The article was updated on July 17, 2024.
Most tech startups are highly vulnerable to financial volatility. Up to 80% of new companies fail early on, with cash problems as the main contributors. Recent data indicates that even promising startups have faced bankruptcy due to unsustainable spending.
Unsurprisingly, much of early success and ability to achieve stable growth depends on how the business puts cash into its operations. Although some startup owners are aware of handling their expenditures, it’s not an innate skill. That’s when the burn rate comes into play.
Due to the rapid market changes, startup burn rate is one of the most critical factors tech startups should prioritize. Burn rate can highlight a startup’s financial achievements, its strategies to manage money, and prolonged success. Startups hoping to contribute to their economic security and demonstrate their attractiveness to investors would benefit from monitoring burn rate.
Let’s explore burn rate definition, what a good burn rate is for a startup, and how to reduce cash burn rate.
Defining startup burn rate
What does burn rate mean?
So, what is the burn rate in business? Simply, it’s the amount of cash a business spends and the pace at which it does so. Burn rate in startups indicates what amount of money a company uses up within a specific timeframe (typically a month). It enables businesses to stay in touch with how much money they have left before running out, which is called a startup runway.
Such a move allows the company to evaluate its next steps and plan its operations. For example, the burn rate for a tech startup highlights the priorities for its apps or services it should prioritize or eliminate.
The importance of monitoring burn rate
Monetary restrictions and high risks in tech make tracking the burn rate for startups a smart move. Here’s a short overview of how businesses can turn cash burn rate evaluation to their advantage.
Financial planning
Startups don’t become profitable immediately, but financial success is their end goal. While it can take up to a few years for a startup to earn revenue, keeping an eye on the situation is beneficial. In fact, a new study indicated that first-year financial statements can predict future startup success.
The burn rate in a startup demonstrates whether an enterprise burns cash faster than it earns it, so managing the burn rate indicates what operations or expenses might be too much. Similarly, tech brands with different products can limit their portfolio or market expansion if they’re overspending.
Operations and risk management
Business owners perform in a rivalry that stimulates their performance and research & development measures. Tom Loverro warns startup CEOs that startups are entering a “mass extinction” and should become more aggressive, adopting performance-based budgets.
Today, the importance of monitoring burn rate reaches beyond cash management and becomes a subject of changing product strategy. Comparing their burn rate to other startups in similar market conditions can be a wake-up call. Instead of indicating a dead end, a comparably higher burn rate might facilitate productive and creative solutions.
Investor confidence
Investments are expected to get scarce, so businesses are increasingly pressed to deliver the startup profitability within two years. Witnessing a high burn rate can be a dangerous signal to investors that their contributions might be in danger.
Tech startups often compete for investors, so it will also determine their future financial appeal.
Performance sustainability
To reduce your technology startup’s burn rate, you should focus on activities that make the most sense. It means targeting long-term solutions and getting rid of ineffective projects or strategies. Such changes may be painful at first, but they will drive a business on a lucrative path with employees focused on the essentials.
How to calculate your burn rate?
Let’s move to calculating cash burn rate now that the basics have been handled. Below, we’ll cover two types of burn rate.
Gross burn rate is the total amount of cash a business spends in a specific time period, usually a month. This analysis doesn’t account for revenue that a startup has gained during the same time. It includes all operations, such as rent, employee compensation, utilities, and any other costs associated with its performance.
Investors typically look at this indicator to make predictions about where a startup is going. To illustrate, if your cloud computing services company has spent $70,000 in a month on all the operations, it’s your gross burn rate.
Net burn rate includes the revenue a company has made during the month. Calculating it requires checking the difference between monthly cash outflows and the monthly cash inflows. So, if the company mentioned above spent $70,000 but earned $30,000, the net burn rate would be $40,000.
The average burn rate in startups
Knowing how to calculate burn rate enables businesses to compare their brand with the industry median. Diverse factors, such as the stage level, market, size of the company, funding, and its strategic business approach among others affect the average burn rate for startups. A single average for any industry does not exist. However, businesses can search for statistics in their narrow startup group.
For example, SaaS companies have a $50,000 monthly burn rate average if their annual recurring revenue is no more than $1 million. This rate grows with the recurring revenue and size.
Here’s what to consider when comparing your startup’s financial performance with others:
- Stage. Every stage impacts how much cash the company burns. For instance, during the seed stage, also called a prototype period, an enterprise invests in emphasizing its business model. Still, it’s also relatively low in cash burn because the team is typically small. When the brand enters a series A stage, on the other hand, its growth can still trail behind its expenses. Its further maturation to series B and further will also alter how the cash burn manifests itself.
- Industry. Every industry has its own list of constituents impacting the pricing of each brand. To illustrate, tech startups often require less money compared to, let’s say, biotech due to having significantly less equipment.
- Revenue generation. Startups with steady revenue streams can offset their burn rate, reducing their net cash outflow. However, it can affect the desire of the brand to expand its operations, which leads to overtrading and overwhelming business capacity.
- Location. Countries with higher living prices have significantly higher expenses to work with, which affects the cash burn rate. More so, startups that operate in countries where the specific talent pool is too narrow might want to spend more on salaries or outsourcing, especially because salaries can make up to 50% of all spending.
Tips for reducing your startup burn rate
How to reduce startup burn rate if it’s higher than your industry average? Of course, every startup has its limits, but there’s much that can be done regardless. By reducing your outflow costs, you can prolong your runway and position your company for growth.
