Small decisions, big impact
After six months of hard work a founder is celebrating her first $500,000 capital raise and planning how she will grow the business over the next year. The success of the financial round was built on a great product idea, a solid prototype, strong product market fit and her ability to recruit a great team.
At the current development pace her team estimates the product will take 12 months to complete. Our founder uses Runway to model her cash burn and visualize her trajectory.
The model shows that even though she has enough cash to cover expenses through a 12 month development cycle, it will take another 5 quarters to grow to the point where the company makes enough to cover expenses.
Her current path would force another round of financing (and further equity dilution) before the business is cash flow positive.
In an effort to avoid further dilution, she challenges her team to come up with ideas that would put the company in a better cash position. The team produces two options that would impact revenue. They feel these options are realistic in scope but are not sure if their impact would be sufficient to get them to positive cash flow on time.
To help with her decision she turns to Runway to model each option’s impact and visualize the results.
The two options modeled are:
- Accelerate product launch
- Increase product price
1. Accelerate product launch
This first plan calls for revising product scope and moving up the launch date by three months. An aggressive development schedule would risk burning out the team, but everyone understands the benefit of less dilution.
The chart shows that accelerating the launch by a quarter gives the company an additional 7 months of runway but that still leaves 3 quarters before cash flow turns positive. A faster product release extends the life of the company significantly but it’s not enough to avoid the capital raise.
2. Increase Price
In the original model product pricing was based on customer interviews done in the early days of the company and the team believes the numbers are out of date. Faced with the cash challenge the sales lead revisited revenue assumptions and proposed a price increase of 10% at launch.
Changing the model to reflect the increase in pricing showed the following results:
A 10% price increase appears to have very little short term impact and only extends the life of the company by 1 month. This is due to the fact that in the first few months of sales the revenue base is still small and the % increase does not add up to a material cash impact. Over time, as the revenue base grows, the price increase will have material impact on the business but in the short term it does not help the team achieve their goal.
3. Combined Scenario
Realizing that each option alone does not have enough impact to bring the needed cash flow, she builds a third scenario that combines both the early product launch and the 10% price increase.
Under the combined scenario the company not only benefits from the 3 additional months of revenue but there is more time for the price increase to show a cumulative benefit. Combining both changes delivers the necessary revenue and the company gets to positive cash flow before having to raise additional capital.
In our experience, any one small change to a financial model rarely has the desired impact of moving cash or profits in a material way. In most cases the best way to get to a goal is to model a series of small changes and see how each impacts the overall result. Working with the operational team to come up with realistic scenarios and combining them in ways that are complementary to each other is a powerful approach.
Learn more about Runway and other tools from the LTSE.
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