You don’t need to feel the burn, and neither do your investors!
Have you wondered what to expect during your seed funding or your late-stage funding? Burn multiple is a critical factor that investors are now focusing on, given the nature of your business and the growth stage that you are at.
Burn multiple highlights your business’s efficiency and management skills in controlling costs. Yes, investors do consider the stage at which your business is while deciding a suitable burn multiple, but there are thresholds to it.
This is especially true for software startups. Investors have to draw a line between high-growth startups and efficient startups. A company with a 300% growth rate but a cash burn of $20 million per year might not attract investor confidence. On the other hand, a company with a 200% growth rate burning only $10 million per year would be preferred by some investors.
If you are looking to raise capital at any stage of your business, burn multiple becomes critical for your efficiency and capital evaluation. Keeping that in mind, we have provided an in-depth guide elaborating on burn multiple, how to calculate burn multiple, and directions on how to improve it.
Burn multiple is a capital efficiency metric used to evaluate cost management and relative returns on such spending for a business. This all-inclusive metric includes every aspect of the business rather than looking at particular segments alone.
The burn multiple provides insight into how much revenue your business generates per dollar spent or ‘burnt’. This multiple goes beyond the net burn rate to reflect how much your business can generate by efficiently deploying the capital it raised.
The general rule of thumb here is that the higher the burn multiple, the higher is the cash expenditure of the startup for each unit of growth it achieves. Even though it might be acceptable at some growth stage of the startup, a high burn multiple is never ideal.
The importance of burn multiple increases manifolds during the times of economic crisis, when capital adequacy and efficiency is questioned thoroughly by the investors. Even though growth rate is always a favorable parameter for startups, burn rate and its multiple plays an equally critical role.
Burn multiple becomes a paramount criterion for startups during their funding rounds, as investors are on the lookout for higher returns in a feasible time frame. Companies that have a high burn multiple will find it hard to raise funds, irrespective of their growth stage.
Burn multiple becomes critical in assessing the product-market fit of a startup as well. A company with a lower burn multiple denotes that the market is pulling the product and there are lower operational and marketing costs. On the other hand, a higher burn multiple would signify that a company is pushing the product in the market, thereby bringing the desirability and the utility of that product in question.
Besides, the burn multiple also acts as a proxy for various other operational and financial metrics of a company. Following is the list of proxies that the burn multiple can signify:
The Burn Multiple formula is used in order to determine the amount of money that a company or a startup is spending so as to gain each incremental dollar of annual recurring revenue.
Companies using the software as a service, also recognized as SaaS companies, generally work on a business model that functions around multi-year contract or subscription services. In the case of startups of SaaS companies, burn multiple therefore becomes an essential part in order to achieve high growth. Here’s the formula for determining the Burn multiple:
Burn Multiple = Net BurnNet ÷ New Annual Recurring Revenue
Net Burn is calculated by finding the difference between total cash revenue and cash operating expenses, and net new annual recurring revenue is calculated by adding expansion annual recurring revenue with new annual recurring revenue and then subtracting churned annual recurring revenue from the derived result.
In order to calculate burn multiple, net burn is divided by the net new annual recurring revenue. If the result obtained is lower, it indicates that the burn multiple of the company is lower, which helps in concluding that the company is more efficient, compared to one which has a higher burn multiple.
If the burn multiple of a company goes below zero, it indicates that the company is cash
flow positive, i.e., the company has more inflow of cash in comparison with its cash outflow.
As per investor perception in the market with regard to startups, a Burn Multiple between 0.5-1 is considered as outstanding, a Burn multiple between 1-1.5 is considered as good, a Burn Multiple between 1.5-2 is considered as mediocre, a Burn Multiple between 2-2.5 is considered as Bad and Burn Multiple above 2.5 is considered as terrible.
Let’s say a startup or a company reports that they have burned $5 million in this quarter in order to generate $3 million in its annual recurring revenue. Hence after putting these figures into the Burn Multiple formulae, we would get the following:
Burn Multiple = $5 million ÷ $3 million
Burn Multiple = 1.66x
So, a Burn Multiple of 1.66x for a startup is recognized as a very good Burn Multiple as per the investors.
Another example of the same is, let’s say, a company reports that they have burned $10 million in one year in order to generate $5 million in its annual recurring revenue. Hence after putting these figures into the Burn Multiple formulae, we would get the following:
Burn Multiple = $10 million ÷ $5 million
Burn Multiple = 2x
So, a Burn Multiple of 2x for a startup is recognized as a mediocre Burn Multiple as per the investors; hence they will think twice about the efficiency of the company before investing in the company.
Once the burn rate or multiple is determined, the next step is to control it. There are various ways in which the burn rate or multiple can be controlled. Following are some of the ways that may help in improving burn multiple:
Fundraising is becoming highly competitive in an economically uncertain environment and investors are increasing their scrutiny with each passing day. This brings the focus not only on the growth trajectory of a company, but also the efficiency of the growth trajectory which acts as an important measure to a company’s performance. This highlights the importance of burn multiple and why it plays a critical financial, operational and managerial role for a company.
The startup ecosystem has evolved over time with investors learning from their mistakes and picking startups that offer more than just ‘scalability’ as their USP. Burn multiple provides a proxy for a broader operational overview of a business, considering various factors that provide a more holistic picture for the management and investors.
Even though burn multiples differ at different growth stages, they have become a reliable rule of thumb to measure a startup’s performance in different time periods and funding rounds.