Every Startup Should Keep Track of Their Burn Rate

Raising funds or otherwise bringing in capital for your startup can be challenging, to say the least – but to achieve growth, founders often must invest those funds into updating technology, creating advertising and marketing campaigns, and product development. This is where the term burn rate comes into play for a startup.

Burn rate is a crucial metric for startup founders and investors to keep track of. It illustrates the runway a startup has and helps all parties involved understand crucial financial timelines for the company.

Today, we’re discussing the importance of burn rate when it comes to startups, as well as sharing some tips on keeping burn rate at a more manageable level for your startup.

What Is Burn Rate?

Burn rate is a measure of negative cash flow that describes the rate at which a company is spending capital to finance overhead before generating positive cash flow.

For startups, burn rate is most often calculated per month. If a company has a burn rate of $100,000, it means it is burning through or losing $100,000 each month. Those funds can go towards company necessities such as salaries, rentals, utilities, or communication as well as towards things like business build out and fixed assets.

Burn rate isn’t a one-and-done calculation, however. It’s something that should be updated and monitored to aid startup leadership in company decision-making, such as hiring, fundraising, or product expansion.

Types of Burn Rate

There are two types of burn startup founders and VCs should be aware of: gross burn and net burn. Gross burn is the total amount of operating costs a company incurs in expenses each month. Net burn is the total amount of money a company loses each month.

Say, for example, your startup has a gross monthly burn of $200,000. If your revenue is $50,000 a month, your net burn is $150,000.

Why Burn Rate Matters

So why is knowing your startup’s burn rate important?

First of all, it will allow you to calculate your runway (the cash you have in the bank divided by your net burn). Returning to our example, if your net burn is $150,000 and you have just completed a funding round of $1 million, you would have a little over six and a half months’ runway.

Second, VCs will most likely expect information about your startup’s burn rate as they’re considering making an investment.

Burn rate isn’t always bad, and in fact, the right amount of it can be a good sign. For many VCs, burn rate can be a good indication of growth – if a startup is spending money in order to develop future products, roll out updates, or scale hiring, for example, it can potentially be more interesting than a profitable company experiencing a long period of stalled growth.

That said, if a startup’s burn rate is on the higher side and the company is struggling to raise funds or is seeing sales slow, VCs may be more likely to advise that a founder should reduce burn.

So what is the right burn rate for your company? It depends on a number of factors, including:

• Whether your startup has found product-market fit
• Whether your growth is sustainable long term
• Whether small steps can be taken in order to reach profitability
• Why your startup was able to break even in the past (if applicable)
• Whether hiring is a necessity or is being considered just to grow talent base
• Your risk tolerance and your investors’ risk tolerance

Tips for Managing Startup Burn Rate

If your startup is losing money at an untenable rate, you may need to take steps to control the burn. Here are a few methods startups can use to reduce their burn rate.

1. Exploit organic growth options

Controlling your burn also means controlling your customer acquisition cost (CAC). Anyone can buy customer leads, but those leads can be costly.

Sometimes the best way to control your CAC is to identify promising organic channels of growth and allocate at least a portion of your valuable resources toward them instead of toward pricier paid growth.

2. Invest in a bean counter

We know that startups sometimes have to cut corners, but based on the scrambled financials we’ve seen, this is not a corner we recommend cutting. A bookkeeper or accountant can sort out your financials and keep them that way, readily justifying their position.

Not only will having that person give you better visibility into your company’s performance, but it will also help you make a more professional impression on potential investors.

3. Strike a balance on perks

Startups often offer perks to their employees – especially when the salaries alone aren’t much of an enticement. But it’s important not to let those perks put you out of business.

While some founders may be tempted to unscrew every other light bulb in the office to save on electricity, others will be tempted to hire Snoop Dogg for the company’s launch event. Your job is to find a balance between those two extremes.

4. Outsource what makes sense

If you have a crack team of software developers, you may be tempted to save money by having that team develop an internal chat system, sales database, or file server. But every hour they spend working on that tool is an hour they aren’t spending working on the product.

Nowadays, there are free or low-cost options for just about everything you need to run a business. Some are open source, some are ad-supported. Take advantage of them.

5. Make the hard decisions

If something (or someone) isn’t working out, it’s in the company’s best interest for you to change course sooner rather than later.

You’ve probably heard the phrase “Fail fast, fail cheap.” Failing fast and cheap requires that you take action as soon you realize that you’re paying for something that isn’t contributing to the company’s success. Every day that you let a problem continue is just money down the drain – money that your employees and investors are counting on you to spend wisely.

Controlling Burn Rate Is Key to a Startup’s Success

It may be too soon for your startup to be cash-flow positive, and additional venture capital may not be available the moment you need it. But controlling your burn is always an option. While that figure may vary from month to month, you should always know how much you’re spending – and whether it’s the best possible use of your funds.

For more information about common venture terms, visit our Glossary of Terms. Not a MicroVentures investor? Sign up today.