An entrepreneur, irrespective of whether he/she is planning to go after venture capital or not, needs to be familiar with the term burn rate. While the term is associated with valuations and raising capital for one’s venture, it also forms an important aspect of the bottom line of their business with or without the availability of VC money.
The current trend of declining valuations and increase in time to raise funds has led the startup industry to conclude that the best way to survive right now is to begin raising funds early and always be cautious of having too high a burn rate because that could end up decreasing the amount of runway that the business would have until it would need more cash to run.
But the toughest question that entrepreneurs have to answer for themselves is, “What is the right burn rate for their company?” While no one can put a specific number on it, one can surely arrive at a ballpark figure based on the following factors.
How Much Time is it Taking You to Raise Capital at Your Stage in the Market?
The thing here to understand is, the earlier the funding round, the less amount of capital you require and the more reasonable the valuation the less amount of time is generally needed to raise money.
When it comes to earlier-stage capital, there are a number of capital sources available. Also, the data on which the evaluation of the investment takes place is very less and the risk of the investor getting things wrong also gets diminished. When a startup is looking to raise larger funding rounds, a more serious “due diligence” takes place. This includes: looking at the company’s financial metrics, calling its customers, doing cohort analysis, evaluating the company’s competitors positioning and understanding about the company’s executive team’s competency.
Recent trends have shown that a majority of the deals nowadays get done in a short period of 2–3 months or even shorter and that stands true even at the earliest stages.
So, the main lesson here is to always remain cautious, begin early, get to know the investors before you need the capital, do your own research on who is more likely to be a good fit for your business and make yourself understand that fund-raising is a 24×7 part of your job, and not something you just have to do for 2-3 months every year during the “fund-raising season.”
Who are Your Current Investors?
A company’s burn rate has a direct correlation with its existing investors. The entrepreneurs should always have open conversations with its investors and know about their comfort levels and also the level of support they’re most likely to extend to the company going forward.
This is mainly because if your company has a strong lead investor who has a market reputation of always having the back of his or her entrepreneurs in the tough times and that investor agrees to give you comfort by writing you your next cheque then your company can end up with a higher burn rate than if you don’t have a strong lead investor in your kitty.
If your company mostly has angels or you don’t feel that your existing investors will be able to support you without any new outside capital then you might want to land yourself a smaller burn rate.
Are Your Current Investors Over Their Skis?
Do a thorough research of your investors, and evaluate if their pockets are big enough to bail you out in case of difficult situations. This means, you must have a decent sense of your existing investors’ capacities in relation to your company.
How Strong is Your Company’s Access to Capital?
While focusing on existing investors is one way of talking about “access to capital” because if you already have VCs in your kitty then your company has “access.” And then you’re just trying to assess whether you will be able to land new VCs or whether your current VCs will be capable of helping you in tough times.
In this case, “access to capital” is being majorly used in the context of fund raising because it can become an important determinant of your likelihood of raising capital.
If your company has successfully raised angel money and maybe has some capital courtesy seed funds that aren’t that popular in the market — then your company’s access to capital may be less strong than you anticipated.
How Complicated is Your Cap Table?
Entrepreneurs often end up ignoring Cap Table issues. The advice here is to openly have a chat with all your VCs or maybe at least with the ones that you trust the most.
What is Your Risk Appetite as an Entrepreneur?
It is almost impossible to assess a company’s right burn rate without having a proper knowledge of their risk tolerance. To put it simply, while some companies are willing to go at it hard and accept any consequence if they aren’t able to succeed. Other people might tend be more careful and have a lot at stake if the business doesn’t pan out successfully.
Assess your company’s burn rate and keep in mind that the burn rate should be in line with your: Access to capital and risk tolerance levels.
How Reasonable Was the Company’s Last Valuation?
Take into account how reasonable your last valuation was. If you are able to raise $1 million at a $4 million pre-money on a limited revenue company and if your investors are constantly telling you that they’re very concerned about your future because they are doubtful that outsiders will be able to fund you at the level you’re currently performing then you have to be more careful about your burn rate — even if it results in slashing of costs.
The problem can be solved by the following four solutions problem:
a) Try confirming inside support to continue funding — even if outsiders won’t pitch in
b) Cut burn rate enough so that you’re eventually able to grow into your valuation
c) Try to adjust your valuation down proactively so that outsiders are still able to fund you at what the market thinks is a normal valuation for your stage and performance
d) Go at it hard and keep your fingers crossed that the market will eventually end up validating your innovation even if the price is higher than what the market might be wanting to bear