Burn Baby Burn

My headline does not refer to the annual event held each year around the end of August in the Nevada Desert known as Burningman. Rather, this post is focused on how founders can reduce their burn rates — which has become a “hot topic” given the current fundraising environment.

A recent post by Tomasz Tumguz from Redpoint shows that the number of seed rounds raised by startups has fallen by about 30% in dollar terms — and by about 50% over the last two quarters. This suggests that investors now prefer to consolidate their investments in fewer seed-stage companies. But the trend doesn’t end there: The seed market is just the first segment of the venture capital market where early stage companies will soon experience a greater shortage of available funds.

So what is a founder supposed to do? Based on our experience with our portfolio companies, a key strategy is to make things people want. Then, focus relentlessly on generating revenue as early as possible by finding product market fit while spending as little as possible. To put that another way: one of the best ways to improve your chances of raising capital is to trim your burn rate ASAP.

Much has been written lately about average burn rates in Silicon Valley. Marc Andreessen, for example, recently guessed that the average cost per employee at Series A startups is around $17,000 per month. But what if you are based outside of the Valley, and benchmarks like this are not as readily available?

Since we have 12 portfolio companies in 10 countries around the world, we wanted to share some of the lessons we have learned to date about burn rates. We realize that every company is unique and that costs could vary significantly depending on the type of company and its location. As such, our data points are based on the average software startup in the enterprise space. To help illustrate my point, I will compare two cities, Berlin and Ho Chi Minh City.

However, before getting into the detail around costs, it might be helpful to provide a bit of background on each of the cities for those of you who have not had opportunity to visit.

Berlin: I live in Berlin and it is an amazing city. It has something for everyone. It also has a very lively start-up scene (see London-versus-berlin-which-startup-ecosystem-will-lead-Europe), in part because it is an affordable place to live and start a business. What the city is still missing, perhaps, is one or two household venture capital firms. That said, 500 Startups recently launched in Germany and Union Square Ventures has also been very active locally. We’re also now seeing that the caliber of founders from the engineering and product side is getting better and better — which has helped in recruiting top talent for our portfolio company, Home Eat Home, an on demand healthy food delivery service.

Ho Chi Minh City: Another amazing city based in a country, Vietnam, that Dave McClure recently noted as “vibrant and growing… with many talented entrepreneurs and engineers.” Despite high levels of poverty, Ho Chi Minh City has a large young and extremely motivated workforce that is very comfortable adopting and developing new technologies. It’s remarkable to see how many people have at least two to three mobile phones. 500 Startups also recently launched a $10 million Vietnam-focused fund. It’s an environment that has helped our local portfolio company, Simple Solutions or S3, a platform that helps both retailers and wholesalers in Southeast Asia better manage their ordering process, thrive.

Let’s get back to the topic of the lessons we have learned in managing burn rates. I have identified a few data points below based on our experiences in Germany and Vietnam that help illustrate some of the advantages in starting a business outside of Silicon Valley:

1. Overhead:

Based on our experience with our portfolio companies, it rarely makes sense to scale the team beyond five to seven initial members. That’s because if you are at the very early stages of your startup and are focused on building a product, then the team size should ideally be between one and five employees — most likely made up of two to three founders, one lead developer, and one junior developer.

In Berlin, the average gross total salary and benefits for a lead developer ranges between $5,000 and $7,000 per month, depending on their level of experience. In Ho Chi Minh City, on the other hand, the same senior developer will receive around $2,500 to $3,000 per month. In both cities, junior developers will cost about 25% or even 50% less than the cost of hiring a lead developer.

Once a startup gets past the early product development stage, it might be then time to make two additional key hires: a head of marketing and one user-experience lead. It is important to get this mix right and get it right early.

We also believe that founders should not pay themselves more than what they are paying their lead developers as it could easily create a misalignment of interests.

2. Office Rents

Berlin has a number of co-working spaces that charge around $250 per desk per month. There are also some small apartments available that could easily accommodate five to seven team members. Rents have been on the rise, but average monthly rates are about $10 to $12 per square meter — or $700 per month in total.

Coincidentally, rents in Ho Chi Minh City are similar at $9 to $12 per square meter for small apartments that are just outside the central business district.

3. Other Expenses

If more than 5% to 7% of your budget is allocated to expenses outside of payroll, payroll tax, benefits, and rent, you are probably overspending. The culprits could be things like servers, advertising, meals, and travel.

Now that we have laid out the cost landscape of operating outside of Silicon Valley, let’s do some math. Again, these numbers will vary depending on the company and the type of solution. But using the figures I outlined above, we find that the average monthly burn per employee in Germany would be around $6,000. In Ho Chi Minh City, the figure is about half that or $3,000 per month. When we compare these figures to that $17,000 in Silicon Valley, it’s easy to see how both these cities make for a great environment to launch a startup before scaling to the point where they could enter the U.S. market.

Here are some other general guidelines we coach our portfolio companies on when it comes to managing their burn rates:

1) Hiring cheap generally means hiring expensive. Instead of hiring more people at lower salaries, a better approach might be to hire fewer people — but making sure they are all A players. You can push them hard and reward them appropriately for their efforts. This strategy has proven to pay off exponentially over the long run for our portfolio companies.

2) Only scale when there is a real need. Unless your startup has tremendous revenue growth and is bursting at the seams, don’t hire. We realize that it can be difficult to recruit top talent, but hiring because you fear missing out as opposed to having a real need could be a recipe for disaster.

3) Obsessively keeping track of your two to three key monthly growth metrics will help determine whether it makes sense to increase your headcount and corresponding burn rate.

In closing, many things happen on a daily basis that founders can’t control. But given the current fundraising environment, it might be prudent to control how you spend your money and to ensure you make something people want.