Burn rate refers to the rate at which a startup spends its venture capital in order to cover overhead before positive cash flow is generated from operations. It’s a common metric startups and investors use to gauge how long a company can keep operating before it becomes profitable or needs to secure additional financing.

Startups must pay attention to their burn rate. Where other metrics might speak to how their business offering is performing with audiences, burn rate indicates the sustainability of the business itself—with 32% of founders in 2023 reporting that they worry about burning too much cash. Below, we’ll discuss what startups need to know in order to understand their burn rate, why it matters, and how to improve it.

What’s in this article?

• How to calculate burn rate
  
• How startups use burn rate
  
• How investors use burn rate
  
• How to manage and reduce burn rate
  
• Benchmarks around burn rate
  
• How burn rate changes at different funding cycles
  
• Long-term consequences of a high burn rate
  

How to calculate burn rate

In order for businesses to manage their burn rate, they first need to know where it stands. Let’s take a look at how to calculate the two main types of burn rate.

Gross burn rate

Gross burn rate is the total amount of cash a company spends each month. This includes all operational costs such as salaries, rent, utilities, marketing, and any other expenses.

Calculation: Total Monthly Cash Expenditures = Gross Burn Rate

For example, if a startup spends $50,000 on salaries, $10,000 on rent, $5,000 on utilities, and $15,000 on marketing in a month, the gross burn rate would be:

$50,000 + $10,000 + $5,000 + $15,000 = $80,000 Gross Burn Rate

Net burn rate

Net burn rate provides a more nuanced view by considering the company’s revenue. It shows the net amount of cash the business is losing each month.

Calculation: Total Monthly Cash Expenditures - Total Monthly Revenues = Net Burn Rate

For example, if the same startup earns $20,000 in monthly revenue, the net burn rate would be:

$80,000 - $20,000 = $60,000 Net Burn Rate

How startups use burn rate

Here’s how burn rate factors into strategic planning and valuation for startups:

• Resource allocation: The burn rate helps startups see where they’re spending money. Burn rate shows which parts of the business are using up cash too quickly, allowing businesses to adjust their spending to focus on what promotes growth.

• Investment strategy and valuation: The burn rate helps investors assess a startup’s runway and funding needs. A startup with a shorter runway may face valuation pressure during fundraising due to the increased risk of cash depletion. Conversely, a sustainable burn rate can increase a startup’s valuation by demonstrating careful financial management and a clearer path to future milestones.

• Growth strategy evaluation: Experts analyze the burn rate in conjunction with growth metrics such as customer acquisition cost (CAC), customer lifetime value (CLTV), and revenue growth to gauge the effectiveness of growth strategies. A high burn rate might be justifiable in the context of swift growth and market capture, but if growth metrics are also low, it could signal a flawed business model.

• Future planning: Startups use the burn rate to plan for various future scenarios. Knowing how different situations could affect their cash allows them to be prepared and make smart choices no matter what comes their way.

• Signal to market: The burn rate serves as a signal to the market about a startup’s maturity and strategic positioning. A decreasing burn rate coupled with increasing revenue, for example, can signal a successful scale phase and attract partnerships and more favorable investment terms.

• Hiring and salaries: The burn rate affects decisions on hiring and salaries, determining how much startups are able to pay people without running out of cash.

How investors use burn rate

When investors examine a startup’s burn rate, they’re looking for insights beyond just the number itself. Here’s what the burn rate tells investors about a startup:

• Timeline: Investors look at the burn rate to figure out how long the startup can keep going before it will need more money. If a startup is spending its money too fast, it might run into trouble soon. A slower rate of spending shows that the company can keep going longer without extra funding.

• Financial skills: The way a startup spends its money shows if its leaders are good at making financial decisions. A high burn rate might mean the company is spending too much without good reason, while a balanced burn rate suggests the company is smart about its spending. Investors like teams that spend money wisely to grow the business.

• Growth trajectory: Investors want to see that the money the startup spends is actually helping it grow. If a company spends a lot but doesn’t grow, that’s a bad sign. But if the company grows well with reasonable spending, that’s a good signal for investors.

• Valuation: If a startup is likely to need more money soon because it is spending too much, investors might think it has low worth. A company that manages its money well could be worth more.

• Market strategy: Investors use the burn rate to see how the startup is trying to position itself in the market. They want to know if the company is spending money in a way that makes sense for its specific goals, such as gaining more customers or growing fast in its industry.

How to manage and reduce burn rate

Startups should always know their burn rate and actively work toward lowering it. Here’s a list of ways to manage and minimize your business’s burn rate:

• Accelerating revenue: Focus on strategies to increase income such as finding quicker paths to market for your products or improving sales processes. More revenue can balance out the burn rate and extend financial runway.

• Reviewing spending: Regularly review expenses and assess the value you’re getting in return. This means looking at all costs—from software subscriptions to marketing campaigns—and evaluating whether they’re effective in contributing to growth.

• Hiring strategically: Prioritize roles that directly contribute to growth or revenue, delay nonessential hires, and consider part-time or contract positions to fill gaps without the commitment of full-time salaries.

