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Neil Patel

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What is a cash burn rate in business?

How do you calculate yours? What is its importance in your organization? How can you shrink yours if it is killing your company? 

What Is Your Cash Burn Rate?

Cash burn rate is effectively the amount of money your company is losing. It is your negative cash flow.

Burn rate is typically quoted on a monthly basis. So, if you have a cash burn of $2M, that means you are losing $2M per month.

This is a very common term in the world of startups and venture capital. Young companies have had a habit of burning through a lot of money through the first few years in business. Though even very large companies have been notorious for losing money every quarter, even though they’ve been valued at billions and have gone public. 

Calculating your burn rate is the same as figuring out your monthly negative cash flow. So, if you have no revenues and your expenses are $10,000 per month, your cash burn rate is $10,000 per month. 

Any revenues you do have offset this figure. Though you may also have additional costs of goods sold when you are making sales. So, if your static expenses and overhead are $10,000, your costs of goods sold is $10,000, you now have $20,000 in expenses. If you have revenues of $30,000, then your burn rate is still $10,000. 

Burn Rate & Fundraising

The most common use of this term is in startup fundraising. You need to know your burn. It will be one of the top questions prospective investors ask when pitching.

The primary reason for this is that your fundraising round should be giving you enough runway to get through to your next milestone and the point where you are eligible to raise another round of funding.

For example, if your burn rate is $100,000 a month, you will likely be raising enough to get you through at least 12 months. Maybe 18 months with enough cushion to absorb delays in closing the next round. You’ll be looking to raise at least $1.2M. That’s not counting any planned increase in expenses. 

Your runway is the number of months of cash you have left at this burn rate. You also must make sure you are raising enough money to hit the next fundable milestone. That may be nailing product-market fit, or getting to revenues.

Remember that storytelling plays a key role in fundraising and you will need capital to scale things up. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.

The Dangers Of A High Burn Rate

While burning lots of money has been trendy, it is also highly risky. At least in most cases.

A high cash burn rate means you are losing money every month. It’s really only a matter of time before you are bankrupt when you continue to operate in this position. At least, unless you are lucky enough to raise more money, get to profitability, or sell the company.

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There are no guarantees of any of these things. Even in spite of the best planning. 

Why Companies Run High Burn Rates

We’ve seen many big and notable companies running extreme burn rates. Uber and WeWork were big examples of this in the world of startups. 

Zillow is an example of a high profile public company that has been around for years, and is still losing money. Despite being in business for 14 years and owning one of the most visited sites on the internet, they are notorious for burning tens of millions of dollars per month. 

They recently went further with a big pivot into buying and selling homes themselves, like Opendoor which raised at least $300M itself. Both were making big bets losing lots of money on a space they hoped could be worth $20B a year. Then the coronavirus hit, and they stopped this lane of their business. 

They thought they could buy the business and industry by expanding rapidly. In the case of Uber it was subsidizing rides. With WeWork it was incredible leverage. Then when interruptions come, like natural disasters, regulator push back or future funding is cut off, it doesn’t matter how big you are, you may only be months from bankruptcy. Even JC Penney and Neiman Marcus, with are 100 plus-year-old companies found that they ended up in bankruptcy with just a couple of weeks of their income being turned off.

Many startup companies have to temporarily run a burn rate until they can get sales and income in the door. Others make it their business plan. They count on getting to big scale to make their idea work. Like marketplace business. Or they plan to just keep raising and gaining market share at any cost until they can sell the company off or take it public. 

What’s An Acceptable Burn Rate?

For some it may just be a few thousand dollars per month. For others it has been millions, and even billions a year. Often without any concern.

There are really four factors that play into this decision:

  1. The market and potential reward for the risk being taken
  2. The direction of the general economy and industry
  3. The future availability of capital to keep up this strategy
  4. Having a fast path back to profitability and solvency if the above works against you

How To Lower Your Cash Burn Rate

If you want to limit this risk, or have run into trouble with a big burn rate, there are two main choices. 

  1. Increase your income to offset your burn
  2. Cutting business costs to reduce losses

Some of the obvious ways to reduce burn by cutting costs today are:

  • Staff layoffs
  • Shedding unnecessary office space, equipment, and recurring bills
  • Running on in-demand, just-in-time inventory
  • Moving to a digital or software product or service instead of hardware

In the video below I cover in detail what is cash burn rate which you may find very interesting.

