Posts from Burn rate

How Much To Burn While Building Product

In last week's MBA Mondays, I wrote about burn rates at three stages of a startup. The first stage is what I called "Building Product Stage" and I suggested that a burn rate of $50k/month was appropriate for that stage.

I got a fair bit of pushback in the comments for that part of the post. My favorite push back came from The Kid, who said:

50k a month?!?!??! maybe it is such in venture world, but if you're a broke ass fool bootstrapping his/her way, try 5k per founder a month until you have paying customers. if you're hardcore (translation: desperate broke ass fool), cut that number in half — it's definitely possible.

The Kid and everyone else who pushed back on that number in the comments are right. You can build a product for less than $50k/month, particularly if you and your co-founders are deeply technical and if you have at least one founder who has great product and design skills.

I was chatting with Naveen, cofounder of Foursquare, the other night. He told me that the month he and Dennis finally raised money for Foursquare from USV and others was the month his savings had run out. Basically he and Dennis worked for nine months without any pay and built V1 of Foursquare all by themselves for basically no money other than their time which they were not charging the company for.

We see this a lot actually. Many (most??) of our early stage investments are in companies that have bootstrapped in this way. So I feel a bit badly about throwing that $50k/month number out there. But there are companies that are fortunate enough to raise money at the seed stage and use it to build product. And for those, I see $50k/month as a good upper limit.

So I stand by the $50k number, but with a big caveat. If you can do it for less, by all means do that. Bootstrapping is a great thing and leads to great products and great companies.

#MBA Mondays

Burn Rates: How Much?

In the comments to last week's Burn Rate post, I was asked to share some burn rates from our portfolio. I can't do that. But an alternative suggestion was to write a post suggesting some reasonable burn rates at different stages. I can do that and so that's the topic of today's post.

The following applies to software based businesses, and most particularly web and mobile software businesses. It does not apply to hardware, life sciences, and energy startups. It is also focused on startups in the US. It costs less to employ teams in many other parts of the world.

Building Product Stage – I would strongly recommend keeping the monthly burn below $50k per month at this stage. Most MVPs can be built by a team of three or four engineers, a product manager, and a designer. That's about $50k/month when you add in rent and other costs. I've seen teams take that number a bit higher, like to $75k/month. But once you get into that range, you are starting to burn cash faster than you should in this stage.

Building Usage Stage – I would recommend keeping the monthly burn below $100k per month at this stage. This is the stage after release, when you are focused in iterating the product, scaling the system for more users, and marketing the product to new users. This can be done by the same team that built the product with a few more engineers, a community manager, and maybe a few more dollars for this and that.

Building The Business Stage – This is when you've determined that your product market fit has been obtained and you now want to build a business around the product or service. You start to hire a management team, a revenue focused team, and some finance people. This is the time when you are investing in the team that will help you bring in revenues and eventually profits. I would recommend keeping the burn below $250k per month at this stage.

A good rule of thumb is multiply the number of people on the team by $10k to get the monthly burn. That is not the number you pay an employee. That is the "fully burdended" cost of a person including rent and other related costs. So if you use that mutiplier, my suggested team sizes are 5, 10, and 25 respectively for the three development stages listed above.

Once you get the business profitable, you can scale the team larger and larger to meet the needs of the business. I don't think of that kind of expense as "burn rate", I think of it as "scaling the team." I believe you want to use a bottoms up budgeting process to determine your headcount needs at this stage of the business.

One final caveat – there are outliers. Twitter had a higher burn rate than I am recommending during the second stage due to the massive scaling costs they encountered. And Facebook had a higher burn rate during the building the business stage due to the size of the revenue team that they assembled and other needs of the business. There are some business opportunities that are large enough that they can justify (and fund) larger burn rates. The mistake we all make is assuming that many of our companies are outliers. There are very few companies that can justify a million dollar/month burn rate or larger. There are many more that thought they could and are no longer around.

