It's a dilemma all startups face. You need to spend to grow your business, but if you spend at a higher rate than your revenue, you might end up burning through your available cash. You begin to wonder if you are overspending, and your investors start to get nervous. So what is the safe amount of cash burn for a startup?
Is It Necessary to Burn Cash?
For startups, this is almost always the case. It takes time to turn a profit, and most companies have to burn cash as they build their customer base and increase revenue. Additionally, burning cash can spur tremendous growth for a startup. This is especially the case when a company needs to quickly establish itself before its market becomes too competitive. However, for a company with limited revenue and no profit, there is a danger in spending too much of its cash.
Watching the Runway
Simply put, the runway is how long a company has until it runs out of cash to burn. For example, if your company has $750k in cash and is burning $25k a month, your runway is 30 months. The closer you are to the end of the runway, obviously, the less freedom you have to keep spending. You can extend your runway by increasing your available cash through investment. However, this requires you to prove that your business is worth investing in despite the current lack of profit. This is possible if your revenue is likely to increase substantially as a result of your spending, but finding investors who are open to this risk can be difficult.
How Much is Too Much?
This depends largely on the amount of cash a company has and its access to more capital, both of which affect the amount of risk it is willing to take. Venture capitalist Mark Suster offers some guidelines for startups to determine how much they can responsibly burn:
- Watch your runway. Avoid dipping below 6 months of cash in the bank.
- Be mindful of spending venture debt. Maintain open communication with your VCs regarding the level of burn they are comfortable with and the available options for more funding, if necessary.
- If you have cash, rapidly growing revenue, strong support from VCs, and are in a position to pull ahead of your competitors, increasing your burn rate can be a powerful move to expand your business successfully. In this case, keep a close eye on the market, advises Suster. Your ability to scale back quickly in response to changing market conditions affects how much risk you can take safely.
If you are a startup looking for financial advice or management, contact The Accountancy Cloud. We specialize in tech startups and will work closely with you to help your company achieve its financial goals.