Startups are quickly adapting to a new normal of constrained VC support and lower valuations. As part of this process, however, founders should also take care to adapt, or at least expand, on some of the go-to tracking metrics they’ve relied upon for the past several years. Case in point: Runway.
For startups, “runway” has long been synonymous with “how many months until we run out of money”. This works well in an investment-rich environment where a startup can trade profitability for growth (and lose millions of dollars along the way) because they reasonably expect to raise their next financing round when that “runway” hits 12 months or so.
How many months until you break even?
However, in a world of lower valuations and intense competition for limited capital, another version of “runway” is increasingly the focus of founders and investors alike: How many months until you break even?
This makes sense. Given the likely operating environment for the rest of this year and much of next, it’s reasonable to wonder when a startup might stop losing money. However, determining when, precisely, breakeven could occur can be an elusive target for many startups. With limited operating experience and often unproven business ideas and products, figuring out how many dollars of revenue (or, more accurately, how many units) need to be sold in order to cover costs is often more of a guessing game than a mathematically-derived formula. For some really early-stage companies, there are just too many assumptions about product-market fit, pricing, etc., to make a months-to-breakeven forecast very reliable. Nonetheless, evaluating all the inputs, growth projections, and expense ramps necessary to reach profitability is a super useful exercise – and when an investor asks when you will start to make money, you will have at least an educated guess.
Calculating Your Breakeven
The basic framework is simple and can be easily added to any financial model that forecasts results monthly. Divide your fixed costs each month by your price per unit or product less your variable costs per unit:
- Breakeven = Fixed costs / (Price per unit – Variable unit cost)
So if you have $50,000 in fixed costs per month and are selling a SaaS license for, say, $100 per month that carries $20 in variable expense per license, the formula becomes:
- Breakeven = $50,000 / $80 = 625
In other words, at month X, you’ll need to sell 625 units to cover your expenses in that month – i.e., break even, because your fixed costs are $50K and your variable costs are $12.5K, so you need $62.5K in revenue to cover costs.
Once you have this back-of-the-napkin formula in place, you can start managing toward particular margin or profitability goals, and easily adjust the moment when you’ll sell enough product to pay the bills as you get new information. That’s your breakeven month, and it’s very common in startups to see that point in the future move as the company learns more about its product, pricing, and marketplace. In fact, this is one of the core insights a fractional CFO can provide – what happens to our breakeven point if this and this happen to our costs, and we adjust our prices by X%?
Many startups raise cash from investors to pay for revenue growth under the premise that, at a certain point, operational leverage kicks in and each dollar of revenue costs incrementally less to obtain & fulfill. All else being equal, this is a sound strategy and is still true. But for startups navigating the next 12-18 months, profitability – or, more specifically, the onset of it – will rightfully be a focus of investor conversations. Understanding this revised version of the runway metric – when and how your company will achieve breakeven – is not only sound practice for any startup CEO, but will help make those conversations easier.