Your first job as an early stage startup founder is to get your first customer. Your second job is to stay alive so you can get the next one.
Blowing Money Fast
So you’ve raised your first round of funding, huh? It’s tempting to see all that cash in a previously empty bank account and start spending money on everything you wanted before you got startup-rich.
I’ve always kept my personal burn low because it allows me to do what I want to do, not what I have to do.
Capital efficiency is freedom.
For some startups1, capital efficiency can mean the difference between being able to negotiate your next round of investment from a position of strength versus needing to accept terms that are less favorable than you want so that you don’t run out of money.
In the early days of your startup, you should be using money to build a lean, mean, product building and selling machine. What you spend money on is just as important as how much.
Is your monthly burn helping you build faster/better or fueling growth?
No investor wants you to cut costs to the point that you slow growth and can’t reach important milestones. But being efficient with capital means being smart about how and where the money is being spent.
Here are some of the wrong things I’ve seen early stage companies spending money on:
- An expensive PR agency before you’ve even found product-market fit
- Being top-heavy on well-paid ‘executives’ — staff who aren’t engineering or front line sales
- Paying market rate salaries instead of off-setting lower cash compensation with equity
- A marketing agency who manages your customer acquisition spend…and that growth knowledge leaves when they do
- Expensive outsourced tech teams that don’t live in-house
It’s really hard for an early stage investor — VC or angel — to invest in those companies. I’ve met founders where I’ve liked the team and product, but when I find out what they’re burning capital on and how much, they become a much less attractive investment.
Burn Baby Burn
The first step to being capital efficient is to understand and constantly track your burn rate and runway. Here is a simple way of thinking about burn rate and runway.
burn rate: the amount of money your startup spends every month
If you spend $60,000 per month and your startup’s monthly revenue is $10,000 per month, then your monthly burn rate is $50,000.2 [MonthlySpend-Revenue=(Net)Burn]
runway: The number of months of cash you have in the bank before you run out of money (at the current burn rate)
If you have $500,000 left in the bank and your monthly burn rate is $50,000, then you have 10 months of runway. [Cash in Bank/Monthly Burn=Runway]
Burn rate and runway are important because it helps you (and your investors) understand the health of your business and most importantly — when you’ll run out of cash, how quickly you need to start raising your next round of funding, and whether you have the metrics to do so.
You should be keeping your investors constantly informed on your burn rate and runway. These are the numbers I want to see in a regular update email — even if it’s bad. The amount of help you can get when you have 6 months of runway is very different than if you don’t raise a flag until you have 2 months of runway.
I’m naturally drawn to founders who have managed to build product and find their first customers with limited resources. If you can build something and show early wins without having raised a lot of money and you can keep that same capital efficient energy, you’ll be better positioned once you do raise money.
But whether you raise venture capital or not, you have only one job…to not die.
1For the purposes of this post, I’m specifically talking about to startups who have shipped early product and raised an initial round of funding, but probably haven’t yet found product-market fit.
2I chose these numbers to keep the math simple, but it opens up the question: is this an acceptable burn rate? It depends. It depends on what you’re trying to do, the type of company you want to have, how much you want to rely on venture capital, and how expensive that capital is. If I saw a company with this burn rate to revenue ratio, it’s a conversation opener. I’d have a lot of questions around where the money is being spent, when you started booking revenue, what kind of revenue this is, and what the MoM revenue growth has been.
Finally, my friend, Mike Sigal, does a great talk on not running out of money — You’ve Raised Money, Now Don’t Run Out of It (SlideShare)