How to Determine the Right Level of Burn Rate

By Tommaso Di Bartolo at What It Takes, for The Pitch

“What is the burn rate for your company?” … Can you answer the question? If you can, is your answer accurate? If you don’t know the answer, or you don’t know if your answer is the right one, you better learn how to determine the right level of burn rate for your startup.

A startup I recently was introduced to was in panic mode when they hit the point of having only enough money to operate for three more months. As they frantically tried to raise funds, we went into their burn rate and was super surprised when they told me “they didn’t know for sure” what it was. While they had an estimate when they started, they were using the money for things like frequent travel and comped meals, and they didn’t figure those costs in their burn rate.

To make a long story short, I helped them leverage a Syndication investment to raise a bridge round and keep operating. With that experience under their belt, they got serious about determining the proper burn rate for their startup and not to neglect their burn rate anymore. As a consequence of that situation before raising funds, they became confident about the amount of burn money they had in the bank, and they had less instances of panicking for funds thanks to determining the right level of burn rate for their startup.

Getting Personal with Your Burn Rate

Realistically, you won’t be able to come up with an exact number for your startup’s burn rate. It is a very personal issue and will vary between startups, so there is no universal answer. You need to decide for yourself what yours is. While you won’t get a specific answer, you’ll want to be pretty accurate and not too high so you know how much runway you have until you need to raise more money. Use the following to figure out an estimated burn rate for your startup.

• Fund raising is an essential part of the job and should be done early, often if not ongoing. It will always be a part of your job as a startup, so don’t expect to be able to set aside a couple of months every year or two to raise funds. You need to think of it as a permanent part of the job as the startup CEO, and not just a distraction from the core business. It’s vital to have enough money to support operations, so even if you only allocate 5% of your time to it, it still should be a year-round activity.
• If you are early round and received a reasonable valuation, your startup likely needs less capital. Additionally, it should take you less time to raise the money you need. For example, it’s going to be easier and faster to raise $2 million and at $6 million valuation than raising $10 million at any valuation. That may seem obvious, but it’s important to remember that you have more sources for capital as an early-stage startup. Investors are evaluating you based mainly off of your product and team, and there is a smaller risk for investors at this stage. At larger rounds, investors need to do more due diligence before funding, so it’ll be harder to raise the money you need.
• Plan about 4.5 months for fund raising from start to finish. While deals may get done in two to three months for the earliest stages, you’ll still want to have six to nine months of cash available when you reach target milestones to raise your next round.
• Know your current investors and how likely they are to support you going forward. If they are known to be loyal to startups, you might not have to worry too much about your burn rate. However, if investors only stick around under certain circumstances, you need to take that into consideration.
• Have open conversations with your investors about where you stand with future funds. Many startups don’t even ask, but it is better to know where you stand. Do it politely, and even if you don’t get a direct answer, you can still read into what whatever answer they give you.
• If you have an investor who has vocalized that their support will continue, they are comfortable writing another check, and they are known to back startups in good times and bad, you can have a higher burn rate. If you’re working with mostly angel investors or don’t feel like your current investor will continue to support you, you might want to lower your burn rate.
• Consider how strong your access to capital is. If you already have investors, then you have good access to capital. If you are trying to find new investors, or your existing ones might not be able to help you in tough times, that needs to be taken into consideration. Maybe you went to school with many people who are now venture capitalists, and you still consider them friends. If so, you could consider your access to capital strong. Many new startups aren’t this fortunate, though, and their access to capital is less strong.
• How much time have you invested in your startup?
• How much money have you, your friends, and your family invested? Is that a significant amount for them?
• Are you comfortable with going all out, or are you generally cautious.

There’s no right or wrong answer, it’s just vital to know your risk tolerance.

• Know how accurate your last round valuation was and be more cautious if necessary. If your valuation was too high and you have limited revenue, and your investors are concerned about your future success, or you might not get outside funding at your current performance level, you might need to be more cautious with your burn rate and potentially cut costs. If your valuation is inaccurate, you can do one of the following:
• Guarantee continued funding from your inside support so you don’t have to rely on outsiders.
• Cut your burn to grow into your valuation
• Adjust your valuation down to what is normal for your stage.
• Go all out and hope that you succeed at your current valuation.
• Know where you stand with your A and B round investors, and get them to work together. Early stage investors may be “over their skis” and unable to help you because they are dependent on your B-round investors or outside money to help fund you. They may truly believe in your startup and know they’ll get no return if you sell. However, B-round investors may be willing to sell your company and be better off just getting their money back if your startup has stalled. If this happens to you, you need to get your investors to work together. Get your A-round investors to persuade your B-round investors to be more reasonable, cut costs, and know where you stand before you decide what the right burn rate is for you.

Use the Formula

Depending on where the startup is located, you can figure $10–12k times the number of employees. For example, if your startup is located in an area that has a higher cost of living, like in Silicon Valley, your startup’s burn rate will be higher than a startup in a midwest location.

This can vary based on the type of company. Consumer companies tend to go through more cash in their early years compared to SaaS companies. Consumer companies don’t see revenue until their consumer adoption has reached a larger scale. The average consumer public startup doesn’t exceed a $1 million monthly burn rate at any point. Alternatively, SaaS companies will burn about $1.5 million as they scale up, but once they go public, their burn rate will fall to sub-$1 million per month.

Why Knowing is Important

Having a lower burn rate allows you to go longer without having to raise more cash. While raising funds is an ongoing job duty for startups, if you can manage your burn rate, you can spend less time on raising funds. Also, the frequency in which you have to raise funds can decrease, which allows you to focus on other areas of your startup.

Do you have a product/market fit that requires an aggressive burn rate. Without a true product/market fit, there is no sense in increasing your burn rate aggressively to stimulate your future growth. For SaaS businesses, you need to monitor indicators like MRR growth, churn rate, cost of customer acquisition, and payback period. The model may be different for consumer startups. You may need to monitor usage and engagement. It will be unique for each startup, depending on the company type.

Are you scaling up hiring for the right reasons? Startups may feel the need to scale up and get the best employees, developers, engineers, etc. because they believe the startup game is an arms race. However, when you have limited funds and a burn rate you need to stick to, you need to consider hiring only when you have a real need for more bodies in your startup.

Are you spending more than 5% of your budget on things besides payroll, benefits, and rent? Of course, you need to spend in the areas listed as they are essential to making your startup work. However, things like servers, advertising, meals, and travel are easy to overspend on, and it’s a good place to look if you are going through your burn rate faster than you should be.

Are you willing to do what is required to break even? It’s not an easy decision, but it might be necessary to let some of your workers go, reduce salaries, eliminate certain salaries, sell some of your extra office equipment and other things, downgrade to a more affordable office or apartment, or even relocate to a cheaper city.

A venture-backed path requires putting a lot of stress on a new business. Be ready to do things that normal businesses don’t have to do when you are on a venture-backed path. You are expected to tackle a big-money opportunity and achieve hyper growth year-over-year. Be ready to put a lot of stress on your startup to grow quickly and take the market as fast as you can, because if you don’t, someone else will. You need a market that is big enough with a large and undeniable target to where your startup will be able to take a small part of it.

TAKEAWAY

As a startup, your budget is a huge part of your future success. It’s important to determine what burn rate is right for your startup so you can make it to your milestones without running out of money. When you’ve determined the right burn rate, you can work on scaling up. Open communication with your investors is key, as is taking a hard look at where you are spending your funds.

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