance is. That is, how much cash is in the bank – not what’s in an Excel sheet, not what is theoretically going to be collected – and how much you’re actually spending on a weekly and monthly basis. And once you know your cash, be realistic and take into account the cost of acquisition, increased churn, and downsell in your projections. “ -- a16z, Kristina Shen and Kimberly Tan

Your runway defines how long your business can operate with your available capital against your monthly burn. Monthly burn refers to the expenses required to keep your business running such as your payroll, rent, marketing, etc. It is crucial to understand where your money is going and how your spending contributes to your growth. With the right plan, you can extend your runway and spend on what actually matters. 

For acquiring capital, remember that each round of fundraising is specifically designed to acquire financial assets for growth to reach the next round or an eventual exit. There will be milestones that you would need to attain in order to demonstrate the progression of your company and its increased valuation, so not hitting these goals would mean that your company might potentially reach a dead end. This is why knowing your runway is crucial -- you can prepare in advance and see if you are performing well enough to reach that next stage by optimizing your finances. 

Calculating your runway is relative to your burn rate: Runway = Cash Balance / Burn Rate

• The “burn rate,” refers to how much money your SaaS company is losing over a given period of time. For example, your SaaS company could be losing or “burning,” $100,000 every month, or $1,200,000 per year.
  
  
• There are two types of burn rates : Gross vs Net.
  
  
• The gross burn rate is the total of your company’s expenses during a given period of time. Everything you spend adds to your gross burn rate.
  
  
• Net burn rate occurs when your company spends more than it earns. It is calculated as your company’s revenue minus total expenses, i.e. its negative income. For example, your SaaS business might make $100,000 in revenue per month and spend $110,000, leaving you with a net burn rate of $10,000 per month.
  
  
• This means that only companies that are losing money have a net burn rate, while profitable businesses net positive income.

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Optimizing your runway

What is the right runway for your SaaS company and what can you do to extend it? Remember, the goal is to compare your spend against your revenue, and find ways to maximize the latter. The simplest way to do that is to focus on pricing and NOT discounting your services to bring cash in the door.  But, cash flow is required to invest in further growth. Catch-22, until now but with the growth of alternative forms of financing for SaaS and recurring revenue companies, this is not a Catch-22 any longer.  

Here are some key takeaways that you may find useful to extend your runway:

• Excellent understanding of your monthly burn rate, cash out date, number of months of runway remaining and whether your burn rate is appropriate given your revenue and growth rate.
  
  
• One milestone at a time. Reach the point where you can generate more revenue than your burn, and from there you can further optimize your margins.
  
  
• Forecast and reforecast. The ever-changing dynamics of the market calls for plans and budgets to be revised every so often based on your performance. An adaptive strategy is a must especially in the COVID-19 pandemic.
  
  
• Focus on pricing.  Discounting should be strategic and well researched. Continue to optimize pricing, as it will have the biggest impact on your economics going forward.

• Focus on product features that will reduce churn and drive pricing power.

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Consider alternative sources of financing 

While capital is an absolute necessity to accelerate growth, there are now more ways to obtain efficient capital. ARR Squared lets companies avoid value destructive behavior such as discounting for upfront cash or other non-optimal cash flow management techniques.  

You can use our runway calculator to help you understand your runway better, and how ARR Squared can help with your financing needs. 

We look at six simple metrics:

• Annual Recurring Revenue - Your expected revenue based on yearly subscriptions. Typically your current MRR x 12
• Annual Contract Discount - The typical discount you provide for annual subscription plans.
• Target Annual Growth - Your expected % year-over-year growth rate. Can you increase this with more investment in CAC.
• Cash in Bank - How much liquid capital your business has in the bank.
• Expense-Growth Ratio - Your % spend vs. revenue ratio.
• Percent of MRR Financed - Current total paid subscriptions in % financed with subscription-based financing.
  

ARR Squared is changing the way SaaS companies finance growth by providing speedy and easy access to non-dilutive growth capital by converting monthly subscription fees into equivalent annual cash advances, we are giving SaaS companies more flexibility to grow their business and tap larger pools of capital on demand based on their actual traction, removing the need to negotiate for equity-based funding using future valuations prematurely.  The SaaS business returns the capital over the course of 12 months, without sacrificing ACV through discounting. 

With cash in the bank and an extended runway for your venture, you’re able to bring optionality to the table, a necessity for SaaS companies in today’s dynamic and competitive environment. More importantly, our capital can be tapped by SaaS businesses as often as required and does not require personal guarantees or warrants, which typically comes with venture debt. We are providing founder-friendly terms to SaaS founders and extending their operational runway at a much lower cost of acquiring this growth capital than through traditional financing avenues.