Burn, runway, and default alive

Two startups each have $500K in the bank, and each loses $60K this month. The two startups have the same runway on paper: 8.3 months. One of them becomes profitable without another investor. The other runs out of cash in month 11. One number makes the difference: how fast revenue grows.

This lesson teaches the words for burn, the runway formula, and the test that tells you which of the two startups you are.

Gross burn and net burn

Gross burn is all the cash that you spend each month: salaries, rent, servers, and everything else. Net burn is the cash that you spend minus the cash that comes in. Net burn is the amount by which your bank balance decreases each month.

Gross burn = Cash out
           = $250K
Net burn   = Cash out − Cash in
           = $250K − $100K
           = $150K

a16z writes that investors watch net burn most closely. When a founder says “we burn $150K a month”, the founder usually means net burn. If you are not sure, ask which one.

Runway

Runway is the number of months until your cash is gone at the current net burn:

Runway = Cash ÷ Net burn
       = $3M  ÷ $150K
       = 20 months

The same company has a worst case. If all revenue stops, the cash lasts $3M ÷ $250K = 12 months. Gross burn gives that floor.

Work it out

You have $1.2M in the bank. You spend $150K each month and collect $50K each month. What is your runway?

Your answerCheck

The simple runway ignores growth

The runway formula assumes that net burn stays the same each month. That is rarely true. If revenue grows, net burn falls each month, and the real runway is longer. If you hire, net burn grows, and the real runway is shorter.

Northwind Labs, the startup of Ada and Ben, has $500K in the bank. Revenue is $40K this month and grows 8% each month. Expenses are $100K a month and stay flat. Net burn is $60K, so the simple runway is $500K ÷ $60K = 8.3 months.

Predict first

Northwind does not raise money, and its growth stays at 8% a month. How much cash does it have at the lowest point?

Type a guess before you continue. A guess first, even a wrong one, makes the answer easier to remember.

Your guessSave my guess

Default alive or default dead

In October 2015, Paul Graham wrote an essay with one question for founders: “Assuming their expenses remain constant and their revenue growth is what it has been over the last several months, do they make it to profitability on the money they have left?”

If the answer is yes, the company is default alive. If the answer is no, the company is default dead. Graham wrote that half of the founders that he talked to did not know which of the two they were. He sent founders to a calculator by Trevor Blackwell. The simulator in this lesson does the same math.

The test is a simulation, month by month. Each month, revenue grows by the growth rate, and the cash changes by revenue − expenses. The company is alive if revenue gets to the level of expenses before the cash is less than zero.

Worked example · step 1 of 5

Northwind month by month: $500K of cash, $40K of revenue, 8% growth, $100K of expenses

1. 1

   Month 1

   Revenue is $40K and expenses are $100K. The company loses $60K.

   Cash = $500K − $60K
        = $440K

Show step 2Show all steps

Now try it yourself. Start with Northwind’s numbers. Move the growth from 8% to 6%. Look at the result. Then set the growth back to 8% and select “Hire two people”.

Simulator

Default alive or default dead?

Set the cash, the revenue, its growth, and the expenses. Expenses stay flat, and revenue keeps its growth rate.

Cash in the bank

$500K

Revenue this month

Revenue growth each month

8%

Expenses each month

$100K

Hire two people: $25K a monthCut $15K a monthReset

Net burn

$60K

$100K − $40K

Simple runway

8.3 months

Cash ÷ net burn

Result

Alive

Profit in month 13

Growth to survive

7%

The lowest monthly growth

Cash at the end of each month

Revenue and expenses each month

• Revenue
• Expenses

Default alive. At 8% growth a month, revenue passes expenses in month 13. The cash falls to $59.09K at the lowest point, and then it grows again.

The simple runway says 8.3 months, because it ignores growth. At the lowest point, the cash pays for 17 days of expenses, so a small decrease in growth can change the result.

Small changes, different answers

The table shows the same company with one change in each row. Cash is $500K, revenue is $40K, and expenses are $100K a month, unless the row says otherwise.

Change	Result	Cash at the lowest point
10% growth a month	Alive: profit in month 11	$137K
8% growth a month	Alive: profit in month 13	$59K
7% growth a month	Alive, barely: profit in month 15	$2K
6% growth a month	Dead: the cash runs out in month 11	Less than zero
8% growth, plus two hires (+$25K a month)	Dead: the cash runs out in month 7	Less than zero
5% growth, with expenses cut to $85K	Alive: profit in month 17	$86K

The table has three lessons:

1. A company with 8.3 months of simple runway can be default alive, because growth decreases the burn.
2. A small decrease in growth, from 8% to 6% a month, changes the answer from alive to dead.
3. New hires change the answer faster than other decisions. Two hires at $25K a month in total change the minimum growth for Northwind from 7.0% to 13.4% a month.

Read the lowest point

The result “alive” is not the full story. Look at the cash at the lowest point, because it shows how much room for error the plan has.

At 7% growth, Northwind gets to profit with only $2K left. Expenses of $100K a month are approximately $3,300 a day. Thus at the lowest point, the cash pays for less than one day of costs. One late customer payment or one slow month changes the result.

At 10% growth, the lowest point is $137K, more than one month of expenses. That plan can absorb a small surprise. When you read the simulator, ask two questions. Is the company alive? How much cash is left at the lowest point?

The month in which revenue passes expenses is the break-even month. After it, the company does not burn cash, and the cash grows again.

Hires change the answer fastest

Graham wrote: “Hiring too fast is by far the biggest killer of startups that raise money.” A new hire adds a cost on day one. The revenue that the hire helps to make comes months later, if it comes. In the table, two hires turn a company that is alive into a company with no cash in month 7.

That does not mean “never hire”. It means that you must run the test before you hire, with the new cost in the expenses. If the answer changes to dead, you must first get faster growth, make a smaller plan, or raise new money.

Work it out

Expenses are $200K a month, revenue is $50K a month, and the company has $1.8M. A hire plan adds $30K a month to expenses. What is the simple runway after the hires?

Your answerCheck

The fatal pinch

Graham gives a name to the worst case: the fatal pinch. His definition is “default dead + slow growth + not enough time to fix it.” A company in the fatal pinch has too little time to correct the problem with growth. Its slow growth also makes it hard to raise money.

Many founders who are default dead plan to raise more money. Graham warns that founders “assume it will be easy to raise more money,” and that “the more you depend on it, the falser it becomes.” Cash that you expect to raise is not cash.

Why does the test keep expenses flat?

Graham keeps expenses flat to give the honest base case: the company that you have today, with no new decisions. Real expenses change, so run the test again for each plan. In the simulator, the hire and cut buttons show how one decision moves the answer.

Quiz · question 1 of 5

Test what you learned

Which statement gives the best definition of "default alive"?

• AInvestors promised to fund your next round.
• BYou have at least 18 months of runway.
• CYou are profitable at this time.
• DIf expenses stay flat and revenue keeps its recent growth, you get to profit before the cash is gone.