Revenue and Runway – Why every cent matters

A month ago on Techcrunch, Michael Arrington wrote about “Twitter’s Revenue Dilemma”: “Your valuation can actually go down once you turn on revenue.”.

“Turning on revenue” frames it as a binary thing. You’re either making money or you’re not. It completely disregards the most important variable in finance: Time.

With the tiniest trickle of revenue you can extend your runway infinitely. That means you never have to raise another cent and you even have money to fund your growth. Let’s take an example:

Say you’re a consumer web business. You have some growth and some traction. You close an angel round for $400k in Month 1. In month 2 you start spending it and your burn rate is $25k for salaries, office and hosting. It takes you 4 months to get the product into shape and launch.

In your first month of launch you make a meagre $500 bucks. And lets say you suck at marketing and your revenue increases by $1000 per month so that a year after you launch your product (17 months after getting funded) you’re making $12,500 per month in revenue.

Even two years after getting funded you’re still only making $19,500 which is far from breaking even.

But what this does it it slows your burn rate enough and buys you enough time so that you never run out of money. That means you can keep paying yourself a full salary and growing your business and you never run out of cash. In month 29 your bank balance drops down to $12,500, but then it starts increasing again because in Month 30 you break even.

If you didn’t generate any revenue in the first 18 months you run out of money in month 17.

You might argue this approach stifles growth. So be more aggressive, increase your burn rate to $200k and raise $3 Million. The same logic applies. Early cash-flow that is far from break-even can extend your runway to infinity (and beyond).

This matters for founders more than anyone else because it means you can raise a single round and never have to give away any of your equity ever again.

The sheet below shows the two scenarios – with and without revenue. [I’ve reoriented the flows vertically for readability]

The DOW 10K priced as opportunity cost

Economists love the concept of opportunity cost because it gives you a the real long-term value of an investment or purchase in relative terms – which is really the only way to calculate value. On Wednesday the DOW hit 10,000 again. The US financial press did their part to ring the bell while the banking community celebrated the boost in perceived value and the increased likelihood that the public would buy their wares.

Fox News, like clockwork, has given former asshole president Bush credit for the recovery. (Skip to 3:00 in the video) “He took the bold moves and look where we are today..”.

John Authers in the Finanial Times is almost embarrassed on Thursday as he delivers the news of what a DOW 10K means in real, opportunity cost terms. If you invested in the DOW in 1999:

  • Relative to emerging markets you’ve lost 80% of your money.
  • Relative to gold you’ve lost 75% of your money.
  • And even in dollar terms corrected for inflation (using the CPI) you’ve lost around 23% of your money.