Here’s the deal with raising growth capital for your startup: it will only last you so long, and you’ll spend it far faster than you ever imagined. Managing your burn rate, or the pace at which you spend your cash, requires a balanced approach to risk. There’s no getting around it; you need to spend money to make money. So, at certain times in your startup lifecycle, you’ll hit the gas pedal and blow through some money to make things happen. On the other side, you should be prepared to slow down (or pull the emergency brake) if you’re moving through your capital too fast.
The thought of finally obtaining the funds to take their business to the next level, and the possibility that it could all slip away (or burn up, if you will) keeps many founders up at night. Founders find themselves fixated on questions like how much runway is left? What’s the zero-cash date? Knowing how to calculate your burn rate, and keep it low, are fundamental to startup success. Read on to see how it’s done.
How to calculate your startup burn rate
Your burn rate isn’t a one-time calculation. It’s not something you cross off your list. Rather, it’s something you closely monitor so you can thoughtfully approach big-ticket expense decisions, such as hiring. Your burn rate will vary drastically compared to other startups. This is not about “keeping up with the Joneses”; it’s about being reasonable with your spending so that you don’t have to shutter your business.
A few terms to understand:
Gross burn: Your average monthly expenses. It doesn’t matter what money you’re making (or if you’re making any at all)
Net burn: Your monthly expenses (gross burn) minus your monthly revenue
Runway: Cash you have in the bank, divided by your net burn
For example: You’re a SaaS company with 9 employees. You have a gross monthly burn of $80,000. You’re bringing in $20,000 a month in revenue, so your net burn is $60,000. You just received a $2M round of funding. This gives you a runway of about 33 months ($2M divided by $60,000). This is great, but now that you’ve received a nice funding round, you’ll likely scale up fast by hiring additional people and investing in more resources, dramatically increasing your burn rate. It’s not uncommon for a serious equity raise to buy a fast-scaling company 12–18 months of runway, if not less.
Startup investors, including venture capital firms, will ask you about your burn rate. They’ll want to look under your financial hood to see how you’re spending your money and if you’re disciplined in your approach. One concern they look for: startups that spend wildly and irrationally after receiving investments. These startups may lose their scrappy nature and frivolously overspend, something VCs and other investors want to avoid.
But don’t feel like your burn rate must be zero. Smart technology investors know SaaS companies need to make hefty investments up front to gain customers and lock them in, long before they’ll see a profit from those new customers. They’re comfortable with high burn rates—if your growth rates are rising in parallel.
What’s a “good” burn rate?
Of course, there’s no one answer, which makes burn rate so tricky. How do you gauge if you’re spending too much or even too little? Venture capitalist Fred Wilson suggests that $10K per employee per month is a good number to aim for. This per person rate includes salary, rent, the overhead, and any tools or resources. It’s just meant to give you a quick calculation to do a health check on your burn rate.
Of course, burn rate expectations—from a VC vantage point—will shift based on your stage. Your burn rate when you’re in the MVP-building stage (which, according to Wilson, should be ~$50K), will be different than your post-release growth stage, when you’re on a mad dash to gather users (at which Wilson thinks you should keep burn to $100K or less).
Wilson’s rule isn’t the only one out there. Some say you should aim to “spend less than 10 percent of your last capital raise per month. If you raised $1.5 million, then you should spend less than $150,000 per month.” And still others note that if you have less than a year to go before you’re at zero cash, you better be in full-blown survival mode, scrambling to raise more money ASAP.
There is no easy answer, so take these “rules” with a grain of salt.
7 ways keep your burn rate low
The moment you take money from investors, especially a VC, you’re going to be expected to accelerate your growth—to the tune of ~100% year over year. You’ll need to spend to make that happen. It’s all about making smart spending decisions, at the right time. Entrepreneurs have come up with a slew of creative ways to go about managing their burn rates:
Hire only when it’s necessary
Think about your real needs and what value each hire will bring to your startup. Count on freelancers to bridge the gap until you’re absolutely ready to make an offer.
Salaries should be your biggest expense
Don’t spend more than 10% on anything else—marketing, sales, travel, etc.
Test new marketing strategies
Don’t sign up for expensive marketing channels if you aren’t sure they will perform. Test everything first.
Lease versus buy
This goes for everything from office space to tech equipment. Leasing not only will give you more favorable terms, but a lot more flexibility.
Count on interns
Boost your productivity and tighten your development cycles throughout the summer months, when you can scale up with summer interns looking to gain experience at a startup.
Use free trials
Leverage free software trials and online tools wherever possible, from free stock photos and editing software to free antivirus programs. Take advantage of these freebies while you can.
Get creative with your workspace
The startup garage office is stereotypical because it’s true. Cash-strapped startup workers use shared spaces, bedrooms, garages—wherever they can—for workspace.
Stay on top of your numbers
Many startup leaders find themselves in the uncomfortable position of managing cash flow and budget, perhaps when they were previously in roles where these tasks were someone else’s responsibility. It’s not always fun, seeing how much longer you can last as a business, especially when you’ve got a payroll to manage and a team that counts on you. But it’s part of being a founder.
Take a breath. Cozy up to your spreadsheets. Know what’s going on with your cash. And if you need to, tighten up that budget!
Looking For Funding?
The loan payments are tied to monthly revenue, going up for strong-revenue months and down for low-revenue months. Visit here to see how it works, and if you like what you see, apply for funding today to connect with our investment team!