• Optimizing operations: Continuously look for ways to make operations leaner. Automate repetitive tasks, improve supply chain operations, or find more cost-effective ways to produce your product or service.

• Forecasting finances: Assess future financial scenarios to anticipate and prepare for potential cash shortfalls. Knowing how different decisions or market conditions could affect burn rate allows startups to make more informed choices.

• Monitoring key performance indicators (KPIs): Keep a close eye on KPIs that directly impact the burn rate such as customer acquisition cost and lifetime value. Identify areas that need improvement and adjust your strategies accordingly.

• Adapting the business model: Sometimes, reducing the burn rate may require more fundamental changes such as adjusting the business model to focus on more profitable products or services, or shifting to a subscription model for more predictable revenue.

• Cultivating financial discipline: Develop a culture of financial discipline and cost-efficiency within the organization. Scrutinize every dollar spent for its potential return on investment.

• Using technology and innovation: Adopt new technologies or innovative approaches to reduce costs. Using cloud-based services can reduce the need for expensive hardware, while embracing remote work can reduce office space costs.

• Funding strategically: Manage when and how to raise additional funds. Secure capital before it’s needed to prevent having to raise money under less favorable terms—which can adversely affect the burn rate and dilute ownership.

Benchmarks around burn rate

Not every type of startup will have the same burn rate; burn rates can vary depending on several factors. Here’s a quick look at software-as-a-service (SaaS) burn rate benchmarks from OpenView’s 2023 SaaS Benchmarks Report to give you an idea of where some businesses tend to fall.

How burn rate changes at different funding cycles

The burn rate of a startup tends to evolve across different funding cycles—reflecting the company’s growth stage, objectives, and market conditions. Here’s how the burn rate typically changes from one funding cycle to another.

• Seed stage: At this early stage, startups are usually focused on product development, market research, and establishing a customer base. The burn rate might be relatively low, as the team size is small and expenses are mostly confined to product development and initial market testing. However, since revenue is often negligible or nonexistent, even modest expenditures can constitute a high burn rate relative to the company’s financial reserves.

• Series A: By the time a startup reaches Series A, it’s expected to have a validated product and some early traction. The focus shifts toward scaling the product, enhancing the team, and expanding market reach. The burn rate typically increases as the company invests in hiring, marketing, sales, and further product development. The expectation is that these investments will fuel growth, which in turn should start to offset the burn rate over time.

• Series B and beyond: As startups progress to Series B and later rounds, they are generally expected to scale operations, expand in the market, and maybe even pursue global opportunities. The burn rate can escalate during these phases due to substantial investments in workforce expansion, marketing and sales efforts, international expansion, and possible acquisitions. At these stages, revenue growth should ideally keep pace with or exceed the increase in burn rate, moving the company toward profitability or at least a path to it.

• Post-IPO or late stage: Once a startup reaches late-stage funding or goes public, the scrutiny on its burn rate intensifies from public investors and stakeholders. The focus often shifts toward achieving profitability, improving operations, and demonstrating sustainable financial health. The burn rate is closely watched and there may be pressure to reduce it, especially if the market conditions are challenging or if the company is not meeting growth expectations.

Throughout these stages, external factors such as market conditions, investor sentiment, and broader economic trends can also influence a startup’s burn rate. In a booming market, companies might ramp up spending to capture market share quickly, while in a downturn, the focus might shift toward conserving cash and lowering the burn rate.

Long-term consequences of a high burn rate

A high burn rate can lead to several long-term consequences for a startup. Here’s what can happen if a company consistently spends more than it earns without a clear path to profitability:

• Depleted cash reserves: The most immediate risk of a high burn rate is the potential to run out of cash. If a startup cannot achieve revenue growth or secure additional funding, it may run out of money—leading to layoffs, downsizing, or even shutting down operations.

• Additional funding not secured: Investors are typically cautious about funding startups with a high burn rate unless there is a viable plan for achieving profitability. A history of high cash burn without corresponding growth can deter investors, making it difficult for the startup to raise new funds on favorable terms.

• Reduced company valuation: A high burn rate can lead to reduced company valuation during fundraising rounds. Investors may perceive the company as risky, which can result in lower valuations and greater dilution of existing equity holders.

• Forced strategy shifts or pivots: To manage a high burn rate, a startup may need to make abrupt shifts or pivots, which can disrupt product development, market positioning, and customer relationships. These changes can dilute the company’s brand and core value proposition.

• Operational constraints: A persistently high burn rate can force a startup to cut costs in areas such as research and development, marketing, and employee growth opportunities. This can hinder innovation, slow down growth, and negatively impact company culture.

• Loss of talent: Skilled workers may be hesitant to join or remain with a startup that has a high burn rate. Losing key talent can further impair a startup’s ability to execute its business plan and innovate.

• Increased pressure and stress: High burn rates can create a stressful environment for the team, with increased pressure to perform and constant concerns about job security. This can affect productivity, morale, and the overall well-being of the employees.

• Reduced sustainability: A high burn rate puts the long-term sustainability of a business in question. If a startup cannot adjust its spending to line up with realistic growth projections and a path to profitability, it risks its long-term viability.