As conversation around the tech correction heats up, many of the conversations have focused on "burn rates."
What Is A Burn Rate And Is A Burn Rate Bad?
Those in startups (especially venture funded ones) with exposure to the p&l, will be very familiar with the notion of a burn rate. The term is a euphemism for how much a company loses (generally expressed as a monthly amount). Along with their burn rate, you will also hear companies refer to how many months or years of cash they have remaining at their "current burn rate."
A high burn rate is not necessarily a sign of a bad company. Many companies today and in the past would have run out of money had they not sold, had investors continuing to write checks, or exited to the public markets. This includes Amazon, YouTube, and Twitter. The vast majority of companies, though, won't be as fortunate to have seemingly never ending funding to see the vision out to profitability as Google did with YouTube.
A seemingly never-ending supply of money is nice when it happens, but it is a very precarious position in which to put yourself. And it is simply not a realistic position for the vast majority of stratups, even though many are essentially binary bets for their investors. That is, the investors either expect it be a big winner or go to zero.
The burn rate conversation is focused not on the odds of a successful outcome but changes to their spending habits that keep the company at bat longer and less likely to need to go back to the till, which if predictions hold true, will be drier than it has been and as such a rude awakening for many.
Moving Away from the Burn Rate Conversation
While I run a startup and have invested in more than two dozen (don't tell that number to my wife!), as I'm not a professional investor, I am in no position to offer guidance on what one's burn rate should be. Instead, I would like to reframe this conversation in a way that almost anyone could identify. And that is by focusing on revenue, specifically customer concentration.
Although obvious, I think it is still essential for every company, especially young ones to understand their customers as much, if not more than their expenses. A simply way to do this is to say, what happens if we lose our top two? Our top five? It is important for a company to know how many companies make up 10% of its revenue, 20%, 50% and so on.
The next step beyond having a grasp on one's revenue concentration is to understand the companies that are spending with you. This is what many didn't understand or see coming during the 2000 internet crash. They might have had many customers. The problem, though, was that all of the customers were the same. It is equivalent of owning many stocks but all in the same sector, such that any sector changes will impact your entire portfolio more than the market as a whole.
A commonly referenced statistic is that 75% of venture funded companies fail. If one's clients are all venture funded, you might be in a position to lose 75% of your business. Even if your clients beat the odds, they might still view you as non-core to their spend. That was certainly the case in the early 2000's. Seeing the carnage pile up, traditional brands and agencies pulled back on all digital spending, hurting all digital companies. That could very well happen again. If big brands decide that spending on social should be tweaked (i.e., cut), even if they cut budgets by 5%, it will mean billions in lost revenue for the ecosystem.
We have seen huge investments - both by investors and companies as clients. There is clear value and amazing things happening, but it doesn't mean that there aren't potential points of exposure. Understanding those points of exposure - both expenses and income - is a first step to being ready as a company for any changes.