Raising 12 months of burn is not enough

At DAN Fund, we talk to a number of startups every day that want to raise just enough cash to get to the next round or to get to their projected cash break-even state.  Oftentimes, it’s no more than 8 to 12 months of cash (for instance, if a company is burning -$100k a month, they want to raise a bridge round of $1.2mm).  The rationale in theory makes sense: raising money is dilutive so why raise more money at this valuation than absolutely needed? In practice however, we’ve seen this lead to the death or stagnation of many startups because inevitably the next 8 to 12 months does not go perfectly and the company misses projections.  They’re then in a position where they either have to cut spend dramatically thereby impairing growth, restructure, or they have to beg investors for more money after they failed to achieve what they said they would do.  In every case, it’s devastating. 

 

We’ve always said a company needs to raise at minimum 18 months of cash and more comfortably, 24 months of cash.  The magic behind 18 months is that it gives you 12 months to grow like crazy and then 6 months to comfortably raise capital based on your 12 months of performance.  24 months is better because it gives you a buffer in case things don’t go perfectly.  This has always been a rule of thumb more so than anything else, so we did an analysis where we looked at the IPO’s of 47 tech companies in the past 15 years (45 SaaS, 2 hardware).  We focused on those that were burning cash at the time of the IPO (27 of the 45 companies), and then looked at the level of cash raised to the level of free cash flow burn in the most recent year.  The data is dramatic: on median, these 27 tech companies raised enough cash at IPO to sustain current free cash flow burn for 4.4 years and current operating income burn for 3.7 years.  The lowest of the 27 raised 1.5 years of burn. 

 

    Year of Operating     Raise/ Raise/
Company CEO S1 Income FCF Raise FCF Operating Inc.
2U Christopher Paucek  2013 -$28,006 -$23,318 $119,275 5.1  years 4.3  years
Secureworks Michael Cote  2015 -$61,093 -$7,310 $111,120 15.2  years 1.8  years
RingCentral, Inc. Vladimir Schmunis  2013 -$37,907 -$29,036 $97,500 3.4  years 2.6  years
Jive Software, Inc. Anthony Zingale 2011 -$35,587 -$9,539 $160,800 16.9  years 4.5  years
Marketo Phillip Fernandez 2012 -$34,208 -$28,202 $79,300 2.8  years 2.3  years
Appfolio Brian Donahoo 2014 -$8,559 -$5,970 $74,400 12.5  years 8.7  years
Five9, Inc.  Michael Burkland 2014 -$28,322 -$21,513 $70,000 3.3  years 2.5  years
Textura Patrick Allin 2013 -$18,793 -$3,796 $75,000 19.8  years 4.0  years
Marin Software, Inc. Christopher Lien 2013 -$22,720 -$24,251 $105,000 4.3  years 4.6  years
Proofpoint, Inc. Gary Steele 2011 -$18,976 -$3,591 $82,300 22.9  years 4.3  years
MindBody Richard Stollmeyer 2014 -$26,950 -$30,532 $100,100 3.3  years 3.7  years
HortonWorks Robert Bearden 2013 -$69,361 -$54,139 $100,000 1.8  years 1.4  years
The Ultimate Software Group, Inc. Scott Scherr 1998 -$15,451 -$10,303 $32,500 3.2  years 2.1  years
Demandware, Inc. Thomas Ebling 2012 -$756 -$2,762 $88,000 31.9  years 116.4  years
Xactly Chris Cabrera 2015 -$15,469 -$14,503 $56,000 3.9  years 3.6  years
BazaarVoice Brett Hurt 2011 -$19,704 -$2,929 $114,000 38.9  years 5.8  years
Athenahealth, Inc. Jonathan Bush 2007 -$3,324 -$3,722 $113,000 30.4  years 34.0  years
Hubspot Brian Halligan 2013 -$35,556 -$28,534 $125,000 4.4  years 3.5  years
New Relic, Inc. Lewis Cirne 2014 -$40,792 -$41,337 $115,000 2.8  years 2.8  years
Shopify Tobias Lutke 2015 -$21,615 -$23,501 $131,000 5.6  years 6.1  years
MobileIron, Inc. Robert Tinker 2014 -$31,849 -$27,744 $99,900 3.6  years 3.1  years
Zendesk Mikkel Svane 2013 -$21,833 -$7,772 $99,999 12.9  years 4.6  years
Castlight Health, Inc.  Giovanni Colella 2014 -$62,339 -$52,651 $177,600 3.4  years 2.8  years
Box Inc Aaron Levie 2014 -$158,780 -$116,193 $175,000 1.5  years 1.1  years
LivePerson Inc. Robert Loscascio 2000 -$3,582 -$4,168 $32,000 7.7  years 8.9  years
WorkDay David Duffield 2012 -$90,209 -$7,443 $637,000 85.6  years 7.1  years
Instructure Joshua Coates 2015 -$54,452 -$36,906 $80,960 2.2  years 1.5  years
               
    Median -$28,006 -$21,513 $100,000 4.4  years 3.7  years
    Average -$35,785 -$23,025 $120,435 12.9  years 9.2  years

 

So why are these companies raising 4 years of burn upon IPO? Perhaps there is a big growth opportunity to take advantage of today.  This would certainly account for some of the need to raise 4.4 years of burn, but at most I believe that could account for 1x of the 4.4x of raise/burn.  Aside from some big growth opportunity, we believe there are a few reasons in every scenario that apply to startups at the Series A/B level as well:

 

-Something will go unexpectedly wrong.  These companies have experienced CEO’s that recognize nothing goes as planned.  It could be losing a major customer they didn’t foresee losing, finding themselves in an expensive meritless lawsuit, some change in Google’s algorithm or Facebook’s methodology that causes them to no longer be seen, the quick rise of a new competitor, etc.  Raise extra cash for the unforeseen so that when it happens, you don’t find yourself in a restructuring or begging for cash from investors. 

 

-Raising money sucks.  Going through an IPO is exceptionally time consuming, but so is raising a Series A, Series B, or bridge round.  You have better things to do than talk to investors (like running the business), so if you raise more money today, you’ll find yourself spending less time raising money tomorrow, especially for bridge rounds which are generally a sign to the investment community that something didn’t go as planned. 

 

-Something will go unexpectedly right.  Perhaps new growth avenues reveal themselves, you want to attack a new market, or an M&A opportunity comes up that you want to take advantage of.  Having the cash on hand now let’s you attack unexpected growth opportunities quickly, whereas if you have to go back out and raise money, the opportunity may pass.    

 

In conclusion, we continue to believe that 18 months of cash is the absolute minimum you should raise.  24 months is far better, especially considering that startups which IPO on median raised 4.4 years of cash.  

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