How Much Money Should Your Startup Be Burning Through? Decisions on burn rate must be made within the context of a startup's growth stage, the industry it operates in and the amount of financing raised.
By Eric Siu
Opinions expressed by Entrepreneur contributors are their own.
If you came here looking for a definitive, "one size fits all" answer on the appropriate capital burn rate -- the rate at which a new company spends its capital reserves -- for all startups, I'm going to disappoint you from the start. Just as every business is different, decisions on burn rate must be made within the context of the startup's growth stage, the industry it operates in and the amount of financing raised.
A biotechnology startup, for example, will likely have a far different ideal burn rate than a software startup. The biotech firm might wait years for FDA approval, while the software-as-a-service company has a shot at becoming profitable through monthly recurring revenue (MRR) growth within a year or two. At the same time, a company with millions of dollars in the bank can afford to play a bit looser with burn rate than one with only a few months of runway left in its accounts.
Related: How to Make Your Cash and the Investor's Patience Last Until You're Profitable
However, the fact that no firm line on burn rate exists doesn't mean that you should spend money without a well-defined plan. Here are a few ways of thinking about burn rate, as well as a framework for determining whether yours is too high or too low:
The old models
When discussing ideal burn rates, many people refer back to a 2011 post by venture capitalist Fred Wilson, who recommended the following limits for web and software startups:
- Building product stage: $50,000 to $75,000 a month
- Building usage stage: under $100,000 a month
- Building the business stage: under $250,000 a month
Wilson's estimates are based on an approximation of $10,000 a month for each fully burdened employee. That is, a startup in the building product stage could support five to seven employees, while a business moving on to the usage stage could support up to 10 and a company actively growing its business could take on up to 25 employees.
New thinking
However, even the few years between his post and today has changed the landscape considerably. In an article written for Medium by Danielle Morrill, CEO and co-founder of @Mattermark, Morrill shares a quote from VC Marc Andreessen that puts his estimates of the cost of a fully burdened employee at $200,000 a year -- well above the $120,000 a year Wilson shared.
Morrill currently estimates her company's burn rate at $150,000 to $200,000 a month, though Mattermark's last fundraising round gives her less than a year of capital to work with at these rates. In an effort to determine whether her approach was "normal," she reached out to other entrepreneurs and found the following estimations, among others:
- Dunwello: $55,000 a month burn, $1.2 million in the bank
- Blended Labs: $20,000 a month burn, $300,000 in the bank
- AdEspresso: $35,000 to $40,000 a month burn, $1 million in the bank
- TattooHero: $26,000 a month burn, $200,000 in the bank
- SourceEasy: $25,000 a month burn, $887,000 in the bank
What's interesting about these numbers is that, although their monthly burn rates are relatively consistent, all five companies are at vastly different stages of growth. While Dunwello, for example, reported recently finding its product-market fit when sharing its financial metrics, SourceEasy, on the other hand, is already reporting future revenue numbers that are on the path to eclipse its seed funding.
Related: Grow Your Business Without Drowning in Debt
Building a burn rate framework
While there are no hard and fast rules you can apply to your startup to see if your burn rate is appropriate, there are questions you can ask yourself to see whether you're on track.
Where are we on the growth spectrum? The core of Wilson's advice -- paraphrased above -- isn't wrong. If you're just starting out and have fewer than five employees, there's no reason to be burning more than $250,000 a month. Similarly, if you've established product-market fit and have moved on to growing your business, keeping your burn rate low for the sake of keeping it low could stifle growth and prevent you from moving forward.
Are we under threat from competitors? According to VC Mark Suster, writing on his Both Sides of the Table blog: "Companies who are scaling quickly in revenue and with a high gross margin often should invest as much capital in growth as they can manage responsibly because when you find a product/market fit and your company is growing at a very fast scale you want to capture market share before competition sets in."
If you have good revenue and margin numbers, and if you expect to encounter competition either when you find your product-market fit or shortly after, ramping up your burn rate to establish yourself in your marketplace may be a smart move.
Do we have strong VC/angel support? Finally, you may have a bit more leeway when it comes to burn rate if you have a strong network of VC and angel investors who are committed to your company. If you're running through your balance sheet but still have investors who believe in your product and its eventual profitability, you're much more likely to be able to secure additional capital to continue your growth than a company whose first fundraising series was hard to come by.
Take all these factors and considerations into account when determining if your burn rate is too high or too low. At the end of the day, it isn't your burn rate by itself that's so important -- it's the way you use this money to stimulate your company's growth and deliver the results both you and your investors are banking on.
Related: 10 Ways to Keep Your Company's Cash Flow Alive