 

FULL TRANSCRIPTION OF THE VIDEO:

Hello, everyone. This is Alejandro Cremades, and today we’re going to be talking about what is cash burn rate? The burn rate of your company is supercritical. It’s going to determine whether you’re going to be able to do an acquisition, a fundraising round, whether you’re going to be able to sustain the current business to really control your own destiny. 

In today’s video, we are going to cover everything related to cash burn rate and also help you understand different exercises that you can do so that you can get to the point and the nitty-gritty of how to really understand and have a clear grasp on your own burn rate. So with that being said, let’s get into it.

What is burn rate? Burn rate, in the end, what it means is the amount of money that your company, in essence, is losing every month. For example, if your burn rate is $10,000, that means that already accounting for the revenues, you are losing – if it’s $10,000, the money that you are in the red every month, at the end of each month after you’ve paid everything, cost, revenue, and everything, essentially that $10,000 is your burn rate.

Burn rate is the typical term that is used in venture capital, especially in hypergrowth companies, and what is going to help the VC, or that venture capital firm investor, is to understand how much burn rate you have or how much runway you have in order to execute your different types of milestones to get to the next stage or the lifecycle of your business.

When we’re thinking about burn rate and fundraising, burn rate is going to be a critical component because you need to understand how much cash you’re going to require to have left in order to get out there and start raising actively. In essence, typically, right now is six months left of cash in the bank. Let’s say if you go out to raise money, and you need to raise at least 18 months of runway, you have a cost of $100,000 every month, which is the burn, you’re going to be having to raise around 1.2 million if you want to get closer to the 18 months. But that’s what you’re going to be discussing with investors.

When it comes to the runway, keep in consideration that runway is going to be the amount of time that you have left before you go crashing. This is, in essence, what is represented as the plane having enough runway in order to take off before it actually crashes. That is why it’s called runway. For that reason, burn rate and runway come hand-in-hand, especially when you’re going out to raise money, and you need to understand how much burn rate you have versus how much runway you have left in order to execute.

In terms of the dangers of the burn rate, or having a high burn rate, in many instances, you’re going to see the super-hyper-growth companies, like the Uber’s or the WeWork’s of the world that have a crazy burn rate. They’re hoping that by having that burn rate, they’re going to be able to capitalize on having a great market share, mind share, and eventually the costs are going to come in parallel with the revenues and that they’re going to be able to design a profitable company.

The thing is that when that happens, and that may work out well when you’re operating in a market that is positive, a bull market, everyone is making money. But if it turns around, and you’re going into a bear market where everyone is losing money, essentially, money is going to dry up, and for that reason, you want to avoid having a high burn rate so that you have more flexibility to maneuver in case you need to course-correct so that you give yourself more oxygen.

When we’re thinking about what’s an acceptable burn rate, there are different factors that come into place because every company is a different world, every stage is a different cycle that you’re in, in the business, so it’s not going to be the same burn rate that is going to be acceptable for a company that is already up and running, that has product/market fit versus a company that is trying to validate their product or service. So there are certain factors that come into play and that play a critical role. Those are the following:

  • The market and potential reward for the risk being taken
  • The direction of the general economy and industry
  • The future availability of capital to keep up this strategy
  • Having a fast path back to profitability and solvency if the above works against you

When it comes down to how to lower your cash burn rate, it’s really obvious. You’re going to be increasing the revenues, and you’re going to be decreasing the costs. That’s the obvious factor. Now, there are other things that you can keep in mind when you’re reducing the burn rate, and some of those factors are the following:

  • Staff layoffs
  • Shedding unnecessary office space, equipment, and recurring bills
  • Running on-demand just-in-time inventory
  • Moving to a digital or software product or service instead of hardware

Again, the burn rate is something that you’re going to have to keep in mind as you’re executing during the 18-24 months of runway. It’s something that you need to be prepared to discuss with potential investors and also with existing investors. Again, account for that, as well, as you’re perhaps preparing your business plan or your pitch deck.

I would love to hear on the comment section below how you’re thinking about burn rate. Also, Like this video and subscribe to the channel so that you don’t miss out on all the videos that we’re rolling out every week.

Then, take a look at the fundraising training, which is the program where we help entrepreneurs from A to Z with everything related to fundraising. There you’ll find live Q&As, agreements, templates, a community of entrepreneurs helping each other all over the world, and I think that you’ll find tremendous value in it. Thank you so much for watching.

 

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Neil Patel

I hope you enjoy reading this blog post.

If you want me to help you with your fundraising, just book a call.

Book a Call