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Cash is the oxygen of startups. Without it — you die. This is why business money management is crucial.
The most valuable asset of almost all software startups is human capital, it also happens to be the most expensive. I just ran the numbers for our company, Visible. For every dollar we spend at Visible, 85 cents goes towards a human salary. If you were to include things like office space and the tools we need to get our jobs done it is much closer to 97 cents.
For the purpose of this post, when I refer to a startup I’m talking about a company that is very asset lean (physical assets, inventory, capital investments, etc) that is building some sort of software.
At Visible, we typically get these questions around burn and headcount:
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How do I calculate burn? How do I calculate runway?
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What should I be burning per employee?
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How can I reduce burn while I try to nail product/market fit?
Related: Learn small business financial management for free.
How to Calculate Burn Rate and Runway
Calculating Burn:
People express their burn in many different ways.
Your burn rate is the difference in your cash on hand between periods (usually expressed in months).
— Visible (@VisibleVC)
Today we are going to try to standardize it for startups: Your burn rate is the difference in your cash on hand between periods (usually expressed in months). If you had $500,000 in cash on June 1 and $450,000 cash on July 1 your burn rate would be $50k per month.
Burn = Start of Reporting Period Cash Balance — End of Reporting Period Cash Balance
In June you may have had $20k in revenue but $70k in expenses netting you out at $50k in burn. If you wanted gross burn that would just your cash out the door so $70k.
Calculating Runway:
The “simplest” way to calculate runway is to take your cash balance and divide by your burn rate. In the example above you would have 9 months of runway with a cash out date in February.
Runway (in months) = Cash Balance / Burn Rate
However, you may want to exclude large one-time expenses like legal fees. I’ve also seen companies take the average of their last three months of burn to calculate runway. No matter what you choose, you’ll want to make sure you calculate it the same way each time. This was it is an easy comparison when you are talking to investors, employees, and other stakeholders.
What Should My Burn Rate Per Employee Be?
The most common burn rate number that is thrown out is $10k per employee per month.
— Visible (@VisibleVC)
As with most things in life, there is no easy answer here. The most common number that is thrown out is $10k per employee per month which is a “fully burdened” cost. Fully burdened includes things like rent, benefits, travel, etc. in addition salary.
Fred Wilson explains more in his post, “Burn Rates: How Much?” However, that post was penned in 2011 and costs have gone up across the board. In Danielle Morrill’s post, “Is My Startup Burn Rate Normal?” she states their full burdened burn is $16,666 per month (removing revenue). The post also points to a lot of real examples and self-reported burn rates from entrepreneurs, so be sure to check it out!
How to Reduce Burn in an Early Stage Startup
When you are an early stage startup, your biggest enemy is the clock until you have product/market fit. You want to do everything possible to extend your runway.
Below are a couple tactical ways you can reduce you burn until you find product/market fit:
1. Lower salaries in exchange for equity.
This is definitely the most common and why startups have always been sexy. Take a below market salary, get equity and, hopefully, you hit it big someday. However, I’ve started to see startup salaries on the rise because of the sheer demand for talent and money flowing into startups.
We’ve found a way to counter some of this at Visible. Everyone at the company is probably making half of what they would make at a larger corporation. If someone takes a lower salary, they are truly committed to the company and excited about their work.
As much as I want everyone to stay hungry, I also don’t want to lose great people because they are concerned about personal cash flow. To counter this, I’ve told everyone once we’ve raised our Series A (product/market fit), we will all be brought much closer to market rates, but in the meantime, everyone is incentivized by a nice equity grant.
2. Carefully monitor your commission structure.
If you employe salespeople, you should not pay out commission until your salesperson has covered their yearly cost. If a salesperson can’t cover their cost why even have them?
Another trend I’ve seen is not even having a commission structure for early sales hires but that they should be incentivised by equity (see above). Commissions structures would start once you have a specialized sales team member (e.g. Sales Enablement or Sales Ops) and predictable revenue.
Most of your early sales hires will be sourcing leads, selling and servicing the customer they won’t solely be focused on selling. I actually buy into this because you want every dollar going back into the business at your earliest stages.
3. Think globally.
They are many talented people outside of our own city or country. Remote cultures are growing in popularity and there is definitely a movement happening in the “nomadic” lifestyle.
Successful companies like GitHub, Buffer, Zapier, Formstack, Automattic and more have successfully built remote teams. Remotive is a great resource for tapping into the remote community.
In my experience, remote workers typically command a lower price point depending on where they are in the world. They also will take a lower salary in exchange for the flexibility of working when, where and how they want. However, you can’t just flip and switch with the expectation of building a remote company or being able to support a couple of remote members. It needs to be built into your DNA and something you have to invest in.
Get the entire story in our #smallbiz_expert Twitter interview w/ Mike!
Keeping an eye on burn is one of the key vitals of your company. It’s important to always monitor it and make adjustments when necessary.
This blog post is brought to you by Mike Preuss, CEO and Co-Founder of Visible.vc – an app that helps great entrepreneurs more effectively manage their investor relationships and updates.
