You’ve heard the saying, "You have to spend money to make money." While true, excessive spending without careful management could drain your company’s coffers faster than you expect.
In fact, the median cash runway of VC-backed tech companies in the U.S. has seen a significant reduction from 16 months in Q4 2021 to a tight squeeze of just over 12 months in Q4 2022. In this current economic climate, being cautious with your spending makes all the more sense.
Knowing your startup’s burn rate is a helpful tool to optimize your spending and build a comfortable cash runway. In previous articles, you might have read about how you can calculate your cash burn rate.
To go one step further, we encourage you to compare your startup’s rate to your industry's average. This can provide a better benchmark for evaluating your spending patterns and help you decide whether to cut back or keep it up.
Throughout this article, discover the average burn rate for startups, factors influencing it, and how to react when it changes.
The Importance Of Monitoring The Burn Rate
Regularly monitoring your burn rate is crucial for several reasons:
- Financial optimization: Helps identify areas where you can optimize spending, reduce costs, and improve overall economic efficiency.
- Cash flow management: Allows you to better manage your cash flow and make informed decisions regarding expenses, investments, and revenue generation.
- Risk mitigation: A high negative cash flow may indicate potential financial distress. Knowing when you’re at risk allows you to avoid cash flow problems, and ensure the sustainability of your startup.
- Investor confidence: Investors and venture capitalists closely examine a startup's burn rate as part of their due diligence. Effective management instills confidence in investors, increasing the likelihood of securing funding for future growth.
What Does Burn Rate Mean In The Early-Stage Startup Ecosystem?
At its core, burn rate refers to how fast a startup spends its cash reserves. It helps determine your startup's financial runway — the time it can sustain operations before running out of cash.
This provides clear insights into the financial health of your startup. By closely monitoring your expenses and surplus cash, you can make informed financial decisions contributing to profitability and growth.
Types Of Burn Rate: Gross Burn Rate Vs Net Burn Rate
Understanding the burn rate's massive influence is the meat and potatoes of your business's financial viability. To that end, you must differentiate between gross and net burn rates.
- Gross burn is the total amount your startup spends in a month. For example, if your monthly expenses are $25,000, the gross burn rate is the same. It doesn't consider other factors, such as revenue, and solely focuses on your monthly outgoing expenditures.
- Net burn provides a more holistic view of your startup's finances. For example, if your startup earns a total revenue of $75,000 monthly, and your expenses are $100,000 for that specific month, the net burn rate is $25,000.
The Average Burn Rate In Startups
The average burn rate for startups varies based on factors such as startup stage, industry, business model, growth strategy, and funding availability.
A study by Scale Venture Partners found that the monthly average for early-stage startups is approximately $50,000 per month. This study also found that it varies depending on the stage of the startup. For example, for seed-stage startups it is around $200,000 monthly, while the average for Series A startups is around $1 million.
It's important to note that these are just averages, and what’s considered good for a startup is based on these factors:
- Startup stage: Early-stage startups typically have higher burn rates than later-stage startups. This is because early-stage startups typically focus on product development and growth, which can be very capital-intensive.
- Industry: Some industries are more capital-intensive than others. For example, startups in the technology industry typically have higher burn rates than startups in the retail industry.
- Location: Office rentals, employee salaries, and other expenses vary based on the location. Startups in high-cost areas like San Francisco or New York City typically have higher burn rates than startups in lower-cost areas.
While it’s okay (and even expected) to have a higher cash burn rate, especially during the early-growth stages, as your startup progresses, you need to focus on lowering it to achieve profitability and financial sustainability. Consider comparing your burn rate with similar-sized startups in your industry to understand your financial position better.
Here are some additional tips for comparing burn rates:
- Choose comparable startups: When comparing your burn rate with others, choose startups similar to yours regarding stage, industry, and location.
- Use multiple sources: Use resources like industry reports, startup databases, and online calculators to access the latest burn rate data.
- Consider your specific circumstances: When comparing your burn rate to other startups, it's important to consider your own specific circumstances. For example, a startup focused on product development may have a higher burn rate than a startup focused on marketing and sales.
Above Average Burn Rate: Strategies And Considerations
If your burn rate is more than similar-sized startups in your industry, it might indicate that you’re on a too fast-spending track than expected. Implementing the following strategies can help lower your cash burn rate:
- Monitor cash flow: Track and analyze your spending closely to identify and reduce unnecessary expenses.
- Optimize operational expenditures: Look for areas of improvement in your business strategy and operations to lower expenses.
- Prioritize revenue generation: Explore ways to optimize pricing, tweak the product/service offering, and focus on sales and marketing efforts to increase revenue streams.
- Focus on other financial metrics: Besides the burn rate, measure and track other financial metrics like customer acquisition cost, lifetime value, and gross margin.
Implementing these strategies and continuously monitoring your burn rate will improve your financial stability and overall trajectory.
Below Average Burn Rate: Potential Implications And Opportunities
If your burn rate is lower than the average in your industry, you're spending cash conservatively and operating efficiently. This is a positive sign of financial efficiency and presents several opportunities for your business:
- Extended financial runway: Having sufficient cash to continue operations longer provides financial stability and allows you to focus on achieving business milestones.
- Improved fundraising prospects: A below-average rate showcases fiscal resilience and sustainability, making your startup more attractive to potential investors and increasing the likelihood of securing favorable funding.
- Resource allocation: With optimal cash utilization, you can strategically allocate resources to drive growth, innovation, and market expansion.
- Competitive advantage: Operating efficiently compared to your peers positions you as a strong competitor, enabling you to gain market share and establish your brand in the industry.
Leveraging these opportunities will accelerate your growth trajectory, enhance your startup's long-term prospects, and increase the likelihood of a favorable venture capital decision.
Effectively Manage Your Startup's Burn Rate
By comparing your burn rate to other startups in your industry or niche, you can get a clear picture of whether you are spending too much money or not enough money. This can help you make informed decisions about your spending and ensure you’re on track to achieve your financial goals.
Consider hiring a fractional CFO to help you with market research and determine whether you’re spending too much or too little money compared with your peers. They can analyze your cash flow and create a strategic game plan to build a comfortable financial runway, helping you win investor trust and raise the required funding to achieve your milestones.