A frequent topic: “What is my burn rate?” Investors frequently talk about potential target companies in terms of their burn rate. When funding start-up companies, investors try to determine the potential target’s burn rate.
Burn rate is the rate at which a company will use its capital to finance operations before generating positive cash flow.
It is usually expressed on a monthly or quarterly basis and is a measure of how fast a company will use up its cash.
For example, a company with a burn rate of $1 million per month will exhaust $12 million in capital in one year, obviously. Burn rate is synonymous with negative cash flow.
This is of importance to investors because it helps them to determine if a company will be sufficiently capitalized with their investment and how long their investment allows the company to operate before becoming cash flow positive.
If an investor feels that their capital infusion is not enough to sustain operations for a long enough period, they will naturally assume that your company will require more financing in the future.
When burn rate is more than anticipated or sales are less than anticipated, companies usually respond by reducing burn rate, which generally means cutting expenses associated with overhead.
Accordingly, investors will look at your company from the standpoint of being able to reduce burn rate in the event that actual performance does not meet expectations.
For early-stage companies’ cash is king.
Managing cash is one of the most important duties of an entrepreneur. Cash required for growing sales usually precede the receipts of cash from those sales.
The lack of cash diverts management attention away from running the business and can disrupt operations as bills become more difficult to pay.
Therefore, the sophisticated investor will take a very close look at a company’s burn rate, the underlying assumptions and the ability to reduce burn in the event of sluggish sales.