#MBA Mondays

Burn Rate

MBA Mondays is back after a week off. Today we are going to talk about burn rate, or cash burn rate to be more specific.

Your burn rate is the speed at which your cash balance is going down. If you had $1mm in cash on January 1st, and now it is October 1st and you have $250,000 left, your burn rate is $750,000/9, or $83,333/month. Just to be perfectly clear the $750,000 in this calculation is the amount of cash that has gone out the door ($1mm minus $250,000 is $750,000). And the 9 is the number of months that have transpired (January through September is nine months).

So it is October 1st and you have $250,000 left and your burn rate is $83,333/month. So how many months of cash do you have left? Well now that you know your burn rate, that's easy. Take the amount of cash you have left ($250,000) and divide by your burn rate ($83,333/month) and you get three months. At year end, you will be out of money.

That's the whole point of knowing what your burn rate. If you had unlimited funds, burn rate would be an irrelevant number. But I've never seen a company wtih unlimited cash. So entrepreneurs, CEOs, and certainly CFOs should always know how much cash they have and if they are burning cash, they should know the rate at which their cash balance is going down. And of course, they should know the date on which they will have no cash left.

If your company is highly profitable and spitting cash (like Apple), then this whole issue is not as important. But companies can go from profits to losses pretty quickly, because of a bad economy or a product cycle transition or some other bad fortune. And when that happens, burn rate can become important very quickly. So having a sense of cash balance and expense structure is always a good idea.

The calculation of burn rate above is what I call the "back of the envelope method". You can do that in a board meeting, a pitch meeting, or in a car driving down the highway (which I did last tuesday) as long as you have two dates in time and cash balances on both dates (assuming there has not been a financing in between).

But there is a more sophisticated way to calculate burn rate. You look at your monthly expenses on your income statement. Add all of them up. And then look at any outlays of cash for capital expenditures or other regular uses of cash on the balance sheet and cash flow statement. Add all of these monthly cash outlays together. This is "gross burn rate". Then you look at revenues, or even better cash reciepts from revenues. Include all incoming cash you are certain you can count on every month. Subtract this from gross burn and you get "net burn rate". This should be the amount of cash that your business is burning in any given month.

Whenever I get a version of this more sophisticated calculation of burn rate, I always do a sanity check by comparing to the "back of the envelope" method just to be sure they are in the same ballpark. If a CFO reports to the board that the Companny has a net burn rate of $100,000/month, but the cash balance has gone down by $1mm in the past five months, it's a signal that something's not right. And then you have to dig deeper.

When you do these "deeper dives" you often run into "one time expenses". "Well, we had to lay out a huge security deposit in February that was a big hit to cash" or "our legal fees on the big contract with IBM were a big hit to cash in June". But my view is if a company has big "one time expenses" every month or two, they really aren't one time expenses. The burn rate calculation needs an accrual for these sorts of things in it.

Burn rates can change pretty quickly.  If revenues are ramping faster than expenses consistently month after month, the burn rate will go down. And for good reason – the company is getting closer to making money, which is what all this stuff is about at the end of the day. Burn rates can also go in the other direction if expenses are ramping faster than revenues or if there are no revenues. Burn rate calculations need to take into account the fact that burn rates aren't constant. If your burn rate is going up, from $83,333 per month to $100,000 per month, then the $250,000 you have left will not last three more months. It might only last 2 1/2 months. Assuming a constant burn rate can be very dangerous. Always know if your burn rate is going up or down and include that fact in your analysis.

Most startups burn money for a time. Some for only a very short time. But many for a longer period of time. During that period of cash consumption, it is critcal to keep a close eye on cash balance and burn rate and cash out date. It will tell you when you need to raise money again (at least six months before you run out of cash please!). And it will tell you how much you are investing on a monthly basis on your company. These are important numbers to know, to internalize, and to operate with.

#MBA Mondays