Every business wants to grow. But how you grow is sometimes more important than how much you grow.
Instead of only tracking top line metrics like ARR and your growth rate, we’ve seen a shift in businesses focused on efficiency metrics.
Enter: burn multiple.
First introduced by David Sacks, Founder of VC firm Craft Ventures, burn multiple is a general measure of how effective a startup is at generating new revenue in relation to the amount of money it’s spending (burning through).
In this guide, we’re going to dig into the burn multiple metric, covering what it is, how to calculate it, why it’s important, common benchmarks, and how to improve your burn multiple figure to lift your chances of securing more funding.
What is Burn Multiple?
Burn multiple is a measure of capital efficiency.
Burn multiple measures the ratio between the revenue a company generates and the cash spent (burn) to generate that new revenue.
It’s not the only measure of capital efficiency, however.
Two common metrics used are:
- Hype Ratio = Capital Raised (or Burned) / ARR
- Efficiency Score = Net New ARR / Net Burn
David Sacks, the creator of the burn multiple metric, liked the second approach. However, as an investor and two-time unicorn founder, he found it more useful to flip the calculation to create a multiple rather than a percentage.
In this way, burn multiple focuses on evaluating burn as a multiple of revenue growth. That is, a 2x burn multiple means your company spends twice as much money than it made (e.g., you spend $2m to create $1m in revenue).
It follows, then, that a higher burn multiple means you’re spending more to achieve each dollar of revenue growth, and that a lower burn multiple is generally better and more desirable than a high one.
How to Calculate Burn Multiple
To calculate your burn multiple, you need two figures:
- Net burn
- Net new ARR (annual recurring revenue)
Then, the formula is as follows:
Burn Multiple Formula
Net Burn / Net New ARR
Pretty simple, right? Let’s illustrate how it works in practice with an example.
Let’s say your net burn for the previous financial period was $6m. During that time, you created $2m in net new ARR.
Your calculation looks like this:
Burn multiple = $6m / $2m = 3x
Shortly, we’ll discuss burn multiple benchmarks, which will put this example in context and help you understand the burn multiple value you should aim for based on your company’s age and stage.
Why Burn Multiple is Important
Burn multiple is a critical metric for a number of reasons.
The most important, and the reason why David Sacks invented it in the first place, is its use as a measure of product market fit.
Consider two companies that each created $1m in new ARR in the last financial year.
However, one burned $3m to create that, and the other spent only $2m. That means that while the companies are both growing at the same rate, they have different burn multiples: 3x and 2x, respectively.
The second company (the one with the lower burn multiple) is growing more efficiently and has likely established a more realistic product market fit. That is, customers are readily purchasing from this company without the need for significant investment in marketing or sales initiatives.
There are several other problems that can be identified based on a high burn multiple, though:
- Cost control issue. The most obvious cause of a high burn multiple is an issue with controlling costs. That is, the company is spending too much money to generate revenue, and needs to look for opportunities to cut costs.
- Gross margin issue. A high burn multiple might be a sign that a company is making a very low margin on its product or services, and either needs to cut costs or raises prices, depending on what is appropriate.
- Sales efficiency issue. A high burn multiple may be a sign that your sales team is inefficient. You’re spending money on salaries and equipment, but they’re not delivering the a significant return.
- Slowing growth. If your burn multiple is increasing across time, this could be a sign that growth is tapering off. This is somewhat natural in later-stage companies, but should be a cause for concern for younger startups.
- Customer churn problem. If new customer acquisition or high expenses are not the problem, the issue could be customers churning. If you’re losing nearly as many customers as you’re gaining, you’re simply filling a leaky bucket. This might indicate a problem with product, support, or sales qualification and fit identification.
Burn Multiple Benchmarks
Though every company grows at different rates and will have different requirements with relation to spending and revenue growth, the following are good guidelines for desirable burn multiples.
Ideally, then, you want your burn multiple to be at 1x or lower.
That essentially means that you’re generating more revenue than you’re spending on a dollar-by-dollar basis.
Of course, this isn’t realistic for many companies, with a 2x burn multiple being more commonplace (that is, a given company spends $2 for over $1 in new revenue it generates).
A burn multiple of 3x or higher is generally considered inefficient.
It’s worth bearing in mind here that, like with all rules, there are exceptions, specifically when we’re dealing with early-stage startups.
Newer companies are less likely to be operating profitability or generating significant revenue. To be sure, some companies are specifically operating pre-revenue (developing a product but still not selling it), and may continue to do so for some months or even years.
As such, it’s a good idea to consider your company’s age and stage when looking at your own burn multiple in relation to benchmarks.
How to Improve Burn Multiple
So, what happens if you calculate burn multiple and it’s higher than you’d like?
Here are a few strategies to improve your burn multiple.
The first and most obvious strategy is to look for opportunities for cost-cutting.
These might include:
- Reducing SaaS subscription count
- Cutting founder salaries
- Moving to a smaller location to reduce rent expenses
Create higher margins
One way to increase your net margins (and thereby reduce your burn multiple) is to find opportunities to charge more.
Assess market pricing and see if you can put headline rates up.
Additionally, consider how you might be able to offer extra services like onboarding and implementation or dedicated support to increase the amount of revenue you receive from each customer.
Reduce customer acquisition costs
Lastly, you might look for ways to reduce your customer acquisition costs (CAC).
Some common tactics here include:
- Identifying the most profitable revenue streams and focusing only on those
- Renegotiating or switching contracts with software vendors
- Temporarily reducing your spending on long-term marketing activities like content production
Burn multiple is an important metric for startups to track.
By constantly monitoring burn multiple, you gain better visibility into your growth efficiency, and can demonstrate to potential investors that you’re able to grow effectively without burning through cash quickly.
Build a powerful startup metric tracking dashboard with Finmark from BILL.
This content is presented “as is,” and is not intended to provide tax, legal or financial advice. Please consult your advisor with any questions.