Applying the Burn Multiple to Marketplace Business Models

The Burn Multiple, which was coined by David Sacks at Craft Ventures, has become a key metric for measuring the efficiency of growth for SaaS companies. The metric looks at how much money is burned for every dollar of ARR growth, effectively showing you how efficient you are growing your company.

Some founders have asked if the Burn Multiple can be applied to marketplace businesses. The short answer is yes. Every company, not just SaaS businesses, should be thinking about the efficiency of their growth. Here’s how to apply the Burn Multiple to marketplace businesses.

There are two tweaks to the formula:

• Use “growth in annualized gross profit” instead of “growth in ARR” as the denominator.
• In addition to the typical quarterly Burn Multiple, look at a yearly version of the Burn Multiple.

The Marketplace Burn Multiple

Why Do We Change the Formula for Marketplaces?

The original Burn Multiple was developed specifically for SaaS businesses. Marketplaces are different from SaaS businesses in that they have more fluctuations in their revenue (eg seasonality), more subjectivity in how their P&L is presented, and a wider range of typical gross margins.

A. Revenue Fluctuations and Negative Burn Multiples

Seasonality can cause quarter-over-quarter (QoQ) declines in GMV, revenue and gross profit. This will lead to a negative Burn Multiple, which is not meaningful or helpful in understanding the efficiency of your company’s growth.

Let’s look at a hypothetical marketplace business to illustrate this point:

Even though the business is growing revenue over 300% year-over-year (YoY), it actually declined quarter-over-quarter in Q121 and again in Q122. Unlike SaaS businesses that typically grow every quarter, these seasonal fluctuations in revenue are common in marketplaces and other transactional businesses.

Because of the QoQ decline in gross profit, the Burn Multiple in Q122 is negative (-51.5) which isn’t meaningful and should be disregarded. Just as a seasonal trough in gross profit distorts the Burn Multiple, so does a seasonal peak: the QoQ Burn Multiple would imply the business is more efficient than it really is during these seasonal peaks.

Use the YoY Burn Multiple if your business has significant seasonality. Use the QoQ Burn Multiple if it doesn’t. This hypothetical company’s YoY burn multiples were 0.7 in Q421 and 0.9 in Q122, which are excellent and suggest that this company is growing very efficiently.

B. Arbitrary P&L Classifications

Marketplaces have a significant level of subjectivity in how they present their P&L. All marketplaces have two “top line” numbers: (i) gross transaction volume (GTV) and (ii) net revenue. There is quite a bit of wiggle room in exactly which line items are included as contra-revenue (between GTV and net revenue) and which are included as COGS (between net revenue and gross profit). Different presentations will lead to different calculations of the Burn Multiple even though the business doesn’t actually change at all. It’s the same business just presented differently. These different presentations shouldn’t affect the Burn Multiple, but they do since net revenue is affected.

To address the arbitrary nature of these P&L classifications, we change the calculation of Burn Multiple so that it is based on growth of annualized gross profit dollars instead of growth of annualized revenue. This also helps to normalize different gross margins, which can vary widely among marketplace businesses (eg, from 35% to 85%) but tend to fall in a narrower range for SaaS businesses (eg, from 70% to 85%).

Target Marketplace Burn Multiples

The following table shows a good rule of thumb for marketplace burn multiples. The thresholds are slightly modified from the SaaS Burn Multiple to account for using gross profit instead of revenue.

Conclusion

Every founder and every investor wants strong growth, however keeping an eye on burn rate and runway is critical. The “growth at all costs” mindset, where companies burn huge amounts of cash to achieve their growth objective, is never a good strategy but especially not during a downturn when access to capital is limited. The efficiency of growth becomes even more important than growth itself. If your Burn Multiple is more than 2.5, consider cutting your burn rate to lower it.

The Burn Multiple has become the de facto standard for evaluating the efficiency of growth for SaaS businesses; we hope this adaptation for Marketplace businesses is just as helpful for marketplace founders.