Outsource
Hiring a remote development team is a great way to cut unnecessary expenses when building a high quality product that requires a fast time to market. Outsourcing offers a number of benefits:
- lower cost – Eastern European developers have significantly lower rates, while maintaining the same level of quality, as compared with local US or European developers;
- reduced administrative burden – you won’t need to worry about an office or equipment as your remote team typically comes fully equipped by the provider;
- increased flexibility – you can grow your team if needed and add any skills you require.
A dedicated development team is the most beneficial cooperation model when working with an outsourcing company. It proves to be especially efficient for ongoing projects: It offers transparent and predictable budgeting, which allows you to keep track of your burn rate and adjust it if needed.
Go agile
The ability to identify the concepts that won’t work and pivot quickly is crucial for any startup. It is even more so for a startup that wants to reduce its burn rate.
Building an MVP first and testing the waters before going “all in” is a great strategy for avoiding unnecessary expenses that might skyrocket your burn rate.
Moreover, the agile project management approach offers more flexibility in terms of resources management. It allows you to apply lean principles, cut waste in the development process, and thus reduce your burn rate.
Read also: Agile Offshore Software Development: Best Practices
Focus on core activities
Reducing the burn rate of a technology startup begins with identifying your critical actions and strategies. Prioritize only those areas that have financial benefits or will enhance product development. For inspiration, Daniel Martinez wrote that his team moved from spreading itself too thin and poured money into the product with a proven track record.
A tech startup would benefit from investing in technology architecture, innovation, or customer acquisition. You can cut a bit on HR, marketing, or legal activities. As a result, this strategy will foster resource organization and help the brand remain competitive without overspending.
Focus on customer acquisition and retention
Until the business reaches a stable milestone, it should seek the best opportunities to attract clients. Finding unexplored markets is one of the most challenging yet rewarding ways to reduce cash burn rate. Just to give you a few ideas: according to Forbes, urban farming, bioprinting, and neuromorphic engineering are promising areas for tech startups.
A high return on investment will reduce cash burn, but tapping into such a market requires connecting with the client base. Using digital marketing, including SEO or data analytics results, will target the desired customer segments.
In the face of decreasing client service quality, customer support can be a winning ticket to build brand loyalty. In the long run, brands with a strong client base will have a stable inflow of revenue to reduce cash burn.
Invest in scalable technologies
Scalable technologies and infrastructure grow and change with your business. Opting for cloud-based services often gives startups flexible pricing and scalability without upfront capital investment in hardware. The cloud-based software market will grow exponentially: Flair predicts that it will reach up to $22.9 billion by 2033 due to its agility and cost-efficiency.
Automation mechanisms and streamlined workflow can address two problems at once: workers’ focus and future orientation. Startups benefit from helping their employees to concentrate on high-impact activities. Moreover, adopting an automated system now simplifies future adjustments to practices and operations.
While the upfront expenses of scalable technologies may seem daunting, they prove cost-effective over the long run. When adapting in the future, your business will improve burn rate during the adaptation and growth processes, meaning your startup won’t struggle with managing expenses during its ensuing growth.
Focus on ROI
As a startup you should only invest in those initiatives and tools that guarantee good ROI. Choose the products that will make your team and processes more efficient.
With all the SaaS tools available for startups, it is difficult to choose 2-3 offerings that will yield the most benefit. However, the truth is, the SaaS model does not always offer the best price for value. Sometimes you might be just fine with a freemium model, especially if you have a small team.
Lots of great startup tools are mostly free, for example Slack, Trello, Skype, Google suite, Gitlab, mobile analytics, (including Google Analytics and Flurry) as well as many marketing tools. In case your startup is already profitable, you should reinvest all your revenue to make your product even better.
Manage your expenses
To be able to reduce your burn rate, you first of all need to keep track of your cash flow and analyze major expense sources. By knowing exactly where your money goes, you can eliminate those unnecessary expenses and put your funds to better use.
Supplier negotiation and the decrease in overhead cost might be smart steps to approach. For example, you can establish long-term partnerships including flexible prices in exchange for contract exclusivity or early payment.
Procurement Tactics highlights that a 1% supplier price reduction can result in a 4% profit boost. Business owners should also consider less expensive workspace alternatives, including remote work arrangements, to minimize spending on rent, utilities, and other costs.
Read also: 7 Ways to Reduce App Development Cost
Grow at a rate you can manage
Uncontrolled growth can do more harm to your startup than a lack of growth altogether. While your burn rate identifies your runway (the amount of time you have before you run out of money), any unplanned growth spurt will make your runway shorter. Unless you can get more funds fast, you should be able to control your startup growth rate.
Final word
Businesses that learn how to improve burn rate do more than just raise revenue. Cutting expenses on non-core activities and targeting features that drive sustainable growth are keys to success in a competitive market. By considering startup cash burn, enterprises transform their advancement into an ongoing and flexible process unique to them.
Launching a startup is hard. We hope these tips will help you manage your burn rate better and avoid running out of money. If you’re interested in outsourcing software development services, contact us and get a free consultation on your project.
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About the author:
Oleg Roberman, Chief of Delivery at Eastern Peak
With strong technical background and outstanding project leadership skills, Oleg helps Eastern Peak customers introduce competitive advantages and instill productive changes in every process by resolving complex business issues and managing multicultural teams through innovation and creative thinking.
