How much runway should you target between financing rounds?
Entrepreneurs have limited access to hard data that could help them make sound decisions when trying to build a successful new company. This is generally due to a fundamental lack of information about the materialized events of previously successful companies.
Consider that there are a few hundred thousand companies founded each calendar year in the United States (Bureau of Labor Statistics, 2016), but only ~ four thousand venture capital deals are reported in any given year. Each year between five and six hundred VC-backed entities are acquired, and a few hundred become publicly traded companies (WilmerHale, 2017). That’s honestly not a lot of data, and unless an entrepreneur has access to any of this historical data — or has the time to do the research — they’re pretty much driving blind when making critical decisions.
That means that there are a whole myriad of questions that entrepreneurs need to answer with incomplete, or worse, false information. One such question is—
How many months of runway should I target between rounds when pursuing venture capital financing?
According to CBInsights, running out of cash is the second leading cause of startup failure. Needless to say—it’s an important question to get right. If an entrepreneur tries to answer this question by triangulating from Google results, they’ll find a few sources that tell them the conventional wisdom is anywhere between 12 to 18 months.
CBInsights estimates the median time lapse between funding rounds for Tech companies to be somewhere in the neighborhood of 12 months for Seed to Series A and 15 months for Series A to Series B. On Quora you’ll find peers, who with no doubt good intentions, also confirm the 12–18 month conventional wisdom. Some experienced VCs however, such as Fred Wilson, recommend planning for about 18 months of runway between rounds. Steve McDermid, Corporate Development Partner at A16Z, also suggests being prepared for the process to take longer than one might expect, and to give yourself “plenty of cushion when assessing your cash runway”. So what’s an entrepreneur to do?
Is it possible that the startup failure rate is so high partially because conventional wisdom tells founders to prepare for 12–18 months between financing events, when in reality they should be preparing for longer like the experienced VCs suggest? We ingested all of Crunchbase to find out.
To answer this question, I looked at all startups that raised a k round and subsequently raised the following k+1 round in the traditional venture capital sequence. In layman’s terms, that means I segmented by all companies that successfully raised a Seed round, and subsequently raised a Series A. Then I took all companies that raised a Series A and subsequently raised a Series B— independent of whether or not they had previously raised a Seed stage round, or ever raised a Series C in the future—and so on—until the Series E stage.
The methodology described above gives us five distinct samples of materialized financing events from the traditional venture capital sequence, which allows us to estimate the average time it takes from one financing round to the next. In statistical terms, that means we’re approximating the population parameter (length of time) which characterizes venture capital financing sequences, by relying on the Law of Large Numbers and sample statistics. In total, we evaluated 13,916 materialized financing sequence events. Given the nature of the venture capital funnel and the number of companies that are actually able to raise their next round, this is a more than sufficient sample size for parameter estimation.
The general shape of the distributions suggests that the bulk of k+1 financing events take between 5 and 35 months from the prior event (plus/minus one standard deviation from the mean), and the long tails suggest that outliers exist which have taken considerably longer to go from one round to another (as long as 115 months, or 9.6 years!). The presence of outliers also tells us that the average values on the left plot (dashed vertical lines) are misleading, since averages are highly susceptible to outliers. The median is a much more robust measure of central tendency in the presence of outliers, so we should put more emphasis on the medians on the right plot (dashed vertical lines).
As perhaps expected, the median time lapse between Seed to Series A is less than the median time lapse between A to B, B to C, C to D, and D to E. Interestingly, the average and median time lapse seems to reach a maximum at the B to C stage, and decreases thereafter. The Series D to Series E distribution is also notably more spread out, which to us suggests that later funding stages are likely more dependent on individual company characteristics.
Depending on the financing sequence, the medians indicate an expected value range of 15 to 19 months, while the averages suggest a range from 18 to 22 months. Blending the samples together creates the average density distribution in the plot below, with overall mean and median sample statistics.
So, is it possible that the conventional wisdom of 12 to 18 months between financing events is an influential factor leading to high startup failure rates? Yes, because the hard data says entrepreneurs should plan for at least 18–21 months of runway, and as much as ~35 months if they want to play it safe and stay within one standard deviation from the mean.
Building a product takes time. Finding the right talent takes time. And it turns out that fundraising takes time, too. If it takes you less than 18 months to raise another round then great—keep going—but don’t reduce your probability of success by planning for less than 18–21 months of runway between your financing events.
Alternatively, if you’re up something a little more advanced then check out our release post on the Investor Cluster Score™ — a measure of the signal produced by a startup’s capitalization table.