How to avoid a scary burn rate

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Do not approach an investor if your startup has a sub-optimal burn rate, or they will disappear from your sight.

According to CB Insights, running out of cash is the second most common reason why startups fail. Therefore, private equity investors (with fewer liquidity opportunities than public equity investors) run away when they see companies with unattractive characteristics.

Let’s back up a bit for newbies.

What is a burn rate?

Basically, it’s how much money you’re spending on a monthly basis.

There are two types: gross (spending) and net (losing). Gross burn rate is the sum of all your fixed costs on a monthly basis, while net burn rate adds up your revenue to calculate how much money you need to put into the company to cover the losses.

One of my life maxims (along with “get rich or die tryin'”) is this: “Tell me what your burn rate is and I’ll tell you who you are.”

Let me be clear first: A high burn rate isn’t necessarily a bad thing, especially if you’re able to execute and achieve the proposed milestones.

It’s all about justification and proof: Is your burn rate high? Yes. Are you achieving results because you’re investing heavily, and therefore it’s justifiable? No? Then, you do have an issue.

Now, is a low burn rate always good? No. But it relies on the same dilemma: profit vs growth.

The convenience store down the street is in black numbers already. But profitability at low scale does not mean a thing to most VCs. Red numbers do not scare VCs; it’s part of the job and it’s actually necessary to achieve high-growth companies.

However, there are also red flags: when the expenses stop making sense and those red numbers portray only over-the-top salaries, office luxuries, and worldwide trips without real strategic purposes. Something like this:

Essentials

Rule of thumb

Moderate hiring

Remote teams

Equity – not cash – is king

Runway

Optimize working capital

The PR myth