To Investors,
According to Statista, the main reason for startups failing worldwide has to do with cash flow problems. This includes either a lack of financing/investors and/or running out of cash.
It takes a little work, but managing capital is paramount to ensuring that your company stays in the arena. The longer you stay in business the more likely you are to survive. Today we’ll look at a framework for how to think about capital efficiency.
One important metric that founders should look at is the Burn Multiple.
Burn Multiple = Net Burn / Net New ARR
Let's say that a company reports adding $250 000 in revenue during Q3, while having used $500 000 of the company’s money.
This company’s burn multiple = $500 000 / $250 000 = 2x.
The higher this number, the more alarmed the founder should be, and the opposite is true.
The idea is not to necessarily reduce your burn rate. Remember investors are giving you money because they’re expecting you to use it, but to use it effectively for growth.
A high burn rate also isn't necessarily a terrible thing, it might just mean that you’re ready for a higher valuation. It's important to ensure you’re always spending in a justifiable manner.
Here are a few reasons why a startup’s burn multiple may be high…
Early years
This is the period where the startup is still new, and therefore has little to no revenue (at zero revenue the burn multiple is negligible).
In the early years, the startup might have also not yet found product market fit. In which case the amount of burn will be high throughout that journey to find product market fit.
Capital Intensive Industries
If a startup is operating in a capital-intensive industry such as biotech, manufacturing, or other deep technology, the nature of the business may be such that high R&D costs are essential.
For Saas Companies
A sales efficiency problem: If customer acquisition cost is strained (i.e. you're having to spend an uncomfortable amount for that additional sale) or sales productivity is diminishing, burn will increase relative to new revenue, causing the Burn Multiple to worsen even though growth continues.
A churn problem: Churn will eat at the denominator of the Burn Multiple, causing the multiple to increase. “A leaky bucket makes it hard to grow efficiently.”
Everything Else
Stalling growth: If growth is a challenge the startup might spend more on marketing, discounts, give-aways, and promotions - this will increase the burn multiple.
Gross margins: If the cost of goods sold of a company is too high, this eats at the gross margin of the company, and in turn increases the burn rate.
The founder refuses to spend wisely.
This is where some people would insert guidance metrics for where a burn multiple should be for venture stage startups, according to the stage of capital raise, however I think it's best to be guided by 1) how long the burn multiple stays at a certain rate; 2) the profitability that the burn rate is generating for the company - profitability should always be trending upwards; and 3) the cash runway - remember that if profitability is growing then the startup has more cash and therefore should have a longer runway before needing to raise additional capital (depending on the economic conditions and the stage at which the startup is in, the general rule is 24 months of runway).
How founders can keep burn low…
First, keep salaries and expenses low in the early days. This will both extend runway and strengthen the impression of product-market fit for when the startup raises the next venture round.
Secondly, depending on the type of business you’re running, it may even be worth giving up unprofitable growth by cutting revenue that comes at a cost that outweighs the income it generates.
In conclusion, the amount of money your startup is spending should always be justifiable - monitor the Burn Multiple extremely closely.
Happy building!
Respectfully,
-Mansa
Disclaimer: this note is not financial advice and is for informational and entertainment purposes only. We may hold positions in the companies discussed. Do your own research.