Burn Rate refers to the amount of a money a start-up is losing, generally on a monthly basis.
Q. Well, this is a real classic from the startup world, right?
A. Yes, indeed. It refers to the amount of money a startup is losing. Two usage tips: 1. if you just use the phrase by itself you normally mean “per month”. 2. It is not the expense rate by itself, a common misunderstanding; it takes into account revenues and so describes how quickly a startup is burning through the money in the bank.
Q. And the most obvious thing that tells you is how much longer the company can go without new capital.
A. Yes. Aside from the many obvious reasons that’s important, it shows you how distracted management might become by running around doing raises… startups that are in constant fundraising mode usually lose focus on executing the basic business plan.
Q. OK, so we clearly don’t want to see any near-term funding crisis on the horizon, but what else can we learn from the burn?
A. It puts the focus on the question of how clear the revenue model is… is the company going to become self-sustaining soon? Of course, this is a fundamental question, almost a religious issue, among VCs: does a startup have to have a clear revenue model before it gets funded? What if you think you see the next YouTube… should you jump in, even if there’s no revenue model? All I can say about that is: from my own point of view, if you’re not a VC or professional angel investor, I’d stay away from startups like that. Don’t try that at home.
Q. But does the startup have to actually be generating revenues, or just have a clear plan to do so?
A. Ideally, as an angel investor, you’d like to see some very basic proof of concept of the model. If you try to wait till the whole thing is fully robust, of course, the entrepreneur won’t need you anymore. But on the other hand I was at breakfast just the other day with a very famous entrepreneur who joking about how much easier it can be to get investor checks than customer checks.
To me, for folks just getting into startup investing, the prudent thing is to invest what you might call “very early growth capital”, dollars that are being used to scale something that already has a bit of demonstrated customer demand. Not massively proven, but some sort of uptake, even if very small. Because then, even if the entity does continue with a high “burn rate” and must raise money later, it’s much more likely to be able to.