Why 16 months are not enough.
In the fast-paced world of startups, planning your runway is one of the most critical exercises. While historically, it was common to aim for 12-16 months of runway, we see a lot of examples that this is not enough anymore to achieve the central goal of early-stage startups - achieving product-market fit (PMF). As founders are commonly too optimistic with their planning and confidence in how things work out, it’s important to get aware of the biases and allow room for error, while planning the runway.
Finding Product-Market Fit: A Dual Challenge
Building a successful startup hinges on striking the balance between product development and marketing/sales efforts. Achieving PMF needs multiple iterations, market testing, and refining your product to match customer needs. It's essential to allocate the right amount of time for both sides to thrive, allowing for a truly validated business model.
Building a Product…
Developing a product that resonates with the market never happens overnight. The one side of the PMF equation means: *product building*. Countless successful startups have experienced multiple product versions that missed the mark.
For most startups their first product version will not be enough or actually will not fit the general market need. This is what everyone plans for. However, also the second iteration most often will not be the right one. Lacking features or not matching market needs are common shortcomings at this stage as well. This is why you as a founder should always allow enough time for a third product version.
Importantly, product building is always slower than expected. The work involves not only developing concepts, UX research, planning, actual development or building, testing and possibly also regulations or other aspects. As there are many problems to appear along the way and normally a multi-disciplinary team to be aligned, it’s crucial to plan for enough buffer here and allow the roadmap to include delays, even when the pressure is on.
… and finding Market Fit
The other side of the PMF equation means finding the right customer group for your iterating product and the knowledge of scaling them with future marketing budgets.
First, this means understanding your audience and the channels of reaching them. Crafting effective marketing and sales strategies requires experimentation and data-driven decision-making. You as a founder must invest in market research, customer acquisition tactics, and campaign experiments to refine their messaging, target audience, and distribution channels.
These experiments also take time and money, as you navigate through various marketing channels, customer segments, and messaging approaches. Marketing and Sales, just like Product, have to solve multiple variables at the same time as well: Finding and optimizing marketing channels, pricing model, positioning, customer research, and understanding sales cycles need to align to find your sales sweet spot. Allowing sufficient runway enables you to test, learn, and optimize your marketing efforts without rushing to premature conclusions.
In addition, one of the chronically underestimated components is the sales cycles needed to get to the closing (especially for B2B). Convincing customers, especially enterprises, to adopt a new solution often requires patience and persistent efforts over multiple months. Particularly for startups breaking into established industries, sales cycles are often their biggest problem, as money runs out.
The time for PMF
Even though founders are optimistic about their speed and ability to execute, it’s important to acknowledge that finding PMF is a lengthy process and should allow for at least three major product iterations. As every major iteration can be seen as an individual product built, you should always allow for at least 6-8 months for each product iteration cycle.
Summarizing, this means instead of aiming for 12-16 months of runway, we recommend startups go for 18-24 months to find their PMF. Especially, as we are currently facing a major economic downturn and not only sales is getting more difficult, but also fundraising becoming more challenging, founders should aim for longer runways than usual.
Bearing the Consequences: Higher Dilution and Price Inflection
Don’t Be Afraid of Dilution
Extending your runway beyond the standard 18-month timeframe requires raising more money in the first place. As you cannot stretch your valuation just because you raise more money, this implies higher dilution at the beginning. This is the main consequence that founders often fear early on. However, this consequence might not be as bad as it appears.
Let’s take the example of extending the runway from 16 to 24 months. We assume a planned burn rate of €50k per month, which means an additional €400k to be raised. In this case, the fundraising would go from €800k initially planned (16 months) to €1.2 million (24 months). If we look at the hypothetical dilution at a pre-money valuation of €4 million, this would imply a post-money dilution of 16.7% (€4.8 million post-money). Hence, the difference to the new post-money valuation of €5.2 million (€400k higher) leads to an additional dilution of around 6.4% (23.1% in total). These values are totally in range of what is normal and would not raise an eyebrow with later-stage investors.
Avoid Bridge Rounds
If you don’t find PMF until your money runs out, you are forced to do bridge rounds that will lead to even higher dilution (which you will gladly take at this point, instead of an early death).
Bridge rounds, though sometimes necessary, steal valuable time of achieving PMF. Also, relying on interim funding to bridge the gap between financing rounds may signal to investors a lack of execution capability within the planned timeframe.
Reaching your Inflection Point
On the bright side, if you achieved your PMF, your next fundraising round will actually work as an inflection point, enabled by a good negotiation position. If you generated the data that VCs want to see and are confident with your validated business model, you will be in a good position to negotiate good conditions and actually achieve less dilution. Hence, you will actually be able to cover for higher first-round dilution once things get rolling in your favor.
PS: The Importance of Cash Discipline
If you actually managed to raise more money, it’s paramount to maintain cash discipline throughout the journey of seeking PMF. While allocating more time for iterations and market exploration, it is equally crucial to monitor expenses, optimize operational costs, and prioritize spending to achieve the runway you need. Striking the balance between adequate funding and financial prudence allows you to extend your runway without compromising the long-term financial health of your startup.
Conclusion
Especially in today’s times, finding product-market fit requires more time and resources than ever before. The delicate balance between product development and marketing/sales efforts necessitates multiple iterations and market testing.
Startups should aim for an extended runway of 18-24 months to allow for at least three major product iterations and thorough market exploration, especially in the face of economic downturns.
While higher dilution and the need to raise more funds initially may seem daunting, avoiding bridge rounds and reaching the inflection point can lead to better negotiation positions and less dilution in subsequent fundraising rounds. Maintaining cash discipline throughout the journey ensures that startups can extend their runway without compromising their long-term financial health, setting the stage for sustainable growth and success.
Are you a founder and currently raising?
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