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. 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.
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.
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.
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. 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