What is Burn Rate?

Burn rate means how fast a company, usually a new startup, spends the money it has to pay for things and grow bigger. It’s a number that tells you dollars per month. If your burn rate is $50,000, that means your company is spending $50,000 each month.

Knowing the burn rate is super important for the people and companies that give money to startups. They’re called venture capitalists. They always want to know a startup’s burn rate. It helps them figure out when the startup is going to need more cash to keep growing and doing stuff.

Why Burn Rate Matters

Burn rate is like a stopwatch timing how fast you’re spending the money you got. Startups raise a bunch of money, but that money only lasts so long. The burn rate tells you how many months you’ve got until you’re broke.

Let’s say the venture capitalists gave your startup $1 million. Yay! That’s a ton of money. But hold up, your burn rate is $100,000 per month. Some quick math and you realize that $1 million is only going to last 10 months.

This is why burn rate is mega important. It’s not just about having a lot of money in the bank. What really matters is how long that money is going to last. The burn rate tells you that.

Good vs. Bad Burn Rates

Now, spending money isn’t always bad. Heck, that’s what that cash is for – to help the startup grow fast. You’ve got to spend money to make money, right? Startups use the money to hire awesome people, get an office, buy equipment and tools, do marketing, all that jazz.

But there’s smart spending and dumb spending. Smart spending is when the burn rate is high because the startup is growing fast, getting more customers, and making more money. The burn rate might be high, but so is the growth rate.

Dumb spending is when the burn rate is high but the startup isn’t really growing. They’re just burning through cash without much to show for it. That’s bad news bears.

How to Calculate Burn Rate

Figuring out burn rate is just basic subtraction. You take how much money the startup has at the start of the month and subtract how much they have at the end of the month. That’s the burn rate.

Here’s an example:

Startup starts June with $500,000 in the bank
Startup ends June with $450,000 in the bank
Burn rate for June was $50,000

Easy peasy.

Why Startups Have High Burn Rates

Startups aren’t like regular companies. Regular companies try to make a profit – more money coming in than going out. Startups are different. They’re all about growth, growth, growth.

To grow super fast, startups spend a ton of cash. They hire a bunch of people real quick. They spend big bucks on marketing to get the word out. They give away their product for cheap or even free to get a bunch of users fast.

All this spending means startups often have high burn rates, at least in the beginning. And that’s okay, as long as they’re growing fast too.

The Startup Funding Cycle

This is where venture capitalists come in. Startups raise money from venture capitalists in rounds. Each round gives the startup a bunch of cash to burn through for growth.

When the startup is getting close to running out of cash, they go back to the venture capitalists for another round of funding. This keeps happening until either:

The startup becomes profitable and doesn’t need more cash, or
The startup gets acquired or IPOs

Each funding round is like gassing up the car. The burn rate tells you how fast you’re burning through that gas.

Dangers of a High Burn Rate

While high burn rates are common in startups, they come with some serious risks.

Running Out of Cash

The biggest danger is running out of cash. Remember, each funding round is only so much gas in the tank. If you burn through it too fast and can’t raise more money, you’re dead in the water.

This is why startups need to be super careful with their burn rate. They need to make sure they have enough runway (aka time) to hit their growth goals before the money runs out.

Investor Confidence

High burn rates can also spook investors. If a startup is burning through cash too fast without much growth to show for it, investors might lose confidence. They might think the startup is being reckless with their money.

This can make it harder for the startup to raise more money in the future. Investors talk to each other. If word gets out that a startup is burning cash like crazy, it can scare off other investors.

Pressure to Perform

High burn rates also put a ton of pressure on the startup to perform. They’ve got to grow fast to justify all that spending.

This pressure can lead to bad decisions, like focusing on vanity metrics instead of real growth, or cutting corners on quality to ship faster.

Managing Burn Rate

Startups can’t avoid burning cash, but they can manage their burn rate. Here are some tips:

Keep an Eye on the Numbers

Startups need to track their burn rate like a hawk. They should know exactly how much they’re spending each month and how that compares to their growth.

There are a bunch of metrics startups can use to keep tabs on this, like:

Burn Multiple: How much the startup is spending to get each new dollar of Annual Recurring Revenue (ARR)
Runway: How long the startup’s cash will last at the current burn rate

Focus on Unit Economics

Instead of just focusing on top-line growth, startups need to pay attention to their unit economics. This means looking at how much it costs to acquire each customer and how much revenue each customer brings in.

If it costs more to acquire a customer than that customer is worth, the startup is going to burn through cash no matter how fast it’s growing.

Be Lean

Startups need to be as lean as possible. This means being really careful about headcount, only hiring when absolutely necessary. It also means being scrappy with marketing and growth spending.

The idea is to get the most bang for your buck. Spend money on the things that are really going to move the needle, not just on flashy stuff that looks cool.

Have a Plan

Startups need to have a clear plan for how they’re going to use their funding. This plan should lay out key milestones and growth targets.

Having a plan helps the startup stay disciplined with their spending. It also helps them communicate their progress to investors.