“What is your burn rate?”
When angel investors ask this question, founders of investor-ready startups have the answer ready to go. Cash is the lifeblood of any business, and investors ask about the burn rate metric because they can use it to make a simple calculation that tells them how long your startup has to live, and how far any new investment will take you.
As a founder, you need to develop a clear understanding of your startup’s burn rate not only to be ready to answer potential investors, but also for planning purposes. Managing cash flow is one of the key success factors for any startup.
Burn rate for a startup is defined as how much money you spend each month to keep the startup alive. A burn rate calculation should account for all costs, including:
Direct Product/Service Costs.
Direct costs associated with monthly sales, such as cost of goods sold, partner or affiliate fees, and so on. Sales and Marketing Expenses. Estimated sales and marketing costs, including travel to customer sites, trade show fees, marketing costs, pay-per-click advertising fees, and so on.
Founder and Employee Pay.
Salaries and wages to keep everybody showing up early and staying late.
Keeping the Lights On.
Other ongoing expenses such as rent, utilities, insurance, and Web hosting fees.
Once you add the above expenses to find the monthly burn rate, you can evaluate how that compares to your startup’s cash position to figure out how long your startup can continue operating to try to achieve breakeven status (where the startup’s monthly gross earnings equal its total spending) and what the impact of any new investments might be. This is:
Months to Live.
How long the company can continue based on the current cash on hand plus monthly cash from operation divided by the current burn rate.
This graphic illustrates the months to live calculation:
One further factor influences the months to live outcome. If your startup is fortunate enough to have some monthly cash flow from customer sales (operational cash flow) then that cash contributes to paying the bills each month and ultimately adds to the number of months your startup has to reach the breakeven milestone.
It is also important to clarify with potential investors whether founders are deferring all or part of their salaries, and the current and future impact of any salary deferrals on the burn rate.
Keep an eye on your monthly spending and cash levels, and be prepared to discuss the details when courting angel investors. For more on startup burn rates and other angel investor hot buttons, check out our Startup Crash Course: Angel Funding