Over the past couple years at High Alpha, I’ve worked with many startups on creating and setting their first financial plan. Some common questions I hear: Is it okay to spend this much? Can we afford this new hire? What’s our budget? I’ve found that before landing on a budget and a plan for cash burn, it’s helpful to first consider a few important questions.
But… two things to note before we get started:
- I’m talking about pre-revenue, pre-product-market-fit companies in this post. Usually pre-seed and seed stage, when you’re still figuring out what your company will look like.
- This comes from the lens of venture-backed technology businesses, in particular software. However, most of it can be applied to all startups.
So… How Much Should Your New Company Burn?
I’ll admit I’ve googled “what’s a good burn rate for startups” in the past. One reason it’s hard to know the answer is that a new startup doesn’t have the constraint of profitability. Unlike a more mature company, you aren’t trying to spend less than you collect in revenue. But you likely do have a cash constraint, and you should anchor your budget around your current cash balance and when you’ll be out of money. About 4–6 months before you’re at cash-zero, you’ll need to start fundraising, and you want a good story to tell investors at that time. Which is why before you can actually determine the right burn rate, you need to decide:
What Are Your Goals?
In particular, what are your goals for this current amount of cash in the bank? What needs to be true about the business when you’re going out to fundraise next?
Set realistic goals, and be aware of what milestones other startups have crossed before raising a certain round of funding. Know what you’ll need to create a compelling story based on your product and business model.
- Is it a product targeted to the individual that could have some virality? Maybe a freemium pricing model? You probably want an MVP with some great usage stats to show potential investors.
- Is it a B2B product targeting a specific vertical? You’ll need some revenue from your first handful of customers, proving you can sell into the space.
- Is it a big-vision product that will take a lot of resources to build? Spend your current funds validating the idea and testing assumptions about the vision, making sure you’re building something the market wants before you put too many resources on it.
Budgeting is about resource-allocation, and determining your near-term goals will help you decide how to allocate your current resources most effectively. Time and money are at conflict with each other in your budget — if you want more time, you have to decrease your burn rate. You may realize you need to spend on certain resources to meet your goals, and spend a little quicker. Or you’ll determine that you want more time between now and cash-zero, and decide to hold off on the extra hire. Either way, it’s a balance. And to find the right balance you need to know:
What Are Your Assumptions?
This is really where you should start when setting your first budget. At this early stage, likely every detail about the future of the business is an assumption.
The more assumptions you still have to prove, the lower your burn rate should be. Take the time to test those assumptions before using up cash resources. As you gather more truths about your business, you can start increasing your burn in order to move faster. What version of an MVP should you start with? Who is your target customer? What go-to-market strategy will work? Budget the resources to test and experiment. Flexibility is key — don’t hire too many full-time resources and commit to a high burn rate before you’ve proven the foundation of your business. Finding product-market-fit always takes longer than you think it will.
Be especially careful about forecasting your first revenue. This can extend your runway, but if things don’t go to plan, it will leave you out of cash sooner and missing your goals.
Because there are so many assumptions, your budget should be re-evaluated often (quarterly, if not monthly) in this early stage. The amount you learn in a startup in one day can be enough to drastically shift your assumptions and goals, and the quicker you can adjust resources, the better.
I love working with company founders to strategically deploy resources to execute their vision, and I’ve learned that every startup is different. If you have other tips or angles you’ve found helpful to consider, please comment!
