Startup Burn Rate Explained
Burn rate is the amount of money you’re burning or losing over time. This is an industry term that you can use in any company. However, the burn rate for startups differs on a few key factors.
Startups don’t usually generate income in the first few months. This makes burn rate much more important to understand for the startup to survive. Ultimately, your goal is to generate and maximize your income. But you need to be smart about how you spend your money in the first phase of your business.
In the beginning, you should keep track of your burn rate when your startup becomes profitable. You can already include income on your burn rate and balance your expenses.
Importance of Burn Rate
Calculating the burn rate is one of the first things you should do when drafting your business plan.
1. Survivability
Knowing your startup’s burn rate is important for your company to survive the first few months before it starts generating income. The biggest concern among startup businesses is running out of funds before your company becomes profitable.
By knowing your estimated burn rate, you can also calculate how much money you need to fund your expenditure. You need to pay for the most important costs first and start growing your business once your company is afloat.
2. Attracting Investors
Funding a startup with a great concept can become a lucrative business for investors. However, the risks are also higher. Remember that startups rely heavily on investors for their capital. Since investors are spending money on your company, they need to be reassured that your company won’t collapse in its first few months.
This is where calculating and balancing burn rates can help you attract investors. No matter how good your idea is, your startup won’t attract investors if your burn rate is not balanced. A smart investor will prefer funding a startup business that might not generate the highest income but has a higher rate of success based on its burn rate calculations.
Remember that investors are risking their money when they decide to fund your business. It’s important to show that you will be able to manage their money well and ensure profitability as early as possible.
A startup’s burn rate should be indicated in the business plan presented to the investors. If they think that your business will be profitable in the long run, they won’t mind a few months of not generating any income.
On the other hand, startup businesses that don’t take burn rate into account are a red flag for investors. It’s too risky for people to put money into a company that might not even survive the first phase.
3. Being Profitable Sooner
The first few months might be the toughest for your startup. However, once your company starts to become profitable, it’s easier to maximize your income. If you underspend, you might not be able to get profitable on your target date. This might be a reason for your company to fail before it even started generating income.
Aside from using your money for important expenses such as overhead costs and salary, you also need to buy the right tools and equipment. This ensures you are able to improve your business as quickly as possible.
Improving Burn Rate
If your startup’s burn rate is too high, you might risk going bankrupt before even earning any money. It is in your best interest to ensure that your burn rate isn’t too high. On the other hand, you don’t want to deprive your company of some of its funds just to ensure a low burn rate.
There is a balance you need to maintain where you’re using your investor’s money to improve the business while also spending little to ensure survivability. First, you need to include the necessary expenses such as the location, equipment, and salary.
Then, you should use the remaining money to optimize workflow which can help speed things up. If you fail to fund these two types of expenses, you might risk delaying profitability. If you can cut costs to improve other aspects of your company, you should consider it.
Ultimately, if your startup business succeeds, you will have more room to expand your business however you desire.
Are you looking for startup funding? Contact us. Peak is an early stage venture capital company.