Your burn rate is often the financial version of faking it till you make it. It can be impossible to grow a business to scale, or to much of anything at all, without using up money as quickly as you find it. But knowing the difference between needed and wasteful spending is crucial--and easier said than done.
The current startup climate doesn't encourage fiscal restraint: Companies like Uber and Airbnb have been generously rewarded with market share and growing revenue despite (or perhaps because of) their lavish burn rates. But we're starting to see high rollers falter: Consider the founders of the late housekeeping service Homejoy, who spent $40 million in venture funds only to discover they couldn't clean up in the on-demand economy.
It makes sense, then, that there's mounting debate in Silicon Valley and on Wall Street over startups' spending habits. Y Combinator president Sam Altman says more than a few founders make no distinction between necessary and unnecessary outlays. Cassandra-like warnings are multiplying from star venture capitalists, including Marc Andreessen, Bill Gurley, and Chamath Palihapitiya.
So when exactly should you start worrying about your spending? First, check your internal benchmarks: If you're missing your targets, consider yourself warned. "Businesses should burn cash only for specific reasons, like growing to a critical mass of users or getting a product to a certain stage of development," says Marc Prosser, co-founder of Marc Waring Ventures, an operator of specialty media sites.
One example of an unnecessary expense: fancy digs, no matter where you're located. "Companies should not burn through cash on noncore expenses like nice offices and perks," advises Miriam Diwan, a former portfolio manager and the co-founder and CEO of NowMoveMe, an online neighborhood-recommendation platform.
Yes, you may be competing with venture-rich companies that can afford luxurious offices, free massages, and an unlimited supply of fancy snacks and catered meals. But, as Diwan warns, you want to hire people who are motivated by more than free food. For young companies, "the employees looking for Facebook or Google levels of perks are not the best fit," she says. "The early years are a complete roller coaster, so it's essential to have a team that's in it for more than that."
Next, watch your reserves. Anything less than six months' worth of cash on hand should trigger an immediate spending reassessment. Wait any longer, and you'll almost certainly run out of money and be forced to close up shop. That almost happened to Dev Chanchani: Back in 2000, his fledgling tech company, INetU, was burning through about $100,000 a month. But he had $2 million in angel funding, which he thought gave him plenty of time to work out the kinks in his business. Until, that is, that tech bubble burst, and his lines to future financing dried up.
Chanchani credits his company's survival to his father, who had urged him to plan for a potential cash crunch. He shut down two of his company's three businesses to focus his remaining funds on its more promising hosting services, and laid off 40 percent of his staff. "You need a clear line of sight between every dollar you burn and the growth in the business," he says now. (Chanchani and his investors sold INetU late last year.)
That's a lesson smart founders of this generation of startups are taking to heart. Just ask Jody Porowski, co-founder of online-advice website Avelist, which she funded by selling her North Carolina home. Her mentors want her to spend on hiring marketing and business development staff. But Porowski is waiting until she gets venture backing, or starts bringing in more business.
"I do believe in spending money to make money," she says. "But I realize how hard it is to actually raise money. As a pre-revenue company that currently runs off investment, I want to stretch our funds out as long as possible."