Burn rate says little about whether a startup is on track

In the first dot-com boom, many companies went public before they were profitable. Since you can only go public once, they had a finite amount of capital and a publicly known burn rate. Projecting that linearly allowed computing the company's death date. I had a site which did this.[1] It was surprisingly accurate. I used to get hate mail from CFOs.

Excessive burn rate led to the demise of basically good ideas such as Webvan, the first instant-delivery online retailer. Webvan, pushed by their investors, tried to operate in too many cities, and ended up with about 3% market share in 30 cities, instead of 30% market share in 3 cities. (The head of operations at Webvan went to Amazon, and is responsible for making Amazon a success in that industry.)

This time around, most startups monetize earlier, so we see less of that.

[1] http://downside.com/deathwatch.html

Paulg's recent tweet sums up the response to this [1]:

> If you're expanding too fast, don't count on your board to warn you. As VCs, kill-or-cure strategies serve their interests.

VCs like high burn rate companies, because they are beholden to VCs. So in the case that it does work out, the VCs will own a large percentage of the company.

If you are founding a company and hope for the company to be successful and generate some wealth for yourself, high burn isn't necessarily the right strategy.

1: https://twitter.com/paulg/status/584468037559918593

High burn rates serve VC interests. Not surprisingly this article was written by a VC. High burn rates make companies desperate for more cash on worse terms, diluting founders equity and control. High burn rates also indicate the company is shooting for the moon. VCs want unicorns, not just successful companies. They don't want your careful 100M exit of which you own 30%. They want a billion plus exit of which you own 5%. The former is far easier to achieve and most companies aiming for the latter burn out.

So basically, this article is entirely self serving. Surprise surprise. Listen at your own peril.

This is not a quality article.

Presumably, the author is responding to Marc Andreessen's comments here:

http://www.businessinsider.com/marc-andreessen-on-startup-bu...

However, the author has ignored the qualifiers and substance of Marc's comments. Marc specifically said, "behind the scenes, they're plowing through that money either on marketing, overhead, or some other expense, which results in high burn rates."

Marc is talking about companies like Pets.com blowing wads of cash on Superbowl ads. He's not talking about a company like Tesla spending a lot of money on battery innovation and other core research. I think Marc knows the difference between the "burn rates" of Pets.com vs Tesla.

I like the analysis but the headline is wrong, it isn't that burn rate doesn't matter, it does, it is that it doesn't tell you anything about the underlying company. So as an evaluation metric it is less useful.

That said, VC money is very expensive money, so getting the most out of it is essential. Being afraid to use it is self defeating, and taking it for granted is risky. But pretty much everyone knows that :-)

Burn rate is one of the few variables a startup can control. It matters. A lot.

I know burn rate can't be analyzed in a vacuum (how many variables can be?), and a high burn rate can be a good thing, but my guess is more companies fail (partially) due to poor management of capital than fail due to spending too slowly.

Are there many examples of the latter that anyone knows of, even if somewhat anecdotal?

I stopped reading when he said something about simple algebra proving his point, and then posted some nonsensical equation that involved the concept of "milestones per month" or something like that.

For those of us that lived through the first round of internet/investor blowhards and shady math[1] this style of article is depressingly familiar.

Although at least now when I read this kind of nonsense no trees are killed in its delivery, so we've got that going for us.

[1] http://www.amazon.com/Dow-36-000-Strategy-Profiting/dp/06098...

The author of the post - partner at an investment vehicle that invests in startups - severely damages the credibility of this post to me. Burn rate may not be something VC's care a ton about, in fact, one of the most common complaints I've heard about raising too much money is that the investors pressure you to spend it faster than you want or need to. For the startup, however, burn is one of the most important numbers to care about, since it determines how long you can live before needing to either raise more money or become profitable (or at least cash-flow positive).

The article misinterprets the Gurley/Andreessen warning call - high overall burn INDUSTRY WIDE is a fair cause for concern and indicator of sub-optimal investing/operating, both for individual companies and for the VC industry as a whole.

On this article's own terms, if everyone is burning like crazy, then it likely that companies in all four quadrants of the high/low execution/efficiency, which means there is bad burn going on.

If you are a company, this means time for self-reflection: (if you want to take the article’s framework seriously) which quadrant are you in? are you burning cash smartly or dumbly? Do you have framework for determining this? do you really believe your revenue can grow faster than your costs? are there places you can reduce cost? how much are you paying for growth in each of your channels, and which are actually worth it short and long term?

If you are a VC, it is time for portfolio-reflection and (if your portfolio companies are lucky) some hands-on portfolio-company coaching: is a company you funded raising again 6 months later (and was this planned…)? have you asked for a burn report and/or a path to profitability? does the board deck summarize the company’s return on spending and tie results to spending (not necessarily in $$ to $$ numbers, but to users, engagement, etc.)? do your CEOs know their main costs, both fixed and variable?

When $$ floods the early-stage market, both companies and VCs do not ask themselves these types of questions enough, and I think Gurley/Andreessen are trying to signal the industry to get more mindful.

As the article states, general advice won't apply to every situation, but I'd advise any startup that generates revenue to consider that their last round of funding is going to be their last. The startups that don't generate any revenue or very little revenue and have a exit strategy that requires them to be acquired or to get critical mass in order to exploit network effects are the exceptions.

It's great to fund growth by burning money, but once the company reaches a respectable size I'd make a plan for how to reach profitability and update it periodically. That plan might be as simple as ceasing all hiring for a year while the revenues grow enough to overtake costs.

High burn rate is good if you spend it on obtaining market share. The money influx will stop. The moment that happens -your revenue better be higher than your expenses.

The money influx won't stop, it will get worse over the next few years.

Consider the case of Europe. Negative yield curves but trillions in pension funds that need a positive nominal return (5% or so). If they invest even a portion of their portfolios in negative yielding bonds they then need to buy assets with growth potential to even it out, with PE and VC being the most attractive due to their illiquidity ironically.

This isn't like 00 when you could sell NASDAQ and buy US government bonds yielding 6.5%..

The thing I'd like the HN crowd to take away from the article is that spending money is fine if its being done prudently (or even what some might deem a little recklessly) to grow or build an asset. And in fact, if you have the rare ability to create value out of cash, you should do so. Being profitable is comparatively easy.

I disagree with the article because so many of these "unicorns" (yet another term underlining the neoteny and magical thinking of the Valley) aren't building the future. Building the future can pay off at VC-acceptable levels in the long term, but does not consist of huge-in-four-years-or-dead gambits.

It's true that, in the Valley, burn rate doesn't much matter. Your one job as a VC-funded startup CEO is to keep investors interested in you and happy. Throwing them expensive bones is better than throwing no bones. With the former, you may need to raise money in 18 months instead of 24, and they'll ask you a lot of questions about why the bone you threw them cost so much. With the latter, they fund your competitors, and then it's over because they've found a shinier, newer toy and, while you might want to switch stage to a sustainable lifestyle business that doesn't need VCs, in practice it's hard to do that in a company that was never built to last (and that probably couldn't withstand an "oops, we grew too fast" layoff) and because investors often won't let you hold growth to a sustainable rate.