Burning Bad: Cash burn, cash runway, and valuation

Burning Bad: Cash burn, cash runway, and valuation

In recent years, the startup landscape has seen a shift in the way valuations are determined. Previously, the focus was solely on growth, with profitability taking a backseat. However, as the markets return to a focus on profitability, valuations are now tied to both growth and profitability. This shift in the recipe for a premium valuation has led to changes in the way startups raise and use funds.

Startups typically require a financial product to get off the ground. In the past, a $3M Series A funding round for 25% of the company was common. However, as valuations have increased, VCs have started focusing on earlier stages, driving up round sizes. The purpose of raising funds is to use them as a backstop, allowing startups to delay the pursuit of free cash flows and concentrate on taking advantage of a fleeting market opportunity.

Cash burn is a term used to describe the amount of money a company spends from its bank account to subsidize the shortfall from current operations. It is calculated by subtracting what a company bills its customers from what it spends. Cash runway, on the other hand, refers to the number of months a company has until it runs out of cash. If a startup is on the venture path, it typically wants a cash runway of at least 18 months. This gives them 12 months to make progress before needing to secure additional funding, plus an additional 6-month buffer in case the markets are not favorable.

To assess a startup's future business success, several leading indicators can be used. These include the CAC Payback Period, which measures the time it takes to recoup the cash spent on acquiring a customer. A CAC Payback Period of under 12 months is considered great for startups, while under 18 months is great for larger, more mature companies.

Another important metric is the LTV to CAC ratio, which measures the multiple of value a customer brings compared to the cost of acquiring them. An LTV to CAC ratio of over 5x is considered excellent. Net retention, which measures how much a customer grows after acquisition, is also a crucial indicator. Additionally, the gross margin, which represents the amount of money left to invest in the business after servicing existing customers, is an important metric. Lastly, the burn multiple, which determines how much cash is burned for each unit of growth, reflects the overall efficiency of the business.

It is important to note that growth is a byproduct of a company's monetization model, not a driver of it. With the shift towards profitability, employees are set to benefit. Raising cash is often seen as a positive signal for a company, and startups often use fundraising events as recruiting tactics. However, if mediocre businesses receive premium valuations, it creates a disconnect. When cash is more gated and valuations are tied to both growth and profitability, potential employees will receive more accurate signals and avoid joining ultimately unsuccessful ventures.

For employees considering joining a startup, it is important to approach the decision as an investment. Asking the same questions a traditional investor would ask when assessing long-term business viability can help in making an informed decision.

Fair Initial Token Distribution for Optimal Decentralization

The initial distribution of tokens plays a crucial role in the decentralization and efficiency of a blockchain network. To achieve a fair and efficient initial distribution, several factors need to be considered.

Firstly, a reasonable number of people should hold the token, with this number increasing proportionally with the market cap of the project. This prevents a small number of individuals from having too much control over the network.

Additionally, the biggest token holders should not possess an overwhelmingly large majority of tokens. This ensures a more equal distribution and reduces the risk of centralization.

Moreover, there should be no large price discrepancies in acquiring the tokens. If some individuals can acquire the tokens at significantly lower prices than others, it creates an unfair advantage and disrupts the distribution.

The importance of token distribution depends on the role the token plays in the network. While token distribution may not directly affect the safety or performance of a blockchain, it has implications for network security, long-term sustainability, incentive alignment, governance, and token categorization.

A decentralized network is more resistant to Sybil attacks and manipulation. By distributing tokens widely from the early days, it becomes harder for attackers to acquire the necessary weight to influence network decisions.

Incentive alignment is also crucial for the performance of a network. A well-designed network should compel every participant to act in their own interests while enhancing network performance. This can be achieved by tying voting weight to the number of tokens held or delegating voting power to trusted entities.

Governance plays a significant role in token distribution. On-chain governance can distribute voting power based on token holdings, ensuring that decisions are made by those with a stake in the network.

Token categorization is another important aspect of distribution. The SEC considers a token to be a security until it is "decentralized" enough. Different blockchain networks have adopted various distribution models.

Bitcoin, for example, distributes its tokens as rewards for mining blocks. The distribution model is considered fair as early contributors received better rewards when the mining competition was low.

Zcash follows a similar distribution model to Bitcoin but also allocates 10% of all rewards to stakeholders in the company. This ensures long-term alignment and incentivizes individuals involved in the health of the chain.

Ethereum, on the other hand, conducted an initial coin offering (ICO) where a significant portion of tokens was premined and sold to investors. The challenge for Ethereum lies in creating efficient distribution mechanisms that put tokens in the hands of those willing to contribute to the network's growth and development.

One example of an efficient distribution mechanism is locking Ether in a smart contract to receive tokens. This incentivizes individuals interested in the project to actively participate without requiring a direct investment.

While there is no perfect solution for token distribution, it is important to align incentives towards long-term sustainability and involve relevant actors in the network's growth.

Actionable advice:

• 1. Startups should focus on achieving a balance between growth and profitability to attract favorable valuations in today's market. This means carefully managing cash burn and ensuring a sufficient cash runway.

• 2. Potential employees should approach joining a startup as an investment decision. Asking the same questions as a traditional investor can help assess the long-term viability of the business.

• 3. Blockchain projects should strive for a fair and efficient initial token distribution to promote decentralization and optimize network performance. This includes avoiding large price discrepancies, ensuring a reasonable number of token holders, and preventing concentration of tokens in the hands of a few.