What is burn multiple?
Burn multiple is a capital efficiency metric that measures how skilled an early-stage startup is in generating revenue using its cash. This term was coined by David Sacks, the cofounder and general partner of Craft Ventures. It is a measure of capital efficiency that evaluates the burn rate of a SaaS startup as a multiple of revenue growth.
SaaS Metrics monitors the balance between growth & operational efficiency. There are many good SaaS metrics, such as customer acquisition cost (CAC), churn rate, annual recurring revenue, customer lifetime value (LTV), and cash conversion score.
But, now, one metric that has become significant to operators and investors- burn multiple. In this article, we'll discuss everything you need to know about the Burn multiple metric. Keep scrolling and reading to learn and find a way to balance growth with the efficiency of your business.
Understanding burn multiple
burn multiple is a tool you need to understand to do more competent cash management. Investors, the new customers needed, and Venture Capitalists use this burn multiple metrics to evaluate a company's worth and efficiency. The higher burn multiple means the company is less efficient at achieving pre-revenue growth, meaning the company has a terrible burn multiple. Conversely, the lower burn multiple shows that the startup's growth is efficient.
A seed stage company or a later stage company whose burn multiple is too high will find it difficult to fundraise. Therefore, low burn multiple is preferred, and the companies try to keep it as low as possible. The concept of burn multiples applies to SaaS early-stage Startups/venture-stage startups as they offer subscription services.
Furthermore, every action you take in your business impacts burns multiples, unlike the efficiency scores such as LTV/CAC ratio. These efficiency scores just focus on sales and marketing, not on the functioning of an entire business. Thus, startups with good burn multiples are capable of withstanding a market downturn and have more runway. Every company needs to have burn multiple benchmarks. This enables them to adequately monitor their burn multiple progress.
Comparing burn multiple to other SaaS metrics
Burn multiple highlights effective expansion, a trait valued by venture capitalists. Capitalists that prefer to give money to those who would use it in a way that increases the value and reduces production costs and wastes work well with burn multiple measures.
Additionally, burn multiple is advantageous to SaaS founders for additional factors. Burn multiple provides you with an approximate response if you're trying to gauge how well your product market fits or even how effective your client acquisition program is. It simply offers a guarantee that when your business makes investments, it will see long-term growth.
Burn multiple formula
The formula of burn multiple is the ratio between net Burn and net new ARR (new Annual Recurring Revenue).
How to calculate burn multiple?
The founder and partner of Craft Ventures, David Sacks, generated a burn multiple net efficiency formula to consider growth within economic downturns. David Sacks was inspired by two measuring capital efficiency: The Hype Ratio and Bessemer's Efficiency Score.
Sacks flipped the numerator (net new ARR) and denominator (net Burn) of the efficiency score as an annualized hype ratio and called it a burn multiple formula. As an annualized formula, you can calculate a company's burn rate monthly, quarterly, or yearly, and this gives a full view of the company's capital efficiency. To further help companies, reasonably good rules are devised for guidance when dealing with burn multiple. A company following rules would hardly suffer downturns.
This particular rule is simple; the more company is burning to achieve the unit of growth, the higher the burn multiple. On the other hand, efficient growth results, delivering later stage growth in lower burn multiple.
What do venture capitalists look for, and how do they measure product-market fit?
Venture capitalists measure the quality of product-market fit by using the burn multiple. The startup report that hits $2 million in Annual Recurring Revenue by burning $4 million is more appealing than the one that generates it by burning $10.
VCs invest in rapid-growth companies where they can make returns quickly. If the growth factor is not so fast and efficient, they're not interested in investing there. During these times, net margins and burn rate are key indicators to assess growth. Hence, startups with a higher burn rate than their growth are not attractive to investors. They are most times forced to immediately cut costs, relieving the company of extra expenses.
What is a good burn multiple?
David Sacks provides the following chart for venture-scale startups to tell what a good burn multiple is for an efficient growth startup. He categorizes the score to guide what is the desirable burn multiple. This general rule of thumb applies to high-growth SaaS companies.
1 - 1.5 x
1.5 - 2 x
2 - 3 x
Moreover, different stages of growth also come in factors to consider the burn multiple. As your business grows, burn multiples should decrease. So, it is essential to examine this metric within your growth stage and ensure you catch all metrics!
How can you improve burn multiple?
It is possible to lower your burn multiple in many ways. Let's take a look at some ways to grow more efficiently.
- Improve your gross margins
- Lower the CAC and improve the sales and marketing efficiency
- Create a market-fit quality product
- Do Revenue Forecasting & Scenario planning frequently
Frequently asked questions about burn multiple
1. How is burn multiple best explained?
A capital efficiency statistic called burn multiple provides insight into how much pre-revenue you're making per dollar burned by taking a comprehensive perspective of your company. It goes beyond multiple net burns to demonstrate the effectiveness with which the funds from investment rounds may be used by your company to produce revenue. Although, a decreasing net burn rate will also have its effect.
When compared to other efficiency rankings, such as the LTV/CAC ratio, which considers only the number of sales productivity and marketing operations, your Burn multiple will be impacted by the decisions you make in every area of the business. Understanding your burn multiple enables you to extend the runway by making wiser cash management decisions, which is crucial during periods of a market downturn.
2. What is the burn rate equation?
When you have a cash flow statement on hand, the burn rate calculation is simple. The equation is as follows: (Starting Balance - Ending balance) / the number of months equals burn rate.
3. What is considered a good burn ratio?
Most business owners and professionals advise always having at least a few years' worth of the runway. Therefore, a healthy burn rate is roughly one-twelfth of your cash on hand. In light of this, a burn rate of roughly $50,000 would be ideal if you had $600,000 in available cash.
4. What is the best way to determine the burn rate for SaaS?
It is computed as a business's revenue less all of its expenses or its loss. As an illustration, suppose that your SaaS company generates $50,000 in monthly revenue, spends $60,000, and has a multiple net burn rate of $10,000.
If you've read this far, you probably work as an executive for a SaaS company and have a genuine interest in the level of the analysis presented here. The primary lesson to take away from this essay is that there are numerous approaches to optimize a SaaS business, Burn rate being an approach. This article seeks to clarify the many levers and how they may eventually impact the major objectives of profitability, cash flow, growth, and market share. You must first measure the variables and track their evolution over time before you may pull those levers.
Additionally, you must establish a heavily focused culture on metrics, which can only be done from the top. The CEO must use these measurements in board meetings with her team, with the executives with whom she consults, etc. Because of the way that people are wired, if you show them a measure, they will naturally want to make it better. True operational efficiency excellence will result from such a culture and hopefully great success.