Burn Rate – What? Why? How?

So now you have a startup with a cool product and you are ready to launch your product in few days. That’s amazing, Bravo. But, what’s your burn rate?  Hmmm, what are you talking about!!! The Burn Rate is the amount of money you are spending every month to sustain your business. They call it Burn Rate because in Tech startups most of the money is actually spent in salaries and not in buying assets. That’s if the idea didn’t work everything is burnt, you’ll not have any assets to sell to recover your initial capital as opposed to other type of businesses that involve asset purchase such as restaurants, grocery shops or car shops.

Burn rate

Let say you are a team of 3 people and you started a company called The 3 Amigos and your family invested US$50,000 in your company and you agreed on the following:

1- Everyone will get paid US$1,000 per month to work full-time in the startup

2- You’ll rent a small office that costs US$500

3- You’ll hire a great part-time designer and pay him US$500 each month

4- You’ll spend US$1,000 on marketing and sales every month

5- You’ll spend US$250 each month on cloud storage and technology

6- You’ll have a budget of US$250 that you can spend in other stuff that is not mentioned above

So what is your burn rate in this case?? Your burn rate will be = (1,000 x 3) + 500 + 1,000 + 250 + 250 = US$5,000 per month. That means the US$50,000 you have raised will support your business to survive for 10 months  (50,000/5,000). Now that’s assuming you don’t make any revenue during this period, which is usually the case for most startups.

The most important number that you should have your eye on is how much money you have in the bank. Forget about the income statement and the balance sheet and focus on the simple cash flow statement, how much cash is out and how much cash is in and how much money is left in the bank. 

Another number that you should understand is your break-even point. Let say on average you make US$50 in revenue per sale, then how many units you need to sell to break-even? That’s a 100 unit per month (5,000/50=100). In summary you are burning US$5,000 per month and you need to sell 100 units to cover these expenses.

Usually in startups salaries are the biggest expense representing between 60-80% of total expenses. Moreover, the amount is also highly dependable on the place you start your business and the stage of your startup. Starting your business in Silicon Valley is much more expensive than doing it in Kuwait. And of course the more mature your startup the more employees you’ll have and the higher the burn rate. Fred Wilson previously posted a great post titled “Burn Rates: How Much?“. In short, he created a role of thumb of burn rate based on startup stage:

1- Building product stage: A team of 3-5 people building the initial product. Burn Rate < US$50,000/month

2- Building Usage 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. Burn Rate < US$ 100,000/month (Hire more engineers and community manager)

3- 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. Burn Rate < US$ 250,000/month (Hire management, finance and operation people)

From a personal experience, I think for our case (the Middle East) all numbers should be divided by 8 or 10. So I’ll recommend keeping it in this range with the following time frame:

1- Building product: Burn rate = US$5,000 to US$10,000/ month for 16-18 months

2- Building usage: Burn rate = US$10,000 t0 30,000 /month for 12-18 months

3- Building business: Burn rate = US$40,000 to US$80,000 and increasing with time

In summary, every entrepreneur should know his burn rate because that’s a number every investor will ask you about and without knowing it you might run out of money without realizing. You should also know your Break-even point to have a better sense on how far you are from sustain your business from your own revenue.

Note: I’m no expert, the above is just my opinion and I’ll be happy to hear everyones feedback